Stock Market Volatility
February was a wild month in the stock markets, and we all witnessed a resurgence of volatility in the markets. This weeks blog focuses on market volatility, and in particular looks at the difference between a market correction and a bear market. I also discuss the actions you can take in your own portfolio to minimize the risks during volatile market conditions.
A market correction is when a stock, bond, commodity or index fall 10% or more (but not more than 20%) from their recent highs. The market correction that occurred in February was officially labeled a correction on February 8, 2018. On this day the Dow Jones Industrial Average (DJIA), and the S&P 500 were down more than 10% from their recent highs, which were reached in January 2018. Market corrections occur during bull markets (characterized by rising security prices, and general optimism and confidence in the markets), and are typically temporary events.
However, the market correction that took place in February 2018 happened faster than any other market correction in history. Namely, the 10% correction took place in just a matter of days, compared with past corrections, which typically occurred over a period of two to three weeks. So what was normally an event that occurred over a few weeks became an event that happened in 3-4 days. Yikes! The speed of this correction took everyone by surprise!
Bear markets are the polar opposite of Bull markets, and are characterized by widespread pessimism in the markets. During a Bear market, security prices fall 20% or more from their recent highs, and more and more investors sell their investments out of fear of ongoing losses in the markets. Essentially, a bear market can be characterized as widespread fear in the markets. The last bear market in recent history was the financial credit crises, which started in December 2007 and ended in March 2009. During the credit crisis the Dow Jones Industrial Average lost over half of its value from August 2007 to March 2009. That is pretty wild!
Factors Involved In February 2018 Market Correction
Two major factors played a role in the February 2018 market correction:
1. It is anticipated that the Federal Reserve in the United States is looking to increase interest rates 3 to 4 times in 2018. Higher interest rates have a negative impact on the stock markets, as it serves to cool the markets. Also, the anticipated rate hikes will have a direct impact on the U.S. 10 year Treasury bonds. Which, as of March 2, 2018 was at 2.855%.
2. Also, it appears that Low Volatility Funds played a role in the rapid market correction that took place in early February 2018. Namely, these Low Volatility funds, which are managed by Artificial Intelligence, where triggered to sell once the markets reached a certain level. Unfortunately, the sell orders on these funds were triggered all at the same time, which negatively impacted the markets. It is reported that one of these Low Volatility Funds was down as much as 90% from its recent high, at one point.
How to Protect Your Investment Portfolio
Here are a few ways you can protect your investments when the markets are volatile:
1. Sell Risky Investments
If you currently hold risky investments in your portfolio (small cap, high beta, high debt investments), this is the time to trim your position in these types of investments.
2. Build Up Cash Reserves
Super-investors, like Warren Buffett, are holding onto large cash reserves, and you should too. This is the time to be patient and start building up the cash portion of your portfolio.
3. Hold Onto Fairly Priced and Valued Investments
This is the time to hold onto quality large cap investments that you purchased at a great price, and that have still not realized their full value.
However, if you currently hold onto investments whereby the price of the investment is much higher then the underlying value of the company, then it may be time to sell that investment, and capture your gains.
The tide has officially turned on the markets, and volatility is playing a major role in the markets in 2018. The time to buy and hold investments without paying any attention to them have passed. These markets require you to pay close attention to them, at every given moment. If you fail to pay attention to your investments during times of volatility, you may be in for a huge shock! Also, get ready to buy great company's when the markets start taking a nosedive. However, only buy quality investments when they are at the right price, and the companies are fairly valued.
If you do your homework, and position yourself correctly, you will be able to capture life-changing profits, in particular when markets are volatile. By purchasing stocks when they are deeply discounted, and avoiding stocks that are much higher than their value, you will be able to realize incredible gains, and build incredible wealth!
Wishing you many great returns!
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