You may see the front page of the newspaper and dread to look towards the stock markets, and while talk of a recession may be on the lips of everyone, most people only have a passing understanding of the markets and how global events affect them. Luckily, those in the trading community can provide a more optimistic tone of voice for these unpredictable and tumultuous times. Indeed, some traders are anticipating that, while the circumstances may be dire, there is always a silver lining and light at the end of the tunnel – it all comes down to how well you respond to the risk. Despite the negative sentiment and market turmoil, could stricter risk management procedures lead to greater opportunities for speculative traders?
What is a Risk Management Strategy?
An effective risk management strategy can be useful for traders, as it helps form the basis of a trading plan by analyzing elements that could result in the market going against expectations. The process involves mitigating against losses that may occur from national and international events that will impact the markets.
These events could be economic changes, like a changing interest rate; political ramifications, such as an unexpected election result; or wider business implications, such as the dominance of one industry or the downfall of another. In tumultuous times, a risk management strategy could help traders navigate through a sea of potential issues to find some opportunities.
Covid-19 Market Panic & Rebound
2020’s Q1 has experienced some of the most unprecedented market panics in generations due to the COVID-19 virus. The overnight stagnation of many industries – from cruise lines to aviation, holiday rentals to leisure centers – has had a significant effect on the economy. Many experts are suggesting the lockdowns in Italy and China will impact factory output and the world will be rocked by a new recession.
However, it should also be noted that Dow Jones trading soared as the growth rate of new cases appeared to slow in April 2020. The markets rebounded after huge plunges in the previous few weeks as steps were made at both state and national levels to tackle the pandemic.
Brexit Market Fluctuations
In September 2019, the ongoing Brexit issue in Britain led to the lowest value of the GBP in the last three years. Months of stalemate, defeated parliamentary bills, snap elections, and leadership battles culminated in uneasy situations for many businesses, and caused global giants such as Honda, Ford, and Barclays to vacate the UK due to the volatility of the situation. UK businesses such as Thomas Cook outright collapsed, with the uneasy market situation as a likely factor.
However, December 2019’s snap winter election saw the Conservatives’ Boris Johnson claim an overwhelming majority, which helped send the value of the GBP back up. Following the exit of the UK from the EU on January 31, 2020, the GBP rose in value against both the USD and EUR.
How to Find the Opportunities
Worldwide events, therefore, have shown us that, while there may be dire circumstances, there are always opportunities. For instance, UK grocery shopping has risen to near-Christmas levels due to early spates of panic buying. While some negative situations solve themselves or find their own unexpected solutions, there are always ways to seek out opportunity in difficult times.
One of these methods is through short selling. Short selling refers to speculating on the drop in the price of a stock, and the idea is to hedge against the risk of a long position in a similar market. Traders borrow stock based on an expected decline (an expiration date) and then sell it at market price. The key is to ensure that the price declines before the borrowed stock is expected to be returned, so the stock can be repurchased at a lower price. Risk management is important here, as the loss could be high if the stock doesn’t decline as expected.
Buy the Dips
Another method is buying the dips. This is similar strategy to selling short, only the asset is bought once the price decline has occurred. This strategy has varying degrees of risk. If the asset is suffering a minor decline, but is expected to see a longer-term rise, this could be advantageous. Other times, there is no guarantee of an increased price, so investors buy at a lower price and hope to potentially benefit from an eventual price increase.
Negative situations give investors opportunities. Even in the direst market conditions, there are always uptrends – that is the nature of the markets. So, by utilizing risk management strategies, investors can analyze where potential opportunities lie within difficult situations.