Playing The Volatility Game

Investing strategies are as diverse as the people who use them. From the long-term investors who annually buy a handful of sleepy blue chip stocks, bonds or managed funds to the adrenaline junky active day trader who plays the minute swings in market volatility, there is something for just about anyone with a few bucks to throw at the market.

My perception of a typical daytrader comes from movies like Wall Street and news clips from 1999 where images of high rolling super-traders driving Ferrari's, flying in private jets and living the American Dream ran rampant. In reality, most day or "active" traders sit buried at their desk in front of 2 or more screens running chart analyses, checking intraday technical events and watching the news all while managing their tweets, facebook entries and video games for the entire trading day pre- to post-market.

Swing traders are defined as semi-active traders who hold positions from a few days to a few weeks and ride a trend. This, to me, is the kinder, gentler form of active trading as it allows people like me who work day jobs to participate in the market in the evenings and weekends using predetermined limits and stops to buy and sell short term positions. A friend of mine refers to this kind of trading as "stealth" trading, since we seem to be invisible during market hours with our presence only felt in the automatic stops and starts we factor into our trades.

Stocks Defined as Instruments

I find it funny that certain technical programs refer to stocks as instruments. But I get the analogy. A stock is an instrument we use to gain exposure to (or play) world financial markets and hopefully reap some rewards in the process. But as with any instrument, the output is only as good as the input. A violin sounds unrecognizable in the hands of a hack. But a highly trained musician makes beautiful music.

Matching the instrument to the player is key. A well trained guitarist does not automatically excel at playing the saxophone. A sleepy portfolio annual investor does not necessarily make a successful swing trader.

Pick Your Poison

So what instrument do you choose? Ah, the one big question. We can't really expect to day-trade sideways trading sleeping giants like Coca Cola or the current version of Microsoft with any big gains over the short term unless you have thousands of dollars to invest in order to see a portion of a percentage point in profit. And we can't be purchasing options and futures and sit on them expecting any kinds of long term gain by ignoring the market and expecting growth. That would be like buying a treadmill and hoping you get fit by simply owning it.

If you have time to sit in front of multiple computer screens, study and analyze charts, read news feeds and trade on a moment's notice, perhaps active trading is for you. However, if you don't have access to this kind of study time, or the psychological constitution that goes along with this riskier kind of style, swing trading or longer term investing is more likely the way to go.

I've heard some day traders boast about not caring what the company does, how good the product is or what the industry of that company is up to. They don't scan the news since they are only interested in the technicals and charts. They trade the probability of rises and falls in instrument prices based on purely the personality of a stock, future, option or index and specific indicators that signal a buy or sell. Other traders factor in wider market trends and probabilities based on world events, financial milestones, company characteristics and the environmental impact on the market. Still others choose to incorporate a combination of multiple factors to determine their buy and sell signals for a certain type of investment and narrow their collection of instruments down from the entire orchestra of market offerings to a smaller ensemble of selections.

Volatility is the key to active trading. Enter, rise, exit....and fast--over several days, hours, or even minutes. Some stocks bounce up and down with great swings each day--highly volatile. Others trek along at a barely audible pace pulling in or letting go mere fractions of a percentage point in any given day.

Cashing in on Volatility

So if you don't want to spend weeks and months studying individual stock charts for consistent patterns of volatility, how about trading trend volatility--like the cost of gold, oil, natural gas, silver, and even the VIX (Chicago Board of Exchange Volatility Index) itself. Having chosen to add a bit of spice and adrenaline to your investing style, there are a few ways to play some of these bouncy market favorites without the confusion or chaos of entering into options and futures and all the rather complicated instruments available in that particular concert hall.

ETF's are now offered by various companies that allow you to win when the market falls, or invest in futures and even the VIX quite easily. An ETF is a basket of stocks, futures, covered calls, or whatever an ETF company can imagine to include. Learn more about ETF's here. Exchange-traded fund companies listing ETF's on the Canadian market include Horizons, Claymore, iShares and BMO.

For example, Horizons offers some ETF's that offer a bull and bear version for various things like gold, oil, natural gas and even the VIX. You can purchase a bear ETF and invest in dropping gold prices, or the bull counter part if you feel gold is on the rise. If you want to invest in crude oil futures--such as during the current oil unrest in the middle east, Horizons has a crude oil bull and the inverse bear ETF in their repetoire.

I find it somewhat less confusing to peruse the various ETF's available than to navigate through loads of managed mutual funds or try to enter into the options, futures and stock-shorting game. The advantages to ETF's are many but for me, the fact that I can trade them like stocks and the MER's are typical much lower than mutual funds, makes them attractive. Add to the mix these inverse ETF's and new plays on volatility, and you don't have to go very far to find your little band of players.

Personally, I have been enjoying my plays with HOU and am no longer scared of an advancing bear market with all of the inverse and bull ETF's available for me to play with.

Happy Trading!