Volatile markets are a problem, but only if you don’t know how to trade them.

Unless you have a plan that you’ll actually execute when volatility kicks into high gear, you’re going to struggle – and you may do something you’ll regret.

While there are lots of ways to trade volatility itself, some of which I told you about a few weeks ago, there are only a few ways to play volatile markets.

Many investors are stricken with panic when it comes to the thought of losing stocks they love; I get it, it can be scary. But you don’t need to panic; you can own great stocks at much lower prices, and you can buy more of them.

Here are the three key things to remember when trading volatile markets.

Patience Is a Virtue
There are two types of investors in this situation; you’re either one, or you’re the other. You are either ready to be patient during volatile periods, or you aren’t.

On one hand, if you’re a long-term investor – meaning you have a time horizon of at least three (but preferably five) years – before you even think of selling stocks, rebalancing your portfolio because your life needs are changing, or you want less equity exposure and more fixed income to live off, don’t do anything when volatility rears its head.

Of course, that’s assuming you love your stocks. And by that, I mean you’re loyal to the companies you own.

You’re loyal to those companies because you love what they do and how they do it, they have tons of loyal customers, they have tons of revenue, and they’re seriously profitable. That’s love.

Those are the kinds of stocks you should own for the long haul, for retirement, and for real wealth creation.

If you love your portfolio because you own those kinds of companies, don’t worry about volatility. Don’t do anything when volatility scares everyone else. It’ll pass, and stocks will keep going up.

The only thing to think about if you own stocks you love is if you’re going to add to your positions when the market becomes excessively volatile. Embrace volatility and add to your positions when everyone else is freaking out over how volatile the markets become, and how it’s suddenly dropped.

On the other hand, if you are afraid of the market, if you don’t have a long-term hold plan, if you are one of those types of investors who react by doing something when you feel you must, here’s what you should do when volatility scares you.

First, understand that volatility is a two-way street. If you’re afraid of it because you’re afraid it will knock the market down and your portfolio and fortunes with it, that’s valid. It can do that.

But volatility, especially when it knocks markets down hard, can be your best friend. That’s because it can give you great entry points to buy stocks or add to positions you already love.

My “protection mode” is and always has been the same. I have stop-loss orders in place on my stock positions. Even though I have stocks I love, I still use stops. That’s not because I’m not an investor, it’s because I’ve been a trader for more than 35 years; it’s what I do. I’m comfortable trading out of stocks I love because I know I’ll get back in.

The stocks I love regularly go up in price. And because I use stops, I have to adjust my stops higher as the stocks I own go higher.

I use technical analysis to figure out where I want my stops, and you should try to do the same. If you’re not comfortable with technical analysis, you can use “percentage bracket stops.”

There Is Science Behind It
On the technical side, I look at where the best, closest “support” is as a stock rises. If support is close to where my stock is trading, I’ll go down to the next support level and put a stop there.

There are only two bad things to consider when using stop-loss orders. Number one is that you get out too soon or too often, in which case your stops are “too tight.” And the other bad thing about stops is not getting back in when you get stopped out.

Instead of using technical analysis to figure out the best place to apply your stops, you can look at your stocks and figure out how volatile they are and how much they move up and down in a month, in a quarter, on average, and in percentage terms.

If your stocks trade within a 5% range up or down (or even up to 10% to 15%), use a stop at the lowest level of the percent range as your stop.

As your stock goes up, past the upper percentage range it’s been trading within, raise your stop up to the next level, which now may be what the upper bracket of the previous percentage range bracket was.

There’s some science (and a whole lot of luck) in having the right stops, not being hit when you don’t want to be, and getting out on a stop when it was the right move to make at that time.

The other bad thing about stops is that they take you out of some great positions, and you might not get back into the stocks you loved after the volatility passes.

That’s why you always have to have a plan to get back into the stocks you love when the coast is clear. Here’s what I mean…

Panic Selling Always Passes

The coast is clear for different stocks at completely different times.

Some stocks lead the market back, and while the market may still look scary to you, some of the stocks you loved are going up because there are lots of other investors who love them.

So, have a plan to get back into your good stocks as soon as you get stopped out.

My plan is always simple. If I get stopped out and I think the coast is clear for the market or for my individual stocks, I buy back into them as they start going back up.

If they go back up quickly and they are higher than where I got out, that’s fine with me. I’ll try to get back into them at a dollar or two higher than where I got out.

Then I’ll put down another stop at wherever the new support is.

But that’s buying back in on a big market dump after you’ve gotten out on your stops, and that’s huge.

You can make a lot of money ringing the register on the way down when you get stopped out and apply that capital a lot lower by buying the same stocks you loved at much cheaper prices.

My plan is to feel out the panic, and I love it when there’s panic selling.

If the market sells off because there’s lots of panic and the financial news takes over the regular news hour on all stations, that’s when I tune in.

It’s a gut thing for a lot of traders – for me, too, sometimes. But more often than not, I’m doing my analysis and expect the panic to subside and some bottom fishing to begin.

But you don’t have to catch the bottom; you just have to get back in when you are scared.

That’s the best time to get back in after a big sell-off.

Here’s the thing: If you get back into the stocks you love at prices a lot lower than where you got out, after you rang the register, you’re already a winner – a big winner.

You’ll own great stocks at much lower prices, and you can buy more of them.

Panic selling always passes. If you’re back in early, so what? As long as you’re back in, you’ll be happy.

That’s how I play volatile markets with stocks I love.

— Shah Gilani

Source: Money Morning