Understanding the role of volatility in market
It has been an age old saying that over a long run market is an instrument which transfers money from the pockets of impatient to the patient ones. Hence every move in the market doesn't need a course correction move from an investor, in fact I would even argue that most of the movements in market indices over a short term shouldn't even attract any attention from an investor. Volatility by its very virtue is a short term affair, that is, it can last for weeks or months but definitely not beyond that. Thus an investor should ride it out with calm and in fact take advantage of it.
What's wrong with the investor mindset and why not to follow market experts?
A lot of experts, brokerage houses, financial advisors advice people to sell their investments in volatile market and advice them to convert stocks into cash. However, given no market expert/financial-advisor/brokerage house has ever predicted volatile markets in advance, by the time these so called experts issue their advice, the markets have already come down significantly (a side-effect of volatility). Post which conversion into cash just materialises the losses from being on paper to being in reality. I would in fact argue that a lot of such short sighted selling decisions based on volatility exist because we consider equity investments as a one night stand versus a long term relationship, in other words we seek thrill from our investments rather than understanding that it is a part ownership in the business.
If a stock falls due to market sentiment and/or volatility, it has nothing to do with the intrinsic value of the business. Also, while making the investment into a stock (taking part ownership of business) an investor should believe in his/her decision. An investor should panic and do research "before" investing into a business rather than doing it "after" his/her investment. That being said, I am not saying that investor shouldn't keep a track of the company after investment is made, but then majority of the research should go into making the decision of purchasing that stake i.e. buying that stock [learn how to pick market winners]. Thus if you have invested in the right business and the stock falls due to volatility, it just presents an opportunity of buying a good business at discount. Consider you own a house, will you immediately sell your house if the property prices in your area have come down for a year or two? I guess not, so why to sell your ownership in a quality business. Volatility can really harm those investors who do not know why they invested in a business, and/or have invested in a business without making their own analysis. However, for investors who make choices based on research, volatility in market is an opportunity. That being said, I will now discuss below how to take advantage of volatility below.
Understanding and taking advantage of volatility
Understanding Volatility: Market volatility is majorly driven by sentiments of the masses. Although it's easier to assume that most of the investors are sane and make informed choices, however in reality it is not true. Markets seldom reflects the true value of an economy and are often either overly optimistic or pessimistic. Most of the investors make buying/selling decision very fast, as fast as right/left swiping someone on a dating app. Investors fundamentally don't like researching their investments and believe their friends or so called market experts who themselves wouldn't have invested in a stock. Guess what, most market experts on national television or commercial investment tracking websites are happy to recommend a stock on national television, just because it is their daily job [learn why following market experts is not good for you] .What else can an investment channel do in order to broadcast content 24x7x365 days? Thus when majority of market investors follow the herd mentality, the market behaves irrationally as well. A small panic event can trigger mass hysteria and make entire market replicate that madness. This mass stupidity is exactly the best ally of a smart investor. He/she should sell stocks when there is over optimism and should buy quality stocks when their is blood on the street (last line is inspired from Warren Buffet). Volatility is that time where market is swinging from being overly optimistic to overly pessimistic and vice versa. Volatility never seizes when market reaches to its true value. Also, please understand that volatility never leads to a stable end point, i.e. the level of market at then end of volatility is a temporary state and then markets will again gradually recover towards it's true value/stable state. Hence, if an investor tried to time volatility, he/she may be in for a losing game. Rather, an investor should sit back and ignore most of the volatility in market and take advantage by making informed choices.
Volatility is sometimes predictable: Although no one can predict market volatility with 100% accuracy, but then there are triggers and symptoms which an investor can notice to predict an oncoming volatile season. These triggers are elections/new governments, major trade wars between powerful economies, a sharp rise/fall in any big global market index etc. As you can see, none of these events directly can change true value of a company overnight, thus, the movement in the price of your stock is also not a true reflection of your stock's worth. Thus, if the movement has made your owned business over-valued, you can book some profits and if it has made your owned business under-valued, you can gradually accumulate some more stake at a discount.
Have a war chest of 15-20% of your total portfolio's worth in cash: In order to take advantage of volatility, especially when it makes market bleed, an investor should have surplus cash ,large enough chunk to bring overall investment price of his/her portfolio down if he/she makes purchases during volatile times. This war chest should partly be kept in cash all the times (as you never know when an opportunity might come at door) and should also be build as a temporary stockpile by predicting upcoming volatility.
What to do and not to do during volatile times? Never sell your investments at losses just because overall market has come down. For a novice investor, I would suggest not to take any action during volatile times as they might panic. However for an average investor, I would suggest that if markets are getting over-valued, sell stocks which are over-valued (looking at current P/E vs. median P/E and/or profits accumulated) and buy quality businesses available at a bargain (check out our stocks at bargain section).
Thus our primary learnings here are to take advantage of volatility and accept it as a regular part of market cycles. Most of the times volatility is something which an investor should just ignore and cut it off like a background noise. Make sound investment decision, trust your decisions and take advantage of volatility if possible :)