How to use volatility to maximise your gains and minimise your losses

We’ve explained what ‘volatility’ means in practice. (see Revealed: the powerful effect of volatility on your investments, in four simple charts)

As the market rises and falls, the most volatile sectors go up and down the most – exaggerating the market movement. The least volatile sectors go up and down the least – dampening the market movement.

So how do we practically apply this knowledge to make more money from the markets?

Here we come to one of the key Saltydog concepts:

When the market is rising, you want to be in the sectors that are the MOST volatile.

And when the market is going down, you want to be in the sectors that are the LEAST volatile.

N.B. We are “long-only” investors, and so when the market is heading down we don’t concern ourselves with trying to short it – we simply reduce our exposure to the downtrend as much as possible.

Why is this?

Since you’ve just seen the charts demonstrating the effect of volatility, this concept should now be easy to understand.

When the markets are going up, you want to be in sectors which exaggerate that upward movement, for bigger gains i.e. the high volatility ones.

And when the markets are going down, you want to be in sectors where that downward movement is minimised, for smaller losses i.e. the low volatility ones. Or even, in extreme cases, out of the market entirely (in cash).

Obvious really, isn’t it?

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