How to make the most of market volatility
Published in AFR.com - October 2011
By David Potts
Volatility is a constant feature of the sharemarket during good and bad times. And there is plenty happening around the world to keep markets unsettled.
Data from Vanguard going back to 1950 shows the sharemarket’s rolling returns plus dividends can move between minus 41 per cent to 86 per cent in just one year. In fact, volatility in the past decade up to the global financial crisis was abnormally low.
“Volatility is more normal now and we should expect it,” says Vanguard Investments principal Robin Bowerman. He adds the best and worst trading days also tend to cluster together. “The October 1987 share crash had six of the worst and five of the best – so if you weren’t in the market in October 1987 you took a long-term hit.”
Advisers say we should grin and bear it. And they have a point about not selling shares when prices have been marked down irrationally.
Others say stay on the sidelines, cashed up.
“We think things will get worse before they get better,” says Thornton Group senior financial planner Ben Woolvett. “The time to re-enter the market is when deposit rates fall into the threes.”
But it’s also possible to turn volatility to your advantage without being glued to a computer screen.
Day trading in this market is almost certainly counterproductive. Traders need a clear trend. At the same time, the traditional hedge for a share portfolio – using put options that let you sell your stock at a certain price, or going short with futures contracts – may not be worth the cost, especially for long-term shareholders.
The more volatile the market is, the more expensive put options become, adding 10 to 15 per cent to the cost of the shares, says Dale Gillham, chief analyst at share education and investment company Wealth Within.
They also need careful watching because their value decays as they approach maturity.
Options over the S&P/ASX 200 Index would be better value, especially for a large portfolio. “Even so it can be cheaper just to use stop losses,” Gillham says. “When you buy, put in a stop-loss (at which you sell no matter what). The golden rule is let profits run and cut losses short. It’s as simple as that.”
Although trying to time the market is frowned upon by most experts since it usually boils down to luck, a former head of the NSW Treasury, Percy Allan, is showing impressive results with his website markettiming.com.au which was set up in 2010. In a similar way to charting, it picks up market signals from various moving averages.
Allan says it’s “a risk-management rather than a get-rich scheme”.
US-based TimerTrac calculated the active and conservative (no more than three trades a year) strategies as returning 18.75 per cent and 17.83 per cent respectively in the year to September 2, when the market went backwards.
“It’s all about probabilities and is slow trading, so it’s not as risky as being a day trader – 80 per cent of whom lose money,” Allan says. “It’s running profits and cutting losses.”
The conservative strategy has been showing a sell signal since May. Rebalancing a share portfolio, where you might sell some stock that has become a disproportionately large holding and buying more of another that is too low, can be very effective in a volatile market.
The price spikes are selling opportunities and the dips can be cheap buys. If nothing else, rebalancing is a good test of why you’re holding a stock and whether anything has changed to contradict your original preference for it.
