Whether you are a new investor or a seasoned veteran, dramatic changes in the value of your investment portfolio may cause feelings of great joy or extreme fear. You may have a portion of your savings invested in publicly traded stocks either directly or within your mutual fund or exchange traded fund holdings. The value of these holdings can change from day to day based on how the underlying stocks or stock market index performs. These changes can be caused by market volatility and can affect the value of your investment portfolio.

The simplest definition of market volatility is when a stock price or a market index changes in value quickly and unpredictably. If the stock market rises or falls more than one percent over a sustained period of time, it is called a “volatile” market.

Some stocks are generally considered volatile, especially smaller company shares. Alternative investments such as cryptocurrencies are considered very volatile. Volatility is frequently associated with price declines, but it can also apply to unexpected price increases.

Market volatility is when a market or asset has periods of unpredictable, sometimes sharp, price swings, it is referred to as volatility.

How is volatility calculated?

If you can remember studying statistics or math in school, you may recall the central moments of tendency. A typical chapter that is found in most curriculums. The mean or average is the first moment, and the second one is the standard deviation. Does that ring a bell?

Investors measure market volatility to analyze the risk versus return potential of an investment. Two common mathematical measures used are beta and standard deviation.

1. Beta – compares the risk of an investment in relation to its index or benchmark; in a bullish market, investments with betas less than one would be expected to decline less in value than the index.

2. Standard deviation - measures the tendency of the returns of an investment to rise or fall drastically in a short period of time in relation to its mean return; a low standard deviation would indicate a less volatile investment however it may also indicate a lower return potential.

Volatility is the standard deviation of a market or a security's annualized returns over a particular period or the pace at which its price rises or falls.

High volatility is defined as a price that varies rapidly over a short period of time, hitting new highs and lows. Low volatility is defined as a price that swings up or down slowly or remains reasonably stable.

What affects volatility?

Economic issues at the regional and national levels, such as tax and interest rate policy, can significantly impact market direction and volatility. Stock markets in many countries react dramatically when a central bank sets short-term interest rates for overnight bank borrowing, for example.

Changes in inflation trends, as well as industry and sector concerns can influence long-term stock market patterns and volatility. For example, a significant weather event in a key oil-producing region can increase oil prices, enhancing the price of oil-related stocks.

Another example of volatility spreading across borders would be during the global financial crisis of 2009. A crisis that began in America due to the housing bubble led to a massive rise in interest rates and defaults. This rippled across the globe, with markets crashing left, right and centre due to increased volatility and uncertainty. One event shook the world, all in the name of high volatility.

There are many other factors that influence the volatility of the markets such as political developments, government policies, etc.

However, volatility isn’t a bad thing!

A market correction may provide an opportunity for investors to add additional funds into the market at a lower cost. Investors who believe markets will outperform in the long run may be able to take advantage of lower market volatility by buying more shares in companies they like at lower prices.

An investor, for example, might be able to get a share that was formerly worth $150 for $60. When you acquire stocks this way, you lower your average cost-per-share, which improves the performance of your portfolio when markets recover.

When a stock increases rapidly, the procedure is the same. Investors might take advantage of this by selling their holdings and reinvesting the cash in places with higher prospects.

Timing the market, however, is not something that is advisable. No one can accurately predict the day and hour the markets will be at their lowest. A better strategy is to have an automated withdrawal from your account into your portfolio, say the 15th of every month, thereby capturing the highs and lows of that mutual fund and averaging out your overall cost.

Prepare yourself and take advantage.

Changes in trade, politics, economic outcomes, and business actions are some of the factors that can impact markets and generate volatility.

Yes, it's uncomfortable, but everything is 'normal.'

Investors prepared for periods of volatility from the start of their investing journey are less likely to be surprised when they occur and are more likely to react rationally.

Investors should prepare themselves and stay focused on their long-term financial goals by adopting a mindset that accepts volatility as a natural element of investing.

1. Establish risk management safeguards Trading in volatile markets entails risk, so be aware of this and be prepared to mitigate it. Risk can be managed in various ways, from diversifying your portfolio to making smaller trades with less risk.

2. Set short term goals It makes more sense to look at long-term investment prospects when markets are less volatile. In a volatile market, however, think back to why you invested in that stock or fund in the first place. If nothing has changed your rationale, then do nothing, or add more funds to the investment. If there are substantial changes, then you need to know where your personal limits are on the amount of profit or loss you are willing to accept. Talking to a financial professional is highly recommended

An Investor education and Awareness initiative of Aditya Birla Sun Life Mutual Fund

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