How cool headed investors can profit from volatility

By:Tim Bennett
When food gets cheaper, you don’t buy less of it. So why do we dump shares when prices fall? This week I take a look at one of investing’s bigger conundrums.

How cool-headed investors can profit from volatility

After a year when equity markets headed steadily upwards in 2017, investors have been faced with a much choppier start to 2018. February’s big correction signalled that volatility is back and all the signs are that it is here to stay for the rest of the year. The challenge for investors is reacting the right way to it and being able to see share prices dips as a potential opportunity even as others are panicking and trying to exit the market.

Good or bad news?

The following slide sums up the two opposing views you can hold of a spell of equity market volatility.
The key to seeing the world like someone on the right is having, and sticking to, a long-term approach. If a company is a good bet when the share price is £2, how can it be less of a good bet when the price is £1.50? If we can overcome our natural tendency to follow the herd and sell when prices dip we can actually see lower prices for what they are in many cases – the chance to get good firms for less. The challenge, as ever, is finding them so that you buy the wheat and not the chaff.

Kicking the tyres

I have written elsewhere at some length on how you can screen stocks to try to uncover good value. Here is just a brief summary of some of the criteria you may apply, along with some of the classic red flags.

Cheap for the wrong reasons

The trick, once you know what kind of company you want to buy, or add to, is to then look at why it has been marked down. Sometimes it is for what I call the wrong reasons – and that is where the opportunity lies.
Once commentators start generalising – for example, talking about very different technology stocks as if they were identical (e.g. the FANGS, comprising Facebook, Amazon, Netflix and Google) – then cool-headed investors can ready themselves to pounce as prices fall. Chances are a group of stocks has been marked down indiscriminately.

Why we don’t keep a cool head

This might all sound obvious enough. However, in reality we are programmed to react the way others do and far from keeping a cool head as prices fall, we may automatically follow the crowd and panic-sell.
The good news is that the moment we recognise this behavioural risk, we can think about ways to do something about it. One of the roles of an Investment Manager, for example, is to stop you from reacting negatively when volatility strikes. Successful long-term investors go a step further – having sensed nervousness in others, they try to take advantage. The ability to remain cool under market pressure is a hard skill to learn but is absolutely critical – in wider life as well as investing!

For more on weighing up stocks

Please feel free to dip into my extensive library of free videos to find out more about some of the points I have touched on here. You can find them at;