Money

What is Market Volatility?

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We hear plenty about the high volatility of the markets, but just what does that mean? And how does it impact your investments? Learn the ins and outs of market volatility and how it relates to your financial health.

Defining market volatility

Market volatility is a common term thrown around the financial world. Essentially, it describes a time when security markets — think: the stock market and other outlets where assets are sold and traded — experience unpredictable price movements. When prices drop, many people focus on volatility, but volatility can also refer to quickly rising prices or any time of heavy price fluctuations. 

Tracking market volatility

If you're a math whiz, you can calculate stock market volatility on your own using variance and standard deviation. But what you need to know is that the more prices stray from the standard deviation of price change, the more volatile a market or portfolio will be. 

Known as the "fear index," the Chicago Board Options Exchange's Volatility Index (called the VIX) tracks expectations of stock price movement on the Standard & Poor's 500 (S&P) for the next 30 days. The S&P 500 has an average daily movement of 0.66%, so any changes greater than 1% strays from the norm. 

The greater the stray or the sheer number of days outside the norm, the more severe the market volatility.

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What's normal in a market setting?

Stocks don't stay steady all the time. The mid-2010s were a time of low market volatility, so it was a bit new for some investors when the S&P 500 movement started creeping back toward historic averages of about 15% standard deviation. 

While standard deviation numbers dropped below 10% in recent years, the movement back towards a historical average is, well, average. Still, changes in the market get people talking and speculating, so if the standard deviation in prices fluctuates beyond historic averages, it could lead the markets into a time of volatility. 

What causes market volatility?

When it comes to buying and selling securities, investors and traders respond to various factors. We see the most volatility when the unexpected happens. That's when people look for a change. That can often include selling off stocks before what they think may be a sudden drop in value. 

Here are a few common sparks that cause market volatility:

  • Economic uncertainty: When economic data surprises people, whether through a poor jobs report or unexpected inflation data, it can spark volatility. If investors were banking on a particular set of consumer spending data only to see the information turn the opposite way, it could send some people to sell and others to follow in their wake. 
  • Political instability: The government sets policies across the economic sector, and deviation from expectations can cause surprise — even alarm — among investors and kick-start a period of volatility. Changes to trade agreements, tariff rules, and many other policies provide investors with cause to buy or sell in heavier-than-planned ways. 
  • International developments: The American economy is closely tied to the international economy, so major changes in the international markets or economic situations can impact the United States. 
  • Individual factors: Even if the larger market remains relatively stable, individual companies commonly experience volatility in their value. A better-than-expected sales report can send prices higher, while a significant public relations nightmare can send stocks falling. When this happens to large companies, it hits harder than with smaller companies since more investors hold those stocks. 

What to do when market volatility hits

First, remember you're playing the long game when it comes to investing. While the downward swings can be brutal to watch, the nature of a swing generally sends it on an upward trajectory at some point. Every individual stock or portfolio is different, based on the companies held. 

Still, history shows that when stocks fall more than 20%, the best time to reap gains is during the immediate 12 months of recovery. Sticking with a long-term focus allows the volatility to even out over decades. 

In any investment situation, employ diversity. So, if all your money is in a highly volatile market, you may want to consider finding safer places for some of your money. If you're nearing the point of needing that money right away and you can't afford to play the long game, consider different investment options for the short term to stave off any risk of volatility. 

Keep in mind that certain investments in your future, such as a life insurance policy to protect your dependents, don't get swayed by market volatility

As you age and your investments grow, you'll want to continually reassess your investment situation, track your assets, and tweak where you invest your money, all while keeping a healthy emergency fund in place. 

The opportunities of a volatile market

If you can invest new money into the market, a volatile market can present opportunities. If prices have dropped, you'll be able to purchase stocks at a lower price and reap the benefits if they make a return to previous benchmarks. 

As with any investment, there's an element of risk associated with your decisions, but if you're able to be patient, buying the right shares and funds during market volatility can yield quality results.

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