A Comprehensive Guide On Making Profitable Investments In Times Of Economic Uncertainty And Increased Volatility

| October 26, 2016 | 0 Comments

uncertaintyIntroduction

There are probably a thousand and one laws on investing (possibly more) with a view to guiding you on how to make profitable investments. Interestingly, the multiplicity of those investment laws could make them confusing. More so, following all of the laws doesn’t guarantee profitable investments. However, the summation of all the laws of investment can be coded into two simple rules:

  1. Don’t lose your money
  2. Don’t forget rule number 1

Nevertheless, it might be hard to maintain your investment or trading capital given the current volatile nature of the markets. If you can’t guarantee capital preservation during volatile market conditions, you are not likely to record gains and the odds that you’ll lose your money are high. This article seeks to provide you with insight on the factors behind the increase in volatile market trends. The article also seeks to provide insight on some smart moves that can help you profit during periods of economic uncertainty and market instability.

Uncertainties about U.S. 2016 election overshadows the equity markets

The U.S. presidential election is one of the main causes of volatility in the U.S. equity markets and in the global economic landscape. The U.S. presidency is being contested by Donald Trump for the Republican Party and Hillary Clinton for the Democratic Party. Interestingly, both Hillary and Trump are polarizing candidates and it appears that the electorate is being forced to choose the lesser of two evils.

The 2016 U.S. presidential election is set to hold on November 8 but the buildup to the election suggests that the eventual winner might emerge by a thin margin. The market doesn’t like uncertainty, but the close forecasts in opinion polls suggest that that the political uncertainty will continue until after the elections.

Interestingly, Wall Street analysts seem to believe that Hillary Clinton’s emergence as the President might good for the market while they are fearful that the emergence of Donald Trump might make the markets unstable. In the coming months, investors can expect to see increased volatility in the market as a function of speculation about where the U.S. economy is heading.

Brexit could trigger bigger geopolitical concerns

It is no longer news that the United Kingdom has voted to leave the EU in an historic referendum that has altered the course of history forever. Last week, UK Prime Minister, Theresa May revealed that her administration will invoke Article 50 to initiate the formal exit of UK from the EU by the end of March 2017.

The Brexit vote has already precipitated a round of volatility in the global marks are the Pound Sterling fell to multiyear lows. However, the initiation of the formal Brexit process will trigger a fiercer and more pronounced round of volatility. To start with, London is the financial capital of the world but many firms in the financial sector might seriously consider taking their headquarters away from London since their presence in the UK won’t offer them a doorway into the EU.

Here’s the year-to-date effect of volatility on the equity markets

The chart below shows the performance of the major market indexes and a traditional safe-haven investment. You’ll observe that the S&P 500 has gained a meager 5.37% in the year-to-date period. The NASDAQ composite and the Dow Jones Industrial Average have also gained 5.69% and 4.68% in the same period. In contrast, Gold has gained a massive 24.76% in the year to date period. Hence, it is obvious that volatility is pushing investors out of equities to invest in relatively safe-haven of gold.

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The chart below shows how the CBOE S&P 500 Volatility Index (VIX) has fared in the year to date period. The Volatility index measures the market expectations of near term volatility in the equities markets based on trends in the stocks options market. From the chart, you’ll notice that the equities market has suffered wild swings in volatility this year.

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As seen from the chart the markets began 2016 with a strong volatile trend that led to a high of 39.90 in February. Subsequently the volatile trends dropped, leading the VIX to a reading around 16 in the middle of March. The VIX index later experienced a lull in volatility as seen in the first pocket of stability before the Brexit vote in June triggered another high in volatility to 26.6.

Equities also enjoyed another bout of stability from August through September but another volatile trend has started in the market. Below are three reasons why investors can expect increased volatility in the markets going forward.

  • Employers skeptical about hiring new workers

Hiring trends suggests that investors should not be too optimistic about the prospects of equities going forward because employers are slowing down on hiring due to the uncertain economic outlook. In September, U.S. employers added 156,000 jobs to miss the consensus economists’ estimate of 176,000 jobs. More disheartening is the fact that the unemployment rate has risen to 5 percent in sharp contrast to expectations that the jobless rate will hold steady at 4.9 percent.

