Volatility, Leverage and Risk in the Stock Market

June 4, 2010

Thanks to the planetary alignments of the current Stock Market Vortex, we are now in a time of extreme market volatility.

Whether you're making long-term investments or day-trading, whether you're involved in the equities market, option trading, commodities speculation, or FOREX, you've probably been experiencing market swings recently that leave you a little bit dazed and confused, if not completely paralyzed as you consider entering new trades.

If that's the case, you're not alone.

Whether you're using tools from W.D. Gann, doing Elliott Wave analysis, or exploring new concepts in financial astrology, this is a particularly dangerous time to trade.

That's why it's so important to take a clear look at the opportunities that are available to you, especially with an eye to the risks involved.

More market volatility means bigger price swings in shorter periods of time, so increased volatility is potentially a key to bigger short-term profits in the markets. But volatility also introduces a much higher level of uncertainty into the trading environment, so the big opportunities that present themselves are not always easy to take advantage of.

In recent weeks, as I have discussed the current Stock Market Vortex with a variety of traders, I've had a few conversations with individuals who were getting mixed up about leverage and volatility.

Although those concepts are related in some ways, it's especially important to distinguish between the two of them as we put together our trading plans.

Volatility suggests a tendency toward big price swings, whether it is in the markets as a whole or in trading an individual stock, commodity, or option contract. But volatility is not the same as leverage, and increasing the amount of leverage in your trading is not necessarily an appropriate response to an atmosphere of increased market volatility.

There are two basic strategies for using leverage in our trading: borrowing money to trade with through the use of margin, and choosing to trade option contracts instead of purchasing underlying stocks outright.

During the increased volatility of the recent weeks in the markets, I have spoken with some traders who have mistakenly felt that the best approach to this uncertain market environment was to borrow more money to trade with, and then to purchase multiple near-term option contracts, seeking the greatest leverage possible.

This kind of all-or-nothing mentality is an extreme form of gambling, and it really doesn't belong in a wise trading plan.

While you may personally choose to use margin or option contracts as a part of your own trading strategy, I would encourage you to do so quite judiciously during times of increased market volatility. While extra leverage can certainly increase the scale of your winnings in the markets, it can also be a trigger for bigger losses as well. In fact, it can put out of the trading business altogether.

The rule of thumb is to be consistent in applying rigorous money management rules to all your trading activities, whether or not there are high levels of market volatility. If you have a clear trading plan and stick to it, you are far more likely to come out of difficult trading conditions with at least some of your trading capital intact, giving you an opportunity to trade again another day.

Volatility comes and volatility goes; leverage is always a matter of personal choice; but clear risk assessment and rigorous money management are absolute necessities if you are going to find continuing personal success as an astro-trader.

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STOCK MARKET VORTEX VIDEO

There's a new update video online on the current Stock Market Vortex and some of the ways it is playing out in the markets. You can view "13 Winning Astro-Trades at the Stock Market Vortex" for free at http://www.financialcyclesweekly.com/public/909.cfm .

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VORTEX WEBINAR REPLAY

If you missed our May 14 webinar on the Stock Market Vortex, you can still take a look at the recording from this important live session. To gain access, sign up today for the replay at http://tinyurl.com/vortexwebinar .

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