Volatility is a friend, not foe!
Investors are afraid of volatility in the stock markets as they assume that volatility is an enemy of their investments. But considering that volatility—that is, fluctuations in stock prices—creates opportunities for profit, the notion that volatility is an enemy of investors is erroneous. In fact, one can say that reasonable amount of volatility is a friend of investors. If stock prices were to remain constant for months like prices of consumer goods, there would be no incentive to investing in equities. After all, investors don’t invest in consumer goods! Volatility in stock prices provides incentive to the investors to invest in stocks, but if stock prices remain constant, there would be no such incentive to invest and, therefore, there would be no stock markets in the first place!
Of course, extreme volatility can damage the financial health of the trader/investor who gets caught on the wrong side of the trade. So, if an investor has gone long on a stock and if the stock price crashes 10% on a single day or 30% within a week, the trader/investor may suffer a huge financial loss if he/she has not put a strict stop loss. On the other hand, if a trader has gone short on a stock and if the stock price shoots up through the roof, the trader faces the prospect of a huge loss. These are the perils of extreme volatility that an investor/trader has to live with. But overall, volatility is good for the investors and the stock markets. In fact, it is the raison d’etre of the stock markets.
When we skim headlines about equity investing, we get the impression that volatility is absolutely the worst thing for investors. Like for the last month or so, the stock markets have been quite volatile and anchors of business TV channels generally have long faces. The headline-writers always assume that since the equity markets are oscillating sharply, dropping on more days than they rise on, it's a bad time for investors. And surely, there must be investors for whom that is true. The crowds of punters whose success or failure depends on correctly predicting what will happen from one day to the next also suffers. But is there any investment strategy that is available to the ordinary saver, which will bring in the gains of equity investing, and yet actually gain from volatility? Is there an antifragile investing strategy that you and I can use?
Of course there is, and it's something that smart mutual fund investors are already practicing. I am talking, of course, about SIP (Systematic Investment Plan). SIP is based on the idea of averaging your investment cost over time and it's the simplest and yet most effective technique of benefitting from volatility. You invest a constant amount every month and keep doing it for a long time. When the markets drop, stock prices are low and so are the NAVs of equity mutual funds. Therefore, the sum you invest gets you more units of the fund. Eventually, when you redeem your money, all units fetch you an equal amount. However, your gains are higher because of the volatile periods, when you were able to invest at a low price. That's antifragile--actual benefit from volatility.
SIP gains depend on the long-term, gradual rise in equity prices, punctuated by periods when the markets are volatile or it drops. It's a supremely antifragile investing strategy. You make more money precisely because markets are volatile. If, hypothetically (it never actually happens), the equity markets rose by a constant amount every day, then there would be no advantage in SIP investing.
SIPs are essentially a psychological trick to keep investing regularly, regardless of whether the markets are up or down. It's the routine that locks investors into an inertia which turns out to be of benefit to them. The antifragile nature is a hidden advantage that proves beneficial over time. When one looks at investing with this fragile-antifragile mind frame, it is immediately obvious that short-term trading of equities (or derivatives) is the ultimate in fragility and long-term SIPs is the ultimate in antifragility.