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Three Ways to Profit From the Volatile Market

Stocks in this article: FAS SSO VXX

BALTIMORE ( Stockpickr) -- The added volatility that stocks have seen so far this month has been more than just headlines -- it's produced a palpable shift in the way investors are looking at the market right now. Enter the CBOE Volatility Index -- better known as the VIX. This index, which measures the implied volatility of S&P 500 index options, was nearly unheard of to most Main Street investors until 2008, when market volatility ballooned in the midst of bursting real estate and credit bubbles.

But while more investors are familiar now with the VIX, investing strategies for a volatile matter are a different story. To close that gap, here's a look at three investment strategies that can help you profit when market volatility is on the rise.

1. Check Your Allocation

The first step to profiting from volatility is to reassess your trading strategy. Whether you're a short-term trader or a buy-and-hold investor, there are ways that you can minimize the risk of holding on to stocks when the market's unstable.

As a short-term trader, volatility is essentially your friend. Increased volatility means that your trades will see higher-percentage moves in a shorter amount of time. The danger with that, of course, is the fact that being on the wrong side of that volatility can result in some crippling losses. Last Thursday proved that for many market participants.

One strategy for traders to consider is derivatives. Historically, derivatives plays were the only way to place a bet on volatility. And while new options have opened up to less-sophisticated investors -- more on those in a bit -- they continue to be an effective way to place a bet on volatility. Derivative volatility strategies (such as volatility arbitrages trades in options or buying VIX futures) are complicated trades, and the implications of making a mistake can be large. Only delve into these if you're confident in your familiarity with the trades.

But what about a strategy for longer-term investors?

In principle, volatility isn't supposed to matter for long-term investors. Holding an investment over a long time horizon essentially negates the short-term ebb and flow of the market. But in reality, few investors want to subject their portfolios to losses, even when times are bad. If you're considering reallocating your long-term portfolio for a volatile market, focus on stocks that have low betas (a measure of a stock's relative risk).

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