The stock market is constantly moving and changing. Every day, market indexes rise and fall; even in calmer times, the S&P 500 can fluctuate by less than 1%. Yet, volatility occurs when the market undergoes sudden and significant price movements. Although increased volatility is sometimes a warning sign, it is practically unavoidable in long-term investment and may be a key to your success.
An Explanation of Volatility
Volatility in the market refers to the regularity and size of price swings in either direction. A call is considered more volatile when there are significant and frequent fluctuations in price. According to Nicole, "market volatility is a natural element of investment and is to be expected in a portfolio." If markets moved straight up, investing would be easy, and we'd all be rich.
How Do Economists Gauge Volatility?
The standard deviation of price movements over time measures the market's volatility. Standard deviation is a statistical measure used to assess dispersion around an average. For now, remember that "the bigger the standard deviation, the more that portfolio is going to wander about, up or down, from the average."
We'll teach you how to calculate it below. Standard deviations are helpful because they give a framework for the probability that a number will change and tell you how significant that change may be.
What is the VIX?
Popularly known as the "fear index," the VIX is the most widely used indicator of stock market uncertainty. Based on trading activity in S&P 500 options, it indicates how investors feel about the direction of stock prices over the following 30 days.
The VIX index shows the expected monthly volatility in S&P 500 prices. When the VIX rises, option prices tend to increase as well. There are a few causes for this: The first thing to remember is that traders can enter into agreements called puts to sell shares of the S&P 500 at a specific price and time.
How Often Should We Expect Market Volatility?
Increased volatility is a common occurrence in the market. An investor should expect annual returns to fluctuate by around 15% from the average. If you can't withstand volatility of this magnitude, you shouldn't be an equities investor, as a 30% drop in the market occurs on average once every five years.
The stock market is relatively stable for the most part, with occasional spikes in volatility. There are typically extended stretches with little to no excitement in stock values, followed by brief times with large swings in either direction.
How To Deal with Market Uncertainty
Your portfolio's ups and downs might be met with several responses. One thing is clear, though: market experts do not advise selling everything quickly following a significant decline.
Schwab Center for Financial Research experts found that in times since 1970 when equities plummeted 20% or more, the highest gains were made in the first 12 months after recovery. If you got out of the market at the low point and waited to get back in, you may have lost all of the value you had invested. Try one of these strategies instead if you're nervous about the market instead:
Keep Your Long-Term Goals in Mind
A diverse, well-balanced portfolio was designed with market downturns like this one in mind. Since market volatility might make it difficult to withdraw cash quickly, you should avoid investing money that you will need soon.
For long-term success, however, being prepared to ride out periods of uncertainty is essential. "Volatility is the price you pay when investing in assets that provide you the highest chance of accomplishing long-term goals." As a possible expense in accomplishing these objectives, it is to be expected.
Don't Panic Over Market Volatility
Thinking about how much stock you can buy while the market is in a negative downward situation may assist you in emotionally dealing with market volatility. Supplies that have performed well over the last several years, in particular, may be purchased at a bargain during times of volatility. For example, shares of an S&P 500 index fund would have been around a third cheaper during the bear market of 2020 than one month prior, following nearly a decade of uninterrupted rise.
Maintain a Solid Rainy-Day Fund
It would help to not worry about market volatility until you need to sell investments in a falling market. For this reason, investors must have a savings cushion of three to six months' worth of spending. To prevent customers from liquidating investments during market volatility, Wirick explains, "we set aside an adequate emergency fund." "Customers can rest well knowing this is in place."
