Entrepreneurs – Don’t fear volatility, embrace it!

By Giles Coghlan, Chief Currency Analyst, HYCM

At the beginning of the year, I spoke regularly in the media about what big events investors and traders need to be aware of as they map out their investment strategies for 2020. Based on what was happening at the time, I mentioned the potential of rising regional instability in the Middle East, the UK’s withdrawal from the EU and the US presidential election.

Underlining these observations, I made a clear and concise point – in trading, nothing is certain. Investors must always be prepared for the unknown and recognise that volatility is an inherent part of the financial markets. Portfolio growth is achievable, but it is by no means linear.

Jump forward to May 2020, and a virus originally discovered in Wuhan, China has triggered a global health crisis. Governments are trying to contain the pandemic through social distancing measures, and the race is now on to find a vaccine. Those earlier trends I identified in the New Year no longer seem as critical, for the moment at least.

The impact of COVID-19 on traders and investors

 

The impact of COVID-19 on the financial markets has been profound. From commodities and currencies to stocks and shares, there have been sharp gains and losses as investors scramble to restructure their portfolios and weather the immediate financial shock brought on by the pandemic.

In times like these, many investors and traders are understandably worried; there is much uncertainty surrounding the current health crisis. The question, therefore, is what should investors do? In my mind, they have two choices.

The first is to hold onto their existing assets and hope that any loses will be recuperated as part of the post-pandemic market recovery. By prioritising liquidity and security over short-term returns, investors can minimise their risk exposure and ensure loses are kept to a minimum.

The second option appeals to the more bullish investor: rather than holding on to their existing assets, they radically restructure their financial portfolio, sell underperforming assets and take advantage of short-term opportunities by reactively buying and selling. It is an aggressive trading strategy that typically brings greater risk – furthermore, it can only be successfully undertaken for those who have an acute understanding of specific financial markets.

Determining the best approach will be informed by each investor’s individual circumstances. Importantly, any decision must be shaped by one’s long-term financial objectives. Do you want a portfolio driven by growth, value or income? Answering this key question will likely dictate which is the most appropriate of the two options outlined above.

Look at the past to anticipate the future

 

No one can ever truly predict how markets will perform in a month, a week or even a day from now. There are simply too many factors affecting how different events will impact different assets. However, by looking to the past, we can observe how the markets have reacted when faced with a similar set of circumstances.

Gold is a very interesting example here. Classed as safe haven asset, it is a popular option for investors in times of crises and this explains why gold has risen in price by 12% this year. The outlook for gold seems positive at the time of writing, but this does not mean investors should simply buy this precious metal as means of mitigating the impact of today’s uncertainty.

I believe that to understand an asset’s shortcomings, we need to understand its strengths. As a tangible asset, gold benefits from constant market demand. However, there is no steady income flow, and its value can quickly drop when a crisis subsides and investors rally to the stock market, for instance.

At the moment, however, there is a growing case for gold buyers. Firstly, we have central banks cutting interest rates, with the prospect of negative rates on the table. The Swiss National Bank, the European Central Bank and the Bank of Japan all currently have negative interest rates. For many countries, where inflation levels are higher than interest rates levels, money in the bank will simply lose value year on year. Therefore, investors who have moved into cash will be looking to place their cash in a safe haven.

In the last three recessions gold has increased in value, so as a hedge for a recession gold does have strong appeal. Furthermore, with large scale quantitative easing programmes being undertaken by central banks around the world, some analysts are anxious this will lead to high stock valuations. Again, gold offers a hedge against such devaluing risk. History, may not be repeated, but the fundamental outlook for gold is currently very strong.

An investor’s position in gold should be determined by their risk exposure and long-term financial objectives. However, if interested in gold, a useful place to start is by observing the Volatility Index (VIX). This index provides a 30-day projection of market volatility. Watching the VIX closely, we can see that when there is a drop in the index, the price of gold rises soon thereafter, and vice versa. Investors could use the VIX to determine when they should be entering (and leaving) the gold market.

Cautious planning for the future

 

We live in uncertain times and any forecast for the future is by no means absolute. At the moment, we could be witnessing the beginnings of a market recovery, though this could quickly become obsolete should there be a second spike in coronavirus cases or a severe drop in investor confidence.

The key message is simple – investors should not panic. They must make any financial decisions with a level-head. For every piece of positive news regarding COVID-19, also consider the potential negative outcomes as well. This ensures every investment decision is made by striking the right balance between return and risk.

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Giles Coghlan is Chief Currency Analyst at HYCM – an online provider of forex and Contracts for Difference (CFDs) trading services for both retail and institutional traders. HYCM is regulated by the internationally recognized financial regulator FCA. HYCM is backed by the Henyep Capital Markets Group established in 1977 with investments in property, financial services, charity, and education. The Group via its relevant subsidiaries have representations in Hong Kong, United Kingdom, Dubai, and Cyprus.