Volatility and the stock market are synonymous, there’s no two ways about it.
Particularly in the short term, where rapid declines of 10% to 15% within a few days or weeks are pretty normal occurrences.
This fact alone frightens away many potential investors who equate volatility with risk…
And as a result, they defer to “safe” investing options, such as managed funds and the like.
But volatility can also hamper the efforts of more experienced investors, with higher levels of risk tolerance.
Sharp declines trigger our natural defence mechanisms, instilling a sense of fear and panic that shuts down rational thinking.
In this highly emotional state, we start making mistakes and deviate from following the prompts of our investment strategies…
And consequently fall off the course to consistent long-term profitability.
Eventually the volatility dies down and rational thinking returns. But the mistakes made can’t be undone. Which is a huge problem for one reason:
Volatility is inevitable and happens more often than not. And is, in my experience, the No. 1 reason why investors undo themselves in the stock market.
So, if you can’t find a way to accept and overcome volatility instead of trying to avoid it — long-term profitability will continue to elude you.
To do this, you must build the “right” mindset to execute your investing system through all manner of market conditions. But this sort of transformation is a long-term solution and doesn’t happen overnight.
So, while you’re building your market-beating mindset, you must also develop mental techniques to stop yourself from reacting to volatility in ways that derail your long-term plans.
In today’s article, I’ll show you a couple of those techniques, along with ways to apply them. I say “techniques,” but these are more mindset alterations that help you handle volatility so you can keep on trucking along to long-term profits despite it.
A quick note before you read on:
If you don’t believe in the importance of trading psychology and can’t commit to something in the long run…
The following mental techniques won’t be of any use to you.
But if you do, they can mean the difference between losing 30-50% of your nest egg during a market crash…
And minimizing your losses while being ready to capitalize on the ensuing rise.
With that said, let’s dig into it.
Technique 1: Ask The Right Questions
No investing approach or system can make short-term volatility go away. Accept this fact.
Then, instead of asking yourself what you can do to avoid volatility, ask this:
“How much am I prepared to lose in the short term to win in the long run?”
It’s critical you answer this question with brutal honesty. Because the answer decides how you set your investing system’s risk management mechanisms.
Optimize these to guard your portfolio value and prevent it from dropping below your “maximum accepted loss point” (so-called retracement buffer) in any possible market scenario…
And you’ll turn fear and uncertainty into opportunity.
When you’ve done everything you can to ensure you don’t lose more than you’re okay with — you’re free to take “risks” without worrying about what will happen in the future.
That’s because you know following your system should at the very least keep you within your definition of “safe.”
This feeling alone can be quite liberating. And can put knee-jerk reactions and falling prey to “noise” in check.
But for this technique to work, you’ve also got to alter the way you think about volatility and its effect on your returns:
Technique 2: Adopt A “Big Picture Perspective” Of How Markets Operate
During volatile periods, your pain avoidance mechanisms kick-in and make you more susceptible to feelings of hurt, loss, and failure.
If you adopt a short-term thinking perspective, and give in to these emotions, then chances are you’re going to make mistakes which end up costing you a lot of money.
But if you accept volatility and understand the role it plays in actually helping you turn a profit, and put processes in place to help you manage it…
The picture changes. For it is the same volatility that puts many people off stock market investing altogether that is directly responsible for all the financial rewards on offer in the stock market.
Now, you can’t make this mental shift by simply wishing it into existence. No sir. It takes time and effort.
But in my experience one of the easiest ways to make this shift is by following a back-tested system with a known Statistical Edge.
Through back-testing, you’re able to see how your system performed through historical periods of increased volatility, and this gives you the confidence to continue pulling the trigger in live market conditions.
And when you live trade through periods of increased volatility and come through relatively unscathed or even turn a profit in the process, well that’s one of the most freeing feelings you’ll experience as a trader.
For example, a portfolio I manage was able to avoid most of the Covid Crash by signalling to move to cash as individual stocks began to plummet…
And because I had faith in this system to keep executing, I was able to take full advantage of the sharp run-ups that occurred after the crash, while many high profile fund managers sat on the side-lines.
Technique 3: Accept The Randomness Of Short-Term Trading Outcomes
Remember that investing is a probabilities game. And while a Statistical Edge stacks the odds in your favour over the long term…
The short term is a completely different story. Trying to predict individual trade outcomes is like flipping a coin.
Instead, try to accept that each individual outcome is nothing more than your Edge playing out. To quote Mark Douglas, who was a friend and mentor to me,
“There is a random distribution between wins and losses for any given set of variables that define an edge.”
Internalize this, and you’ll begin to emotionally untangle yourself from the short-term ups and downs.
Once you grasp all of the above and set the retracement buffer I mentioned earlier— volatility’s hold on your emotions should at the very least loosen up.
Technique 4: Embrace Volatility As Your Companion On The Road To Long-Term Profitability
Sounds counterintuitive and a bit wishy-washy. This is why so many investors discard this mindset alteration at their peril.
Essentially, all the techniques I’ve mentioned so far converge and lead to this. They help you see volatility as an unavoidable occurrence. One you can’t control or work against but only organize your efforts around.
So, if volatility is bound to hit you, why not reposition it in your mind as an ally in outperforming the market over the long run?
If you play your cards right during volatile times while other investors are running around like headless chickens…
You’re setting the scene to profit after taking inevitable losses, which hopefully your investing strategy minimizes. And doing this over and over again is how you achieve consistent profitability in the long run.
Once you become confident your investing system and process can help you handle volatility like this — you no longer dread it.
Instead, you actually look forward to market declines so you can continue growing your portfolio during the ensuing rises.
Reframing How You See And Handle Volatility Is A Huge Step To Long-Term Profitability… But It Can’t Take You There On Its Own
Look, if you just read what I wrote above, acknowledge that it’s a mind opener, and carry on thinking and acting as per usual…
Nothing will change.
It’s not enough to know what needs to be done — you actually have to do it.
Start by suspending the belief that psychology talk is rubbish and start building your mindset and mental skills.
All the techniques I’ve introduced today are just a part of this building journey. And the quickest and most sustainable way to ingrain these and other market-beating attitudes, beliefs, and habits is by using a mechanical investing system, with a known Statistical Edge.
Now you can’t use a system profitably if you don’t have the mindset to execute it come what may.
But you also can’t profit by executing a system that’s not built on solid foundations (i.e., doesn’t have a verified Positive Statistical Edge).
So, if you don’t have a system in place, first focus on building one or finding one from a third party. Then once you have the system to match your needs, come back to this article.
And if you already have a system, then focus all your energy into executing it regardless of how you feel in the moment. Hopefully today’s article can help you with this.
Read it whenever volatility arises or when doomsayers start preaching about the next crash.
And then stay your course.