REVEALED: Why You Should Embrace Volatility

REVEALED: Why You Should Embrace Volatility

Posted On December 8, 2021 1:25 pm

Many people equate volatility with risk.  Or, conflate risk management with risk aversion. Both views would be wrong and detrimental to your ability to invest or trade profitably. 

In all my writing, I’ve repeatedly emphasized the importance of risk management; be it through position size, having predetermined entry and exit points, and applying hedges.  This doesn’t mean that I’m avoiding, or being risk-averse.  Risk, and the possibility of loss, comes part and parcel with this business. To repeat, there’s a difference between being risk-averse and risk management — avoid the former and implement the latter. 

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One should take a similar view of volatility. Volatility in and of itself is not risky.  In fact, it represents opportunity.  Simply put, if prices didn’t change there’d be no possibility for profits. 

This doesn’t mean going headlong or blindly into the most volatile asset classes.  The level of risk and volatility to embrace is your personal choice, depending on temperament, financial situation, and goals.  I’ve discussed how I generally avoid the momentum or meme names and stick to larger, more mature, and generally-profitable companies. This is basically a function of my trading style where I use spreads, and make adjustments to harvest premium through time decay and grind out singles rather than looking for home runs. Basically, I’m more comfortable being a HIMI (Happy I Missed It) trader than one driven by FOMO (Fear of Missing Out). 

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One way to embrace volatility is to think of it as the school principal who forces everyone to behave.  Or, at least be thoughtful about the size and nature of risk we’re undertaking. Are you willing to assume the consequences if you’re caught doing something “wrong?” 

If not for volatility, the fluctuation and drawdown, the pain of seeing dollars on a screen disappear, then premium returns over the interest rate on a checking account wouldn’t exist. That’s where the term ‘risk premium’ comes from. If there is no volatility there is no risk. No risk, no premium, or potential for profits.  

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About author

Steve Smith

Steve Smith have been involved in all facets of the investment industry in a variety of roles ranging from speculator, educator, manager and advisor. This has taken him from the trading floors of Chicago to hedge funds on Wall Street to the world online. From 1987 to 1996, he served as a market maker at the Chicago Board of Options Exchange (CBOE) and Chicago Board of Trade (CBOT). From 1997 to 2007, he was a Senior Columnist and Managing Editor for TheStreet.com, handling their Option Alert and Short Report newsletters. The Option Alert was awarded the MIN “best business newsletter” in 2006. From 2009 to 2013, Smith was a Senior Columnist and Managing Editor for Minyanville’s OptionSmith newsletter, as well as a Risk Manager Consultant for New Vernon Capital LLC. Smith acted as an advisor to build models and option strategies to reduce portfolio exposure and enhance returns for the four main funds. Since 2015, he has worked for Adam Mesh Trading Group. There, he has managed Options360 and Earning 360, been co-leader of Option Academy, and contributed to The Option Specialist website.