It's imperative to be prepared for the risks that come with investing during uncertain times. Photo / Getty Images
It's imperative to be prepared for the risks that come with investing during uncertain times. Photo / Getty Images
COMMENT:
Following a month in lockdown at alert level 4, New Zealand has finally shifted to level 3 – bringing with it (slightly) fewer restrictions, and more potential waves of market volatility.
While many may see this as an opportunity to diversify their investments beyond KiwiSaver and the property ladderor want to take advantage of the pandemic's fallout.
As with all investments, those looking to enter the market should assess the risks as part of their own individual strategy.
Although trading and investing have a number of differences, both share a common goal - generating a significant market return. The nature of trading activity (higher volume and frequency, thrives on volatility), means there's a deeper pool of acknowledged principles - some of which can be applied to investment in general.
Here are four key lessons new Kiwi investors can learn from trading experts:
Every seasoned trader knows it's a long game – but when it comes to high-risk environments, a trader can make impressive gains and significant losses within a matter of seconds.
It's inevitable for most, so in order to not get ousted from the game, capital preservation is crucial. The key to this is diversification, across and within asset classes, so you can minimise the impact of losses when they occur.
Successful investors invest in themselves first. That's why it's advantageous to study and get familiar with a range of derivative instruments such as futures, options and "contracts for differences" (CFDs) in order to have more portfolio protection choices.
For example, the surge in market volatility due to Covid-19 has resulted in options being considerably more expensive than before. Whereas on the other hand, futures over major global indexes and CFDs on stocks may offer capital preservation opportunities.
As was the case in the 2009 global financial crisis, the NZ dollar has again weakened due to the pandemic uncertainty and market sell-off. This drop could still provide an opportunity to hedge NZ dollar exposure and benefit from any rise in the US dollar on a portfolio - i.e. owning offshore assets in the US stock market will benefit from falls in the NZD/USD rate.
Be flexible and adaptable
Traders generate profit or loss in real-time, so ignoring changes within the market environment is not an option. If a trader ends up with a losing position in a stock, they can't just hide it by disregarding the loss. That's why flexibility and adaptability are such critical attributes in trading.
When it comes to severely disrupted environments, like the one we're experiencing right now, success stems from accepting fluctuations in conditions. Doing so allows traders to adjust their approach and strategy accordingly – and investors should follow suit. A failure to adapt may have significant (potentially catastrophic) consequences.
Michael McCarthy is the chief market strategist at CMC Markets.
Take dividend yields for example. Before Covid-19, New Zealand had a relatively stable market environment and low interest rates, so dividend levels were a key decider for Kiwis looking to invest, particularly for those who were seeking income. Now, companies may potentially cut dividends due to earnings drops, and therefore reliance on dividend yields could mislead and trap investors.
Exercise patience and discipline
Reducing position sizes is a technique traders use to reduce risk during high volatility. Kiwis who want to invest under these uncertain conditions can do so, but diving in all at once is a higher risk approach. Buying portions of stock at a desired price over a period of time, instead of in one go, reduces buyer risk and offers flexibility.
This strategy requires patience and discipline, two virtues of great traders or investors. Days, weeks or months could pass where no trading opportunities align with your plan – but it's important to exercise discipline and patience. Then, when the right investment opportunity does fall into your lap, you'll be able to take full advantage.
Even the top traders can't predict the future, which means at some point you're also likely to make a mistake that leads to a loss. Successful traders understand that focus should be on minimising the impact of losses, rather than avoiding them altogether. Making money requires taking risk, so planning in advance for the worst-case scenario is important to generate higher returns in the long run.
Test the waters
When working the markets, Kiwi investors might find themselves on an emotional rollercoaster – which can be a huge risk to investment success. As soon as real profits and losses are added to the equation, greed and fear can blind one to danger and result in poor decision-making.
These days, trading simulators spark a common beginning for many traders around the world, including in New Zealand. Practising trading on demo accounts is a safe and risk-free way to learn the ropes on a wide range of financial instruments, before committing actual funds. However, the game changes when real money is on the line.
Once you're ready to transfer your skills to the real world - and especially if you're looking to do this while Covid-19 is hitting the markets - remember to not let your emotions rule, and avoid trading blindly by acknowledging the defeats in your portfolio. The best investors are those who accept sunk costs, and don't look back.
- Michael McCarthy, chief market strategist at CMC Markets APAC
