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How Volatility in Stocks impact Your Investments

13 Nov 2021 0 COMMENT

Introduction

Speculation drives prices in the stock market. Investor behaviour, alongside other factors such as weather, transportation, political climate, incentives or restrictions imposed on trading, etc., combine to form market conditions. Market conditions are one of the primary determiners of profit or loss in stock market trade. The Dutch East Indies Company (VOC) was able to pay dividends to its shareholders because market conditions remained favourable for the company. The great banking collapse of London in the 1790s happened due to excessive speculation and shorting, influencing market conditions negatively. Similarly, the Great Depression of the 1920s occurred because investors were unable or unwilling to consider the prevailing conditions.

What is Stock Volatility?

  • Stock volatility is defined as the range of dispersion for the mean or average returns on a stock or security.

  • Stock volatility is generally calculated via the standard deviation method. That shows how the stock's price is clustered around its moving average. If the price is clustered very closely, then the volatility is said to be low, and if the price is clustered loosely, then the volatility is said to be high.

  • Several factors influence volatility. International, regional and national economic policies, such as interest rates, tax rates, restrictions on trade or incentives, all contribute to the stock market's volatility. Similarly, inflation and factors related to relevant sectors also influence the volatility of stocks.

  • Volatility directly influences market fluctuations. Higher volatility leads to a market downtrend, creating the condition for a bear market. Low volatility leads to an uptrend in the market, leading to the possibility of a bull market.

How volatility impacts investments

  • At its simplest, higher volatility leads to the fall in the price of the stocks in one's portfolio, while lower volatility leads to the rise in the price of stocks in one's portfolio. Higher volatility correlates to higher risk and increased possibility of financial loss, while lower volatility relates to lower risk and increased chances of profit.

  • If you are a trader or a short-term investor, you cannot ignore volatility favouring risk mitigation via investments in a diversified portfolio.

  • Volatility also impacts the amount an investor chooses to invest. Generally, investors looking to mitigate the risk from volatility invest a set amount of capital routinely, which keeps the investment costs down and prevents a large amount of money from being tied up in a high volatility market.

  • Volatility can lower the price of investing in companies with a good reputation. That makes a volatile market perfect for investors who wish to invest in good companies at a relatively low cost. Investors must, however, research the upward potential of the company they want to invest in.

  • Volatility in the market may be a key factor influencing investors to get professional counsel regarding their investments. Thus, volatility can contribute towards better investments.

  • The risk of high volatility encourages investors to diversify their portfolios, as a balanced and diversified portfolio is less susceptible to market fluctuations and shocks caused by stock price volatility.

Additional Read: How to start equity investment

Conclusion

Stock market volatility is one of the more essential factors investors must consider before making any investments. Different investors may deal with stock volatility differently, with speculators likely to try and take maximum advantage of said volatility. At the same time, hedgers invest in protecting themselves from market fluctuations caused by volatility.