How Can We Know If The Market Has Low or High Volatility?
We live in a world where people are bored, impatient and emotional. It shouldn’t come off as a surprise that these traits can be detrimental when it comes to investing. Many of us are trying to compress the required time horizon by fiddling with more knobs in hope to produce higher returns. The problem is with more levers that we pull, the higher the odds of something, at some point, will cause us to second-guess ourselves. More often than not, it is the off chance that we’re right once or twice that hurts us. It is in our first-hand successful experience that gives us a false sense of forecasting confidence. It is easy to confuse skill with luck and take personal credit for what works and claim to be a victim of what doesn’t.
We tend to mistake luck as skill which increases confidence, but not ability.
This is where technical indicators such as Bollinger Bands (BB) come into play. When you include the usage of BB into your technical analysis, it motivates you to do less and wait more. Similar to the RSI Indicator and Moving Averages Indicator, simply go to any price chart comparison sites such as TradingView, key in the stock that you’re keen in, look for “Indicators” on the top, type Bollinger Bands and click it. Now that this is out of the way, let’s dig into how it works. There are three lines that compose Bollinger Bands: A simple moving average (middle band) and an upper and lower band. The upper and lower bands are typically 2 standard deviations +/- from a 20-day simple moving average, but can be modified according to your desired timeframe. As standard deviation is a measure of volatility, when the markets become more volatile, the bands widen. Conversely, when the markets are less volatile, the bands contract.
Similar to RSI, a common way to use BB is to identify overbought or oversold market conditions too. The closer the prices move to to the upper band, the more overbought the market is. It is a good time to consider a pullback. Similarly, the closer the prices move to the lower band, the more oversold the market is. It is a good time to consider a bounce. Ideally, you should be considering to sell (and not buy, duh!) when the prices are nearing the top and considering to buy when the prices are nearing the bottom of the bands. Most of the time, price action will stay within the bands, but there will be moments when you notice that it breaks above or below them. While this is an indication of extreme market conditions, kindly note that this is not a trading signal in itself and you’re supposed to use other indicators to aid you in making a more informed decision.
In my humble opinion, the game of investment focuses less on occasional great decisions and more on consistently avoiding the blunders that move the needle even more. The exciting part shouldn’t come from witnessing how high an asset’s price has gone, in fact that scenario should be characterized as unsurprising and very much expected. The timing isn’t predictable, but the occurrence is foreseeable. The exciting part should come from spotting things at a discount and buying them cheap.
Many of us feel that we have a high risk tolerance when things are going great.
You feel on cloud nine when everything is in the green, but when you see a 50% market decline, how do you actually feel? Be honest. In reality, everything in your world is the same except for the fact that stocks are 50% cheaper now. When words such as a brutal recession, a political meltdown and pandemics are plastered all over newspapers, it is the opportunity to exercise your high risk tolerance. You’ll be surprised at what you will or will not do then. Many of us will be in doubt. Here is the thing about surprises, we only truly learn something when we’re genuinely surprised. We don’t learn very much when we read the correct answer or are told that we’re doing something wrong. We learn better when our jaws hit the floor.
