Volatility is synonymous to unpredictability and, if you prefer to look at it in a different light, excitement. High volatility rate means that markets move up and down unpredictably and at a rapid pace. Market volatility calls for extra caution on the end of the investors but at the same time, it can also be seen as an opportunity for substantial gains. Here are twelve things that investors may not want to hear, but are very important in managing the effects of volatility.
1. When deviance of stock prices are high, volatility is just around the corner.
One way of determining market volatility is by looking into how prices of stocks are closely knit together. When deviance of stock prices is high, that usually signals volatility. Price that moves beyond the standard deviation represents either unusual strength or weakness.
2. Bear market is around the corner on high volatility days.
Bear market is called as such because of the sluggish nature of the actual animal. Markets usually perform at below their moving average on high volatility days.
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3. Volatility cannot be easily predicted.
There are statistics that describe volatility but like earthquake, there is hardly anything that can be done to generate an accurate forecast. Present volatility may not be related to future or past data.
4. There are national and global-scale factors that an investor cannot control.
Political uncertainty and certain economic policies can highly contribute to market volatility, as several studies have suggested. This is particularly true in emerging markets, such as Malaysia during the October 1987 worldwide market crash and the Chinese-Malay riots. The coup attempt and the Marcos-Aquino conflict in the Philippines in the late 1980s were also associated with the market volatility during the same period. Volatility is influenced by economic, political, and social events, both in the domestic and global level.
5. Market volatility can be an overreaction to a bad news during good times.
The stock market is not just all about figures and statistics. Volatility can also be attributed to investor psychology and fear. People are wired to act defensively at the slightest hint of threat.
Pietro Veronesi of the University of Chicago conducted a study on the overreaction of investors to “bad news in good times.” In summary, the price of an asset decreases (more than the present value) because risk-averse investors expect a price decrease when they hear bad news. The investor’s “willingness to hedge” explains their overreaction to bad news, even during fairly good times. Sometimes, it’s the investors own doing.
6. Retirees are one of the most vulnerable investors during volatility.
Market losses contribute to the depletion of retirement assets, making it difficult to withdraw when markets are volatile. When market volatility hits during the early stage of the retirement plan, the risk of losing retirement assets in the midst of retirement is quite high.
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7. Panicking can do more harm than good during market volatility.
This fact is related to the aforementioned investor psychology. Investors who panic usually turn a blind eye on the big picture. They sell their weak stocks even if prospects look brighter in the long run. There would be no buyers if all investors think that way, causing the market to collapse. The market falls when investor confidence falters.
8. Market volatility is sometimes manufactured by Wall Street.
This may be surprising to new investors but volatility benefits certain sectors. In Gilani’s article, “The New Abnormal: Permanently Engineered Market Volatility”, he narrates how Wall Street creates market volatility so that they can profit from the investment fees which they charge individual investors for their expertise.
9. Low volatility does not last long.
Nothing is ever permanent, even in the stock market. Low volatility never stays that way, and prolonged periods of it can lull investors to complacency.
10. Neophyte investors mislead themselves by thinking that risk and volatility are the same.
They are not the same thing, even if people confuse the two to be the same. For one, risk is a potential for loss or gain. Even risk can be managed in a high volatile market.
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11. All option trades have a volatility component.
Option trading is attractive because of its versatility but its versatile nature also comes with a speculative side. Those who are attracted to option trades but do not have the heart to weather it in a volatile market may have to rethink their decision.
12. Hating volatility is overrated.
This may go against the stigmatized concept of volatility rammed down your throat but irate fear of volatility can impede the possibility of profiting from it. Volatility induces heightened emotions of fear and reluctance. As mentioned earlier, your natural impulse will probably tell you to sell. This is the typical move of highly emotional investors who did not think their investments through.
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No markets will be extremely volatile forever, in the same manner that low volatility cannot be sustained forever.
If you truly want to benefit in a volatile market:
- Engage in systematic investing. Systematic investing means investing in regular periods, no matter what the market condition is. This way, you can take advantage of investment opportunities when the market is volatile.
- Diversification. Even if the stock market is volatile, you can still rely on bonds and cash deposits.
- Rebalancing. It’s still one of the best ways to hedge.