The constant up and down movement of the stock market and securities is called volatility. In a more technical explanation, volatility is the measurement of how investments or a market index are consistently performing, either with its own average or compared to a benchmark.
Market volatility is a normal part of investing. While volatility is often associated with fear – like stock market crashes or economic downturns – it does not necessarily measure the direction. Instead, it measures how large the price swings are and can have both positive and negative connotations.
How Does Volatility Work?
The stock market typically has upward and downward movement. However, if it is moving more than normal it is considered a volatile market. Normal movement is defined by the average movement of the market over a set period.
While volatility can be discussed in regard to specific stocks, market volatility is referring to the movements of the stock market as a whole, or particular market indexes, like the S&P 500. If the index falls or rises more than 1% over a sustained period of time, the market is considered volatile.
Why Is It Important for Investing?
Understanding market volatility can help your investing strategy. First, it is important to remember that investing is a risk. There is always the potential chance for loss. But, that does not mean you should be checking the market daily and reacting to price swings.
Volatility is completely normal and for long-term investors should not create panic. However, if you are worried about market swings, you should work with your financial advisor to create a more conservative investment approach. For investors who are comfortable with the market swings, volatility can be a great way to improve your position.
When the market is higher than typical, and you are invested in the market, you’ll be happy to see the price swing in your favor. While on the flip side, if the market drops, you might be a bit concerned. However, instead of being worried, downturns are a great time to pick up stocks that will more than likely recover in the near future. And do not worry, the market has always bounced back.
How to Deal with Market Volatility?
There are a few ways that investors can deal with market volatility. The first is to do nothing. There is no need to panic buy or sell securities, so you can sit by and stick to your original plan. Stay invested and walk away from the news or other media sources that could cause you worry.
Market downturns are a great time to look at your portfolio to make sure you are fully diversified. It might be time to evolve your portfolio. Times of volatility are a great time to reevaluate and reassess, whether on your own or with your financial advisor.
Also, do not forget that you can use a downturn to be proactive and purchase additional securities when you are confident it will bounce back.
No matter what, do not make panic moves – either good or bad. Emotional investing can cost you in the long run. If you have questions or concerns speak to your financial advisor to help assess your investing strategy and decisions.
Is Market Volatility Good or Bad?
Market volatility can be good or bad, and it is inevitable. A volatile market, no matter how bad it may seem, will eventually rebound. There has never been a time in history when the market did not recover.
On the flip side, as an investor, you will never make money if the prices do not fluctuate. As mentioned above, in times of volatility, work with your financial advisor to assess and rebalance your portfolio if needed, but do not make any panic moves.
Is Risk and Volatility the Same?
Risk and volatility are not the same but, do go hand in hand. Volatility is how quickly or significantly the market changes over a period of time. Risk is the probability that this will result in a long-lasting or permanent loss of value.
How to Measure Market Volatility
On any typical day that the stock market is open, the prices are going to fluctuate. There are two different ways to measure market volatility: Volatility Index (the VIX) and Average True Returns.
Volatility Index
Created by the Chicago Board Options Exchange (CBOE), the Volatility Index (called VIX) measures the market index. It is a constant, real-time market index that represents the expectations for volatility over the upcoming 30 days.
Average True Range
Another tool to measure market volatility is the Average True Range (ATR). ATR calculates price movements by measuring gaps in the range of the market over a set period. It utilizes the difference between the low and high price of the market on any given day.
If you want to calculate ATR, you will need to utilize these three equations.
TR = True Range
H = Current day’s high
L = Current days low
C.1 = prior days close
Equation 1. TR = H – L
Equation 2. TR = H – C.1
Equation 3. TR = C.1 – L
If it is higher, equation 2 will show the volatility from the prior days close. If the market has been down, equation 3 will show the volatility.
What Are Indicators of Volatility?
Understanding the highs and lows of the market is a valuable analysis tool. There are several volatility indicators that can help you as an investor identify opportunities.
Beta
Beta measures individual asset’s volatility compared to the movements of the overall stock market. At the end of each trading day, the market will either be up or down. But utilizing beta allows investors to see how certain stocks compare to others based on market volatility.
Standard Deviation
Standard deviation is another way to measure market volatility. It measures how widely the prices are separated from the average price. As the market becomes more volatile, the standard deviation price will rise. A low return on standard deviation indicates low volatility.
How Do You Calculate Market Volatility?
Calculating market volatility can be done in a few ways. Many investors use standard deviation to calculate and measure it. Typically, analysts look at historical volatility – the measure of past performance.
To utilize this method, you need to graph the historical performance of the market by creating and generating a charge called a histogram.
No matter which way you choose to calculate market volatility, it is important to remember that past performance does not indicate future returns. This is only a way to have a baseline measurement of the investment risk.
Uncertain Times Are the Best to Lean on Your Advisor
When a time of market uncertainty comes, take a moment to pause and consider your strategy. It is unavoidable that the market will fluctuate. Market swings can be a beneficial time for you and your financial advisor to assess your risk tolerance and redefine your investment goals. Try to remain clear-headed and make strategic choices during any times of uncertainty.