Nov 15, 2022
Investing 101: What is market volatility?
- Market volatility is the measurement of how much and how often the prices of stocks increase or decrease over a specific period of time.
- Stocks are considered volatile if their prices frequently fluctuate in a short period, hitting new highs and lows.
- Higher stock price volatility typically means more risk. The more fluctuations that happen with prices, the higher the risk.
- If a stock has low volatility, that means prices are steady and not increasing or decreasing significantly over a period of time.
If you’re an investor (or looking to get started), you may have come across volatile stocks at one point. If not — you’ll likely come across them at some point in your investing journey. So, what is stock market volatility? And what are volatile stocks?
Well, if you’re a math lover, think of it this way: Stock market + large and frequent price movements in a period of time = Volatility. And if you’re looking for the longer answer… we’ve got them all here. So let’s dive right in.
What is market volatility? 🌊
As investors, we often hear about stock prices, high volatility, risk tolerance, bear markets, etc. We’re here to break down all the tricky investing terms — one by one. So let’s start off with the basics. What is the true meaning of market volatility?
Volatility is the rate of deviation around the mean at which the price of a stock or other assets increases or decreases over a particular period of time.
Higher stock price volatility typically means more risk. It means prices swing up and down constantly and quickly. The higher the risk, the more fluctuations that may happen in the present and possibly, the future. Think of high volatility as big and rapid waves — going up and down.
On the other hand, if a stock or overall market has low volatility, that means prices are steady or stable over a period of time. Think of those waves as being gentle and small — they may still go up and down — just not as quickly and harshly as the more volatile ones.
How is volatility measured in the stock market? 📈
The quickest way to measure market volatility is to compare stock market prices over time. Calculate the difference between month-to-month average prices — or even day-to-day prices. Or follow the investing experts.
They look at the S&P 500 index’s monthly prices and compare them to the year’s average monthly prices. How, exactly? You’ve heard about standard deviation in your math class.
But — here’s a quick refresher: Standard deviation measures the distances of various points in a dataset compared to the mean. To calculate the standard deviation, you have to figure out the square root of the variance.
Investing experts calculate the standard deviation over a set period of time to measure volatility. By doing this, experts can accurately measure historical volatility.
And on the other hand, to estimate future volatility (a.k.a implied volatility) a popular index to follow is the Chicago Board Options Exchange’s Volatility Index, or VIX for short. Many investors call the VIX the fear index. Although the calculation itself is complicated — its output is simple. It uses market data to calculate how well the S&P 500 index is expected to perform within the next 30 days.
What to watch for — and how to identify a volatile market 📉
As an invested investor, sometimes, all the ups and downs can feel like a never-ending rollercoaster. And sometimes, seeing all the price movements can make investors emotional. We’re here to remind you — even though it feels like your portfolio is on the decline now, your long-term investing strategy focuses on the future.
Fluctuations are normal, and as long as you’re researching your investment choices carefully, there is no reason to panic during turbulent times. Volatile markets will happen — especially when the economy is struggling. Think — 🐻 bear markets.
Remember February 2020? As the Covid-19 pandemic was starting — the American economy entered a bear market. On average, market prices dropped 33%. However, it only lasted 33 days. By April 2020, stock markets globