Rising market volatility is dangerous for traders and investors because of the uncertainty and unanswered questions about what’s next.
Rising volatility is much different from high volatility. Maybe you’re scratching your head wondering what the difference is, but stay with me.
Why rising market volatility is so dangerous
When volatility is rising, it means price ranges are expanding and trading is getting increasingly difficult. A normal range might be 1% over a month. But a range when volatility is increasing might be significantly larger, perhaps 1.5 to 2% during a single trading day. That is a substantial difference!
Rising volatility also means that traders and investors are very worried about where the markets are going. Many of them are reaching for index put protection as quickly as possible. More on this below.
One thing you’ll notice about the Volatility Index (VIX) is that it’s usually on the move. It rarely becomes stuck at one level. We get used to the VIX’s movements, but it’s important not to get complacent when the VIX starts moving higher.
Too many traders don’t always recognize rising volatility. Once they notice it, though, it might be too late to respond or prepare for what’s next: a big selloff. If you are still holding shorter-term positions, like options, your portfolio could get hammered with massive losses.
With last week’s big move in the VIX, I heard stories about traders who literally lost it all in days or hours. Let that sink in. And let that motivate you to always pay attention to the VIX.
What’s the difference between rising and high volatility?
Volatility will eventually hit a high level; big swings will continue to occur. Go back a year to “Liberation Day”. The Volatility Index (VIX) hit 60, the third highest level ever. Markets swung like a pendulum; the Dow Industrials saw swings of 1000-1500 points up and down.
How the heck are you supposed to trade when prices are constantly going up and down?
Massive levels of uncertainty are causing the current rise in volatility. An unprovoked war in the Middle East quickly spread. A US economy that appears to be built of cards. Oil prices are increasing, which will goose inflation (higher energy prices cause everything to become more expensive). People are buying up precious metals, so those prices are rising, too.
Another shock may cause the VIX to move even higher.
Be prepared! Keep holding and buying index puts to protect your portfolio from wild swings. It’s times like this when you’re happy to hold insurance.
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