There is constant movement in the stock market. Their indexes experience gains and losses each day. However, there are times wherein the market has dramatic price changes. The phenomenon is called volatility. For securities markets, significant swings usually define volatility, whether upward or downward. If the stock market has a high or low of more than one percent within a sustained period, it can be considered a volatile market.
Understanding market volatility
Volatility measures the dissemination of returns in a given security or market index. Also, it refers to the amount of uncertainty or risk linked with the size of fluctuations in an asset’s value. Most of the time, a higher volatility level would mean riskier security. On the other hand, lower volatility levels would mean that the value of a security does not fluctuate sharply and is likely to be steadier. The standard deviation or variance between returns from that particular security or index could measure it.
A market’s volatility is determined by how big and frequent its price swings are. However, it is a normal part of investing and is commonly in portfolios. According to experts, investing would be a piece of cake if markets’ movements were always upward. As a result, everyone will be rich.
Measuring market volatility
Market volatility can be measured by determining the standard deviation of price changes at a particular time. Its statistical concept will let you see how much something differs from the average value.
Standard deviations tell you how big of a change a value can have and give a framework for the times it can happen. Usually, traders calculate standard deviations of market values on closing trading values, value changes in a trading session, or forecast future value changes.
Normal market volatility level
If you are an investor, you can expect to see a 15% volatility level from average returns in a given year. About one in five years, anticipate a downward motion in the market by 30%. But if you cannot handle that type of volatility, it is not recommended that you should be an equity investor since that is the average.
The stock market tends to be pretty calm most of the time, dispersed with shorter periods of above-average market volatility. Stock prices do not constantly bounce around because there are extended periods of dullness followed by short periods of drastic changes. These scenarios alter average volatility to higher-than-normal levels.
Tips on handling market volatility
There are several ways of normally reacting to your portfolio’s upward and downward movements. But based on experts, you need to steer away from panic selling after a sharp market drop as much as possible.
You can try some of these approaches if you ever need to deal with market volatility:
Create a long-term plan
Investing is a long-term game; portfolios were built with time periods like this in mind. If you need to use your funds after just a short term, it is not recommended that they be in the market since volatility can affect your chance of withdrawing them quickly. For goals in the long run, volatility is expected to be a part of your growth journey.
Since there are high possibilities that you will face market fluctuations, coming up with a long-term plan can help you go through with it with fewer worries.
Take it as an opportunity
To handle fluctuations in a way that is easier for your mental state, think about how much stock you can purchase while the market is bearish. For stocks known to be strong in the past few years, market volatility can give you a chance to buy them at discounted prices.
Strengthen your emergency fund
Unless you need to liquidate an investment, you will not find market volatility a problem because you can be forced to sell securities in a down market. Having a solid emergency fund worth three to six months of living expenses is essential for investors. Emergency funds can come in handy when clients do not want to worry about selling down investments to earn cash, giving them peace of mind.
This would be more important for individuals who are close to retirement. They need to plan a more extensive safety net for up to two years of non-market-related assets. These include bonds, cash, life insurance, cash values, and home mortgages. According to a financial advisor, you can pull money from those when the market is down while you wait for it to recover before withdrawing from your portfolio.
Market volatility can dramatically change investment values, meaning your asset allocation can swerve from your goal divisions after multiple changes in either direction. Rebalancing your portfolio in times like that can bring it back in line to match your investing goals towards the desired risk levels.
When rebalancing your portfolio, try selling some of the asset class that turned into a more significant part of your portfolio than you would want, then use the funds to purchase more of the asset class that shrunk. Remember to rebalance when your allocation turns away by 5% or more from your central target mix.
High market volatility can stress out investors as prices change wildly and suddenly. Long-term investors should shrug off short-term volatility periods and remain in the course since stock markets tend to rise in the long run. Emotional factors such as fear and greed can get exaggerated in volatile markets and negatively affect your long-term strategy.
Other investors consider the market fluctuations a chance to add to their portfolios by buying the declines as prices are more affordable. Using hedging strategies to negotiate volatility, like buying protective puts, can limit losses without selling shares. However, it would help if you remembered that put options could get more expensive with high volatility levels.
Suppose you can comprehend how it works. In that case, you can better understand the current stock market situation, assess the risks involved in a particular security, and build a stock portfolio suitable for your growth goals and risk tolerance.