  • Fed uncertain about what to do on Interest rates

The weak employment situation has weakened the Fed’s resolve to raise interest rates because the Fed has maintained that decision on whether or not to raise interest rates is data dependent. In the last two months, investors have found strength in the Fed’s hawkish stance on interest rates; however, the poor jobs number suggests that the rate hike chatter might be postponed until December.

However, a December rate hike is not certain. Fed chair Janet Yellen, has noted that “With labor market slack being taken up at a somewhat slower pace than in previous years, scope for some further improvement in the labor market remaining, and inflation continuing to run below our 2% target, we chose to wait for further evidence of continued progress toward our objectives.”

Here’s how to benefit from the increased volatility in the financial markets

From the foregoing, it would appear that the markets are crazy right now and that it might be smarter to stay on the sidelines until the volatile trends subsides. However, it might interest you to know that sophisticated investors know how to profit from the markets irrespective of whether stocks are trading up, down, or sideways. In fact, volatile markets provide one of the best scenarios for investors to record the biggest gains because volatile trend are often accompanied by massive price and volume actions. Below are three smart ways to profit from increased volatility in the financial markets.

  • Trade the iPath S&P 500 VIX Short-Term Futures ETN (VXX)

The iPath S&P 500 VIX Short-Term Futures ETN (VXX) is the largest investment vehicle linked to market volatility. The exchange-traded note is designed to maintain long positions in the futures contracts of the first and second months. Hence, the ETN tends to record gains when the level of volatility in the market escalates and investors start running around like headless chickens. Conversely, the ETN tend to record losses when the stability return to the markets and volatile trends subside. A

  • Short iPath S&P 500 VIX Mid-Term Futures ETN (VXZ)

The iPath S&P 500 VIX Mid-Term Futures ETN (VXZ) note is designed to maintain long positions in the futures contracts of the fourth, fifth, sixth and seventh months. Hence, the ETN tends to record gains when the level of volatility in the market escalates and investors start running around like headless chickens. Conversely, the ETN tend to record losses when the stability return to the markets and volatile trends subside. You should note that a VIX reading of 30 and above signals an increase volatility while a reading below 20 implies that the equity markets are stable.

  • Trade forex on the most volatile currencies

Another smart way to profit in periods of increased economic uncertainty and market volatility is to trade forex on volatile currency pairs. For instance, the realities of the Brexit vote will always make the USD/GBP pair an interesting trade and the pound sterling seems to be in a bear cycle that is lifting the U.S. dollar higher. More so, the uncertain rate hike environment will make the XAU/USD pair an interesting trade as investors try to know the fed’s plan for interest rates.

However, it is important that you compare forex trading brokers before you opt to use forex as vehicle to profit from market volatility. Any investor who is comfortable with making profits from a volatile market environment will be at home in the forex trading environment. To start with, forex trading brokers offer a large variety of instruments that you can short in order benefit from volatile market trends.

Forex trading brokers also provide traders with leveraged trading accounts, which could allow you to make exponentially bigger gains with your trading capital. More interesting is the fact that forex brokers provide an impressive ease of access that supersedes the possibilities in other trading/investment vehicles. For  instance, forex brokers would allow you to sign up for a trading account online and you can start trading within minutes. More so, you can easily deposit funds into your trading account through an online transaction.

  • CFDs can offer exponential ROI at a small cost

One of the biggest benefits of trading CFDs is that the leverage that traders enjoy on CFD contracts. You can trade an underlying CFD asset with a fraction of what it could cost you to buy the actual asset.  More so, CFDs offer you an opportunity to record profit irrespective of how the market fares. For instance, you can buy a CFD for profits when the market is going up and you can sell CFDs for profits when the market heading south.

CFDs also provide investors with a means to diversify their investments across a wide range of assets. Some brokers offer as much as 10,000 assets such as stocks, commodities, forex, foreign equity indices, and precious metals. CFDs also have the added benefit of convenience with flexible order sizes and lot requirements.

 

Note: The author of this article is ValueWalk Staff.

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Category: Options Volatility Watch

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The author of this article is a contributor to ValueWalk.com. ValueWalk is your everyday source of breaking and evergreen news on everything hedge funds and value investing.

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