For those who are agile enough, volatile markets offer traders plenty of opportunities to make quick profits.
However, if you are not ready to trade a fast-paced market, it can also mean you will be overwhelmed.
In this article, we’ll look at some stock and option strategies for volatile markets that can help traders take advantage of the opportunities while minimizing risk.
General equity and option strategies for volatile markets
When the market is moving fast, it’s easy to lose sight of everything else. Finally, focus on your positions, exits, entries and potential new trades. But don’t forget about the big indices and bigger stocks that can move the market.
How are other indices and larger stocks performing? Should you worry that a bigger stock has gains to come? Is there a FOMC meeting in the next few days? All of these events can add to volatility. Trading around these events can mean that some vulnerable positions will be reduced or closed.
The strategies in this section apply whether you are trading stocks or options. Instead of strategies, they are more like tactics. In other words, you can incorporate them into any strategy.
Prices move quickly in volatile markets. There are a few ways to compensate for this when adding new positions. But one of the most proven stock and option strategies for volatile markets is to reduce position size.
For example, if you typically trade 100 stocks or 10 options contracts, maybe you should use 75 stocks or 7 contracts. Depending on how fast the markets are moving, you can reduce the size even further.
As a rule of thumb, traders with smaller accounts should never risk more than 1% to 3% of their account on a single trade. And the more volatile the market, the closer to 1% you will likely want to be.
With a $ 10,000 account, sticking to a maximum position size of 1% means you would never risk more than $ 100 on any given trade. Yes, this means that if your position increases by 20%, you will not benefit that much. But it also means that if the trade quickly goes 20% against you, you will lose a lot less.
Broader stop loss
Stop losses don’t work that well with options. This is due to the wide “Bid x Ask Spread” that is present with many options. The same applies to stocks with low liquidity.
But for liquid stocks with smaller bid-x-ask spreads, a wider stop loss may work better. So instead of placing a stop loss of 1.00 point from an entry, for example, you might consider 1.50 or 2.00 points.
Scaling in and out
Scaling into one position offers the potential for a better price. For example, if you buy 100 stocks with a limit of 97 only to see the stock drop to 90 due to volatility, you’ve missed a great entry price.
We cannot know the future. But such movements are common in a volatile market. You can know that. To smooth out rapid price movements, do the following:
- 50 shares at 97
- 30 shares at 95
- 20 shares of 93
You might not get a 90, but your cost base will be less than 97. Also, if the price never hits 95, you can only get 50 shares at 97. This is fine as you were prepared for lower prices, but ended up with a smaller position taking advantage of the first point above.
It also works the other way around. When exiting a position, instead of selling all the stocks at the same price, consider spreading the stocks across multiple prices.
Stock-specific strategies for volatile markets
Charting tools can be of tremendous help in volatile markets. It may appear that a stock fluctuates back and forth randomly. But after examining the charts, you can see patterns as well as support and resistance levels.
Also with Mishaps and outbreaks Informing your trading timing works better with stocks than with options. A breakout usually occurs when the stock price moves up and out of a range. A breakdown moves under and out of an area. Both are preceded by a consolidation or an area-specific period.
In the graph below we see two recent breakouts for Coke (COKE).
Breakouts and mishaps can work better in volatile markets due to the rapid price movements. However, it can still be just as difficult to trade as fake-out is always possible and this is where position sizing can help too.
Option-specific strategies for volatile markets
Single leg trades (buying or selling an option) may allow traders to get in at a price that differs from the current share price. This creates a certain margin of error and allows the price to move more.
As an example, ABC stock is trading at $ 80. A call buyer decides to buy the 85 strike for 0.70. This option must be above $ 80 for the strategy to make money. In a volatile market or a stock with good momentum, either can be beneficial for this type of trading.
With the same stock, another trader sells the 78 strike put for 0.75, believing the stock will also rebound. With the stock staying above 78, the put seller will make money. When the stock rises, the option premium drops from 0.75 to 0.20. The put seller decides to close the trade and receives $ 55 per contract (0.75-0.20).
A multi-legged approach, which consists of two or more options in a single position, offers several ways to take advantage of the volatility in options trading. For example, if a particular stock is moving wildly, an options trader can use a straddle. The straddle will make money as long as the stock moves above or below a certain price range.
On September 10, TSLA was trading at 752. A trader buys the September 24 put and call:
780 call @ $ 8.82
720 Put @ 11.72
total cost: $ 20.09
In this case, the profitability of the trade depends on TSLA moving away from 752 in either direction.
If TSLA is 795 on September 16, the trade will be $ 30.10. And if TSLA is 710 on the same day, the trade will be $ 31.40. The main premise of trading is that TSLA is a volatile stock and is likely to move into one of the profitable areas of trading.
Volatile markets require a lot of focus and a large tool kit (i.e. strategies and tactics). The more strategies you learn with both stocks and options, the better prepared you’ll be to dive in rather than be sidelined.