Let us not beat around the bush: Chinese assets can be extremely volatile and as 2020’s price action when it comes to pretty much all asset classes made clear, it hardly represents the only asset category susceptible to extreme volatility. It just so happens that just like with everything else, there tends to be a pit of a pecking order with respect to volatility and in that equation… yes, Chinese assets can sometimes be on the overly volatile side.
Is volatility good or bad?
For the most part, neither.
Investors and especially traders have a bit of a love-hate relationship with volatility because on the one hand, wild price swings enable savvy economic actors to position themselves properly and do very well if the market moves in the direction they had anticipated.
Let us start with investors. As far as they are concerned, volatility makes it possible to snag bargains by pulling the proverbial trigger when everyone else is panicking on the one hand and on the other hand, the same volatility enables them to exit the market when they notice what Schiller/Greenspan would call irrational exuberance.
What about traders?
Take everything that has been stated about investors and add leverage to the mix. Leverage which can, of course, make it possible for said traders to increase their profits if they are on the right side of a certain trade but the same way, it can get the very same traders into margin call and ultimately forced position liquidation territory if they are not.
To take things to the extreme, an investor who simply buys and holds without using leverage can theoretically ride a position indefinitely and as long as the price of the asset in question doesn’t go all the way to zero, the investor cannot be liquidated. As such, especially when it comes to extremely (even compared to Chinese assets) volatile assets such as bitcoin, there have been investors who let’s say bought at the very worst possible time back in 2013 (at $1,000, for example) and held through a depressing downturn that saw prices flirt with the $200 zone but survived, with prices then moving strongly north, all the way to the $20,000 area in 2017. Even if they didn’t sell anything at $20,000 and even if prices are still quite a bit south of $20,000, any investor who bought the proverbial top back in 2013 is still sitting on career-defining profits.
On the other end of the spectrum, pretty much any leveraged trader who bought the same top in 2013 would have been liquidated well before prices came even close to the $200 area and therein lies the difference one needs to understand with respect to leverage.
The exact same principle is valid with Chinese assets.
Volatility can be great if your bullish or bearish hypothesis ends up being proven right but it is crucial to ask yourself what were to happen if things unfold in an unfavorable manner? Deploying prudence when choosing how much leverage to deploy or even when deciding whether to use leverage at all is the operative attitude, especially when it comes to assets that can be quite volatile… such as yes, Chinese assets. Even if we are not exactly in cryptocurrency-level volatility territory, being prudent so as to protect your capital represents a more than necessary first step.
Does this mean one should not use leverage at all for volatile assets?
Of course not.
It simply means that, more so than when investing in “safer” assets, it makes sense to tone it down a notch when deciding what your leverage-facilitated profit expectations are. Otherwise, and this happens time and time again, it will matter little that you were right and that your vision ultimately materializes in the long run if you ended up being liquidated before that happened.
Remember: it is one of the most common misconceptions in the investment world that by being right, you will automatically be profitable. Time and time again, overly-ambitious investors who were indeed right with their underlying hypothesis were completely wiped out due to the fact that greed got the best of them. To put it differently, they had so much in the way of conviction that they went overboard and chose to trade in an over-leveraged manner… a scenario that rarely ends well.
At the end of the day, the conclusion is a fairly straightforward one: in light of the fact that Chinese assets aren’t exactly the least volatile option in the world, it makes sense to be even more prudent when handling the leverage bar than with other assets. Being ambitions can be excellent in the right dose but the same way, it can bury your career as an investor and especially trader far sooner than one might think.
Therefore, always understand that capital preservation needs to be your number one priority. The more investing/trading books you read and the more successful investors and/or traders you follow, the more you will be exposed to the idea that being humble is the way to go. It is precisely humility which will enable you to keep your expectations in check and it is precisely humility which should compel you to see the big picture: the fact that you do not have to generate retirement-facilitating profits through this one trade exclusively and on the contrary, that there will be far more equally juicy trades where the current one came from.
Yes, it is a metaphor so overly-used that is almost lost any and all meaning but it bears repeating in this one instance: especially when investing in or trading volatile assets, understand that you’re in a “marathon” rather than “race” situation and that capital preservation is a goal that is pretty much always worth the price (in missed opportunities), especially in the long run. Your career is measured in years or even downright decades, most certainly not merely in days or months and with that stated, we wish you the best of luck and are at your disposal should you be interested in our help with your investing and/or trading career.