3 Ways to Reduce Effects of Market Volatility

Instead of being a victim of stock market volatility a value investor can take advantage of it to increase investment returns. The value investor must be able to think the opposite, or contrary, to what others are thinking; particularly when there is a large majority or consensus on an investment.

Technology has increased the ability to trade assets worldwide and disseminate information and knowledge instantly. But what hasn’t changed is investor reactions and human emotions to the information received. The result is markets react stronger and quicker, creating large price swings; particularly in a stock market crash or secular bear market.

Stock Market Volatility Leads to Portfolio Volatility

Very few investors understand how stock market volatility eats away at your returns. If you haven’t read my post on portfolio volatility you may want to read it now. It’s an important investment concept. The simplest way I can explain it quickly is that if you have a 50% gain and a 50 % loss you have an average of 0% or break even. But you have actually lost 25% of your portfolio!

How to Reduce the Affects of Stock Market Volatility

1. Employ Fundamental Value Analysis

The kind of stock market volatility you really want to avoid is downside volatility. All major market tops coincide with high valuations. This makes fundamental value strategies an important part of investing. These tools can guide you away from over priced investments that are prevalent at market tops.

2. Have a Maximum Drawdown Plan

Have a maximum drawdown policy as a part of your risk management plan. A large part of your asset allocation strategy should be based on how you will manage and minimize a portfolio drawdown. It is large portfolio drawdowns that destroy your long term returns.