What is Volatility?

When a market or asset has periods of unpredictable and sharp price swings, it is referred to as volatility. In general, indexes such as the S&P 500 gain or lose less than 1% per day. However, the market does experience major price movements from time to time, which experienced investors refer to as “volatility.”

In this article, we’ll cover all you need to know about;

1. What is volatility in the stock market?

2. What are the causes behind it?

3. What is the right level of market volatility?

4. How to handle market volatility?

What is Volatility in the Stock Market?

The pace at which the price of a securities rises or falls for a particular set of returns is known as volatility. It measures the risk associated with a security’s fluctuating price by calculating the standard deviation of annualized returns over a specified period. In simple terms, it’s a measurement of how quickly the value of securities or market indexes changes.

What Causes volatility?

Volatility can be caused by a variety of factors that include:

1. Political and economic factors

When it comes to trade agreements, law, and policy, governments have a big role in regulating sectors and can have a big impact on the economy. Everything from speeches to elections can elicit reactions from investors, affecting stock prices.

Economic data is also important because once the economy is doing well, investors are more likely to respond positively. Market performance can be influenced by monthly job reports, inflation data, consumer spending figures, and quarterly GDP calculations. If these, on the other hand, fall short of market expectations, markets may become more volatile.

2. Factors affecting the industry and sector

Volatility in an industry or sector might be triggered by certain occurrences. For example, in the oil industry, a significant weather event in a large oil-producing region might cause oil prices to rise. As a result, oil distribution-related companies’ stock prices may climb, as they are likely to benefit, while those with significant oil costs in their business may see their stock prices decline.

Likewise, higher government regulation in a particular industry may cause stock prices to decline as a consequence of enhanced compliance and personnel costs, which may influence future income growth.

3. Company performance

Volatility may not always be market-wide; it might also be specific to a single company.

Important news, such as a solid earnings report or a new product that is impressing customers, can boost investor confidence in the company. If a large number of investors are interested in purchasing it, the greater demand may help to drive up the share price significantly.

A product recall, data breach, or bad management behavior, on the other hand, can all cause investors to sell their stock. This favorable or poor performance might have an impact on the larger market, depending on the size of the company.

What Is a Reasonable Level of Stock Market Volatility?

Markets are subjected to times of increased volatility regularly. As an investor, you should expect around 15% fluctuation from average returns over a year.

“Every five years, you can expect the market to drop around 30%,” says Brad Lineberger, CFP, president and founder of Seaside Wealth Management in Carlsbad, Calif.

“You really shouldn’t be an equity investor if you can’t manage that kind of volatility, since that’s about common.”

The stock market is rather tranquil for the most part, with brief episodes of above-average market volatility. Stock prices aren’t always bouncing around—there are extended stretches of little movement, followed by brief spikes in either direction. These events cause average volatility to be higher than it would be on regular days.

Bullish (skyward trending) markets are known for their low volatility, whereas bearish (downward-trending) markets are known for their unpredictable price movements, which are frequently downward.

Lineberger explains, “This is how it works.” “And, if you can take it, you’ll be able to outperform inflation by about three times per year.” “Embrace volatility and know that it’s normal,” is my greatest advice.

How to Handle Market Volatility in Stock Market? 

1. Keep in mind your long-term strategy.

Investing is a lifelong pursuit, and a well-balanced, diversified portfolio was designed specifically for times like these. If you need money shortly, don’t put it in the market, where volatility can make it difficult to get it out quickly. But, in the long run, volatility is a necessary aspect of achieving big growth.

2. Take Advantage of Market Volatility

Consider how much stock you can buy while the market is in a bearish downward trend to help you mentally cope with market volatility.

“Volatility periods, especially in stocks that have been strong over the last few years, actually allow us to purchase these stocks at discounted costs,” says Freddy Garcia, a Naperville, Illinois-based CFP.

After nearly a decade of uninterrupted growth, you could have bought shares of an S&P 500 index fund for approximately one third of the price they were a month before during the bear market of 2020.

3. Maintain an Emergency Fund

Market volatility isn’t a concern unless you need to liquidate an investment, because you may be obliged to sell assets if the market falls. That’s why investors must have an emergency reserve of three to six months’ worth of living expenses.

If you’re nearing retirement, financial advisors recommend putting aside up to two years’ worth of non-market associated assets.

How to Get the Best Out of Market Volatility?

Once you’ve decided to try to profit from a turbulent market, you’ll need to think about your objectives. Here are some helpful hints to get you started.

1. Pay Special Attention to Trending Stocks

Since the market as a whole is volatile, the key to success is identifying specific stocks. In a volatile market, this will allow you to make quick gains.

2. Manage Risk

Trading in volatile markets entails risk, so be aware of this and be prepared to mitigate it. Risk can be managed in a variety of ways, from diversifying your portfolio to making smaller trades with less risk.

Is Risk the Same as volatility?

You might think that risk and volatility are the same things based on the definitions presented here. They aren’t, however.

Risk is only a prediction of loss — and, by extension, irreversible loss — whereas volatility is a prediction of future price movement that includes both losses and gains.

The two are linked. And when it comes to risk mitigation, volatility is an important issue to consider. However, combining the two could drastically limit your portfolio’s earning potential.

The Bottom Line on Market Volatility

Market volatility is common, and it’s understandable to be anxious. Seeing large—or even small—losses on paper might be frightening.

Finally, keep in mind that market volatility is a normal component of investing, and the firms you invest in will react to a disaster.

Investors who understand volatility and its causes may be able to capitalize on the investment possibilities it presents to achieve higher long-term profits.

Explore our other articles, videos, and infographics about investing through volatility.

Key Takeaways: 

1. Volatility is a statistical measure of an asset’s return dispersion. It shows how large an asset’s values move about the mean price.

2. Since the price of volatile assets is anticipated to be less predictable, they are often regarded riskier than less volatile assets.

3. Though volatility isn’t the same as risk, volatile investments are sometimes regarded as riskier due to their less predictable performance.

4. Volatility is a significant factor in determining option prices.