Market volatility

Market Volatility is an investment term that refers to instances when a market or security undergoes phases of uncertain and occasionally abrupt changes in prices.
Market volatility
3 min
04-June-2024

Market volatility refers to when a market or security experiences periods of unpredictable, and sometimes sharp, price movements. It measures the rate and extent of price changes in the market, indicating the level of uncertainty and risk associated with investments. High market volatility suggests that prices can fluctuate widely in a short period, while low volatility indicates more stable price movements.

Volatility is an inherent and inevitable aspect of stock market investments. It is essentially a measure of how much and how frequently an asset’s price fluctuates over a period of time. Sudden price movements can be attributed to a number of factors like political unrest, market speculation, geopolitical conflicts, or simply cyclical. In this article, we delve into the meaning of market volatility, how it is measured, and how to tackle it.

What is market volatility?

Market volatility refers to the frequency and magnitude of price fluctuations in the stock market. In simple terms, market volatility means the rate of increase or decrease in a stock’s price over a particular period of time. The bigger and more frequent the price movements, the more volatile the market. Investors use the concept of market volatility to gauge the risk associated with stock market investments and draft the best investment plan according to their risk appetite and financial goals.

How does market volatility work?

Market volatility is intrinsically linked to investment risk assessment and perceptions. This concept plays a vital role in shaping investment decisions and curating a portfolio. If a company’s stock prices have undergone rapid and frequent fluctuations within a short period of time, the stock would be considered more volatile. Alternatively, if a company’s stock prices have remained relatively stable with minimum deviation over time, the stock is considered less volatile. Periods of heightened market volatility can lead to fear of uncertainty in the minds of investors, resulting in the panic selling of their holdings.

In the context of mutual funds, market volatility represents the frequency and magnitude of price swings in the underlying assets. Mutual funds are investment instruments that pool investor contributions to buy stocks, bonds, and other assets. Market volatility impacts the net asset value (NAV) or the price at which each unit of the fund is bought and sold. Mutual funds with a higher equity exposure are usually more volatile than those investing in bonds or other assets. For instance, equity mutual funds invest over 60% of their total assets in equity shares of different companies. During intense periods of market volatility, the value of individual stocks rapidly fluctuates, affecting the overall value of the equity mutual fund as well as the investor’s total returns.

How is market volatility measured?

Now that we have covered the meaning of market volatility, it is time to focus on how this essential risk perception metric is calculated. Market volatility can be measured by calculating the standard deviation of price changes over a particular period of time. Standard deviation is a statistical measure that shows how much the price of an asset has changed relative to its average price over a specific period of time. Market volatility is defined by the standard deviation of returns, with returns being calculated over a specific timeframe - like a month or a year. The higher the standard deviation, the more the portfolio is going to fluctuate from the average. Trades can calculate standard deviations based on the end-of-day trading values, changes to the values within the same trading day (intraday volatility) or projected changes in values.

Historic volatility is calculated using past market prices, while implied volatility uses data on S&P 500 options to anticipate future volatility trends. The CBOE’s Volatility Index or ‘fear index’ is commonly used to measure forward-looking volatility. This index gauges investor expectations about market volatility based on S&P 500 options trading. In the Indian context, VIX is calculated by the NSE using NIFTY options’ order book. It indicates investor expectations of market movements over the next 30 days. A higher VIX suggests greater anticipated volatility, while a lower VIX suggests greater market confidence.

How much market volatility is normal?

Volatility is an intrinsic and unavoidable element of stock market instruments. Thus, when investing in the stock market and mutual fund schemes, investors often wonder about the ‘normal’ degree of market volatility. According to experts, investors should brace for a volatility of about 15% from the average returns during any given year. Generally, stock markets are relatively calm and stable, interspersed with brief periods of rapid price movements. Usually, bullish markets with rising prices tend to be less volatile than bearish markets which are associated with downward price swings.

How to handle market volatility?

During intense periods of market volatility, stock market and mutual fund investors may turn to panic selling. In such instances, they may wish to sell holdings to cut-down on losses, missing out on the potential of better future returns. Instead of succumbing to fears of further price declines and losses, experts suggest using the following tactics to tackle market volatility:

  • Remember your long-term plan
    Focusing on the long-term plan can help mitigate short-term volatility. Historically markets have always rebounded after periods of intense volatility. Thus, staying invested for a long haul can help balance out short-term volatility and generate long-term wealth. For instance, panic exits from mutual fund investments can result in losses since the fund’s performance may recover in the future and offer better returns.
  • Consider market volatility an opportunity
    Periods of market volatility can provide investors an entry-point into better investments. Investors can exploit bearish trends to purchase stocks with strong performance records at a discounted price.
  • Keep a healthy emergency fund
    A healthy emergency fund makes weathering market volatility relatively easy. A contingency fund that can cover 3-6 months of living expenses helps minimise the chances of needing to liquidate assets to meet urgent cash flow requirements. In other words, you will not be forced to sell assets in a bearish market.
  • Rebalance your portfolio as necessary
    Rebalancing is a tactic used to make periodic adjustments to your portfolio to keep it in line with your desired asset allocation, investment goals, and risk appetite. Experts suggest rebalancing portfolios if asset allocation has shifted 5% or more from the original mix.

Conclusion

Market volatility is a part and parcel of stock market investments. As an investor, you should be prepared to weather market ups and downs to generate long-term wealth. While it may be tempting to give into the impulse of panic sales, understanding what is market volatility and how to tackle it can help assuage fears and capitalise on returns.

Curating a diversified portfolio with different mutual fund investments can help manage market volatility. Mutual fund schemes invest in varied asset classes like equity share, debt instruments, money market instruments, and more to lower the impact of market volatility on your total returns. You can use the Bajaj Finserv Mutual Funds Platform to review and compare mutual funds and make an informed choice. With over 1,000 mutual funds in one place, you can choose funds that best fit your investment objectives, risk appetite, and returns expectation. Depending on your investment strategy and preferences, you can make a lumpsum investment or start a SIP investment with periodic contributions. You can also use the Lump-sum Calculator and SIP Calculator tools available on the platform to estimate your returns.

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Frequently asked questions

What is market volatility?

Markets or securities often experience periods of unpredictability, witnessing sharp price movements. This is known as market volatility.

What is the best market volatility indicator?

Traders often use 8 volatility indicators to make the most of fast-moving markets. Among these, Bollinger Bands, Average True Range (ATR) indicator, and Donchian channel indicator are some of the most prominent ones.

How do you overcome market volatility?

The most popular and prudent method to overcome market volatility is portfolio diversification. This strategy involves spreading your investments across various sectors and asset classes. This reduces the impact of poorly performing stocks during volatile periods.

Is market volatility good or bad?

Seasoned traders can look at volatile periods as an opportune moment to make more money. This is because as volatility increases, so does the potential to make money. However, higher volatility also implies higher risk.

How do you measure market volatility?

To measure market volatility, you can employ methods like standard deviation and maximum drawdown. Traders often use Bollinger Bands to analyse standard deviation, while growth investors and speculators rely on maximum drawdown to limit their losses.

What reduces volatility?

The best method to reduce the impact of market volatility is portfolio diversification. You can also invest in ETFs and other index-basket securities to reduce the impact of market volatility on your portfolio’s performance.

What is the market volatility index?

The CBOE Volatility Index (VIX) tries to measure the magnitude of price movements (volatility) over the following 30 days. It is a real-time market index that helps investors measure the level of fear, risk, or stress in the market.

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Disclaimer

Bajaj Finance Limited (“BFL”) is an NBFC offering loans, deposits and third-party wealth management products.

The information contained in this article is for general informational purposes only and does not constitute any financial advice. The content herein has been prepared by BFL on the basis of publicly available information, internal sources and other third-party sources believed to be reliable. However, BFL cannot guarantee the accuracy of such information, assure its completeness, or warrant such information will not be changed. 

This information should not be relied upon as the sole basis for any investment decisions. Hence, User is advised to independently exercise diligence by verifying complete information, including by consulting independent financial experts, if any, and the investor shall be the sole owner of the decision taken, if any, about suitability of the same.