How investors can trade in topsy-turvy markets

In a decade filled with uncer­tain­ty and sur­pris­es, few things have been more inscrutable than the finan­cial mar­kets. Traders have had to learn to nav­i­gate volatile mar­kets, exac­er­bat­ed by glob­al economies being forced to embrace an immi­nent reces­sion brought on by the coro­n­avirus pan­dem­ic, the inva­sion of Ukraine, and sev­er­al oth­er geopo­lit­i­cal issues.

“The way it’s changed this year com­pared to the pre­vi­ous two years is that you could often buy into mar­kets when they fell and still make mon­ey,” says David Jones, chief mar­ket strate­gist at Capital.com. “We’ve had boom­ing mar­kets – whether stock mar­kets or com­mod­i­ty mar­kets – since March or April 2020.”

Investors and traders have enjoyed ris­ing mar­kets in the last few years. In such a mar­ket, buy­ing the dip was a pop­u­lar and some­times prof­itable strat­e­gy among traders, but in 2022 they are find­ing that is no longer the case. The broad US stock mar­ket, the S&P 500, is down 22% this year alone. “Mar­kets are much more volatile,” says Jones. “Blind­ly buy­ing the dip isn’t work­ing this year.”

That isn’t a sur­prise to long-term investors, but is a rude wake-up call for any­one enter­ing the mar­kets in the last few years. “It’s impor­tant to be a lot more defen­sive now than pre­vi­ous­ly,” he says.

How­ev­er, there are ways investors can still find oppor­tu­ni­ties in the mar­ket, even in the extra­or­di­nary sit­u­a­tion we now find our­selves, but it requires step­ping away from wide­ly used long-only trad­ing strate­gies where you buy low and sell when prices rise.

Embracing the short sell

Three-quar­ters of all trades exe­cut­ed by Capital.com users in 2021 were long-only trades, mean­ing they bought shares in a com­pa­ny hop­ing the price would rise. It’s a gen­er­al rule of thumb that con­tin­ues today, even as mar­kets every­where are falling – more than half of the traders still take long posi­tions. “It’s cer­tain­ly some­thing that’s ingrained into plen­ty of us as investors and traders,” says Jones. “You buy first and then sell high­er up, hope­ful­ly.”

How­ev­er, in an upside-down mar­ket, atti­tudes and approach­es need to change. Short-sell­ing – spec­u­lat­ing on assets or secu­ri­ties that you pre­dict could lose val­ue – is one way to poten­tial­ly make mon­ey in a chal­leng­ing econ­o­my, where val­ues and prof­its are being squeezed in every way. With short-sell­ing, you sell a posi­tion in a com­pa­ny high, and look to buy when it’s low­er in val­ue. “But that’s quite a change in psy­che for a lot of investors and traders,” says Jones.

There is also a belief by some that it’s uneth­i­cal or unpa­tri­ot­ic to bet against com­pa­nies – though that over­looks the dynam­ics of the mar­ket and the idea that every com­pa­ny can lose val­ue as well as gain it. Short-sell­ing was curbed in the Unit­ed States in the after­math of the 2008 finan­cial cri­sis, but remains a valid and legal method of trad­ing that investors may con­sid­er in frag­ile eco­nom­ic times like this. It does, of course, mean that investors lose mon­ey if a com­pa­ny per­forms bet­ter than fore­cast­ed, so the advice is to be care­ful with your cash.

Jones says: “With short-sell­ing, it’s impor­tant to have risk con­trols in place, but you’re lim­it­ing your oppor­tu­ni­ties if you don’t look at the idea, par­tic­u­lar­ly in the sort of mar­kets we’ve had this year. It’s one strat­e­gy to look at if you thought mar­kets were going to con­tin­ue to slide from here in the months ahead.”

Using stop losses

When mar­kets are in freefall, it’s impor­tant to apply the brakes. “Using stop loss­es is real­ly impor­tant,” says Jones. In mid-May, Tes­la was trad­ing at around $900 a share. In mid-June, it was trad­ing clos­er to $650. Traders who put mea­sures in place to man­age their risk were insu­lat­ed from the full scale of that loss by putting in a stop loss, which is a notice to trad­ing plat­forms that you want to sell if the val­ue of a posi­tion drops below a cer­tain val­ue. “You can say: ‘I’m hap­py to buy at $900, but if it drops 10%, I want to come out’,” he adds.

Many retail traders, such as those who use plat­forms like Capital.com, aren’t ful­ly aware of the range of options avail­able to them, includ­ing stop loss­es. Jones advis­es deploy­ing sen­si­ble risk con­trol mea­sures like the stop loss in order to insu­late your­self from the chal­lenges mar­kets cur­rent­ly present to investors and traders alike.

Diversifying your portfolio

The chal­leng­ing mar­ket is hit­ting every­one at present, but one way to try and slow the tide is by diver­si­fy­ing your invest­ments. “It’s hard at the moment, because every­thing is falling,” says Jones. “But it’s bet­ter to spread the risk across dif­fer­ent asset class­es, com­pa­nies and invest­ments than to pur­sue prof­its from one sin­gle area that could quick­ly go south.”

Jones points to the price of oil: if a trad­er had rushed into oil in March this year when it surged after Rus­sia invad­ed Ukraine, they would have lost around 30% of their invest­ment. “Diver­si­fi­ca­tion is one option – and a very sen­si­ble option – when it comes to trad­ing and invest­ing,” he says. That includes invest­ing in exchange trad­ed funds (ETFs) and trad­ing deriv­a­tives on a host of dif­fer­ent mar­kets includ­ing com­modi­ties, if investors think these will con­tin­ue to rise in val­ue. Gold, for exam­ple, con­tin­ues to prove pop­u­lar in chal­leng­ing cir­cum­stances.

There is also anoth­er option he sug­gests, albeit one that seems unusu­al for traders and investors proac­tive­ly look­ing for oppor­tu­ni­ties to prof­it. “You could do noth­ing,” he says, “if you thought this was all a lit­tle bit too crazy.” But think­ing longer-term is cru­cial. “It can be very tempt­ing, when mar­kets are crazy, to be very short-term,” he says. “Don’t think because mar­kets are crazy, and mov­ing real­ly quick­ly, that you have to act the same way.”

To learn more about short-sell­ing and oth­er retail trad­ing strate­gies, vis­it capital.com/trading-explainers

Pro­mot­ed by Capital.com