Over the last few months we have witnessed a notable rise in volatility. This reflects the widely divergent views market participants have over the near-to-medium outlook for both global equities and the broader economic landscape.
Volatility offers the perfect environment for CFD traders to potentially profit from rising and falling markets.
What’s causing the current volatility?
For much of 2010, investors have been plagued by fears and uncertainties surrounding European sovereign debt levels, Chinese growth trajectory, the US economic recovery and more recently Australia’s outlook with the government leadership change and the proposed resources tax (RSPT). Add to this some end of financial year tax loss selling and it's plain to see why markets have been so turbulent of late. We can expect to see volatility begin to ease when markets move definitively past some of the issues mentioned and a more unanimous path is agreed upon.
Looking at the past year, traders have been forced time and again to adapt to changing conditions and sentiment in different asset classes. We have seen volatility pick up and recede as governments try to convince the equity, debt and forex community that they have their fiscal houses in order. During these times, it is more important to have the flexibility to adapt, than the ability to predict future moves. Looking at how changes in sentiment can lead to these moves is key to executing winning trades. Measuring sentiment is vital here and can be done in different ways.
Volatility Index
The VIX or Volatility Index (also known as the ‘fear index’) is a popular measure of implied volatility of S&P 500 index options. It has been rallying of late as the cost of protection or buying puts have increased. When market participants get nervous about a potential negative event, not only do traders often look to close out of long share positions, but they can effectively limit any losses by selling put options against it.
In October 2008, at the time of Lehman’s collapse, we saw the VIX spike up to 90 as panic and fear was rife. Following periods of renewed confidence earlier this year, the index has spiked to around 50 in the last couple of months and now sits in the mid 30s. This shows that traders are still nervous and indicates volatility could be with us for the foreseeable future.
Manage your risk
Until clarity is provided by the reporting season and other macro issues subside, short-term traders can take advantage of the high market volatility to potentially make significant profits. However, it is also important to have a stringent risk-management strategy in place and keep a disciplined approach to each and every trade. With IG Markets you can take steps to limit losses while ensuring that potential profits are uncapped. Find out how we can help you to manage your risk.
Discover how you can profit during volatile periods using CFDs. At IG Markets we offer a range of CFD markets to go long or short on.
To see how you can make the most of these turbulent times, view our free free online seminar.
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Updated:13/07/10
Disclaimer: The above comments do not constitute investment advice and IG Markets accepts no responsibility for any use that may be made of them.
Remember that CFDs are a leveraged product and can result in losses that exceed your initial deposit. Trading CFDs may not be suitable for everyone, so please ensure that you fully understand the risks involved.