In times of crises, investors are faced with two choices - either ride out the storm by holding onto existing assets or radically restructure one's portfolio to ensure any immediate loses are kept to a minimum. Giles Coghlan gives some guidance
This is by no means a simple decision to make. Investors need to determine the level of risk they are willing to take, the liquidity of their assets and their long-term financial goals.
Conservative investors among us - those who are pursing a low-risk, low-return investment strategy - would decide to hold on to their existing assets with minimal buying and/or selling activities. On the other hand, investors who make daily trades would no doubt be on the look-out for new opportunities that offer short-term gains.
In theory, it is easy to group investors into abstract categories. However, such behavioral models can quickly become irrelevant when investors are actually faced with volatile trading conditions."
In theory, it is easy to group investors into abstract categories. However, such behavioral models can quickly become irrelevant when investors are actually faced with volatile trading conditions. Panic can set in, leading to irrational and impulsive decision making.
Covid-19 certainly has investors nervous, and much of this is due to the fact that there are so many unknowns that they have to currently contend with. It is not known when, or indeed how, the health pandemic will be stopped and how long it will take for the markets to recover.
As a result, significant and sudden losses are being recorded across the major indices. In early March, the FTSE 100 Index suffered its biggest one-day decline since 1987, plummeting by 10.9%.
Even the most seasoned investors and traders look to have reason to feel slightly apprehensive. However, there is no reason to panic. In times like these, it is important to keep a level head and not let speculation distort from the facts. Suddenly, the decision between holding onto existing assets or restructuring a portfolio has become more complicated.
Having watched the markets closely over the course of the last year, there are two interesting observations that can be made concerning the price of safe haven assets and stocks and shares. Understanding how to purchase these assets in today's climate may help inform the strategies of investors managing the financial fallout from COVID-19.
When to buy safe haven assets
Anyone who professes to have a basic understanding of the financial markets knows that in times of instability, investors rally to safe-haven assets. As a general principle of trading, this is the type of behaviour witnessed time and time again. At the beginning of the year, the price of gold reached a seven year high as a result of escalating tensions in the Middle East and the threat of a regional conflict taking place. Investors rallied towards gold as a safe haven asset - pushing its price up.
However, there are more important observations to be made - at what point in time did investors begin flocking to gold? When did they stop? Why has the price stopped peaking and when is it likely to drop?
These questions show that one should not simply buy gold when the markets face uncertainty. There is no guarantee that gains can be made and there is the added risk of prices quickly dropping should the situation change.
One useful way of determining when it is the right time to buy gold is through the Volatility Index, or VIX for short. This real-time market index provides a 30-day projection of the expected volatility to be encountered by the world's major indices, measuring future risk and predicted investor behavior. Investors interested in gold should consider a purchase when the VIX falls. By tracking and identifying the points of correlation, history shows that a drop in the VIX is typically followed by a rise in gold prices.
Opportunities in the stock market
The stock market is an inherently complex and sensitive entity. Share prices are in a constant state of flux and can be extremely sensitive to political, economic and social events. For example, in the 12 months leading to March 2020, the FTSE 100 decreased in value by 27.3%. These losses were incurred primarily as a result of the economic fallout stemming from covid-19.
As we have seen in the past, the FTSE will no doubt recover from covid-19 over the long-term. The challenge is pinpointing exactly when this will occur. However, it also means that certain stocks and shares are trading well below their typical value. The FTSE has a strong track record when it comes to recovering from economic crises which is why some investors are looking to purchase undervalued stock in the hope prices will quickly recover.
For those willing to expand their shareholdings, it is important to find established companies with low debt, low price-to-earnings ratio and substantial growth potential. This is easier said than done, and naturally requires the necessary research and insight. The stock market is still volatile and there is nothing to suggest that the recent gains recorded are the beginnings of a long-term recovery.
Based on the performance of currencies, commodities and stocks and shares over the last few weeks, the above observations should prove useful in understanding the state of the financial markets. Of course, the situation is changing on a daily basis - at this point of time, we are not sure whether the pandemic has peaked or if cases will continue to rise. For now, at least, investors and traders must keep a level head and ensure the actions they take fit into a broader investment strategy.
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Giles Coghlan is chief currency analyst at HYCM - an online provider of forex and Contracts for Difference (CFDs) trading services for both retail and institutional traders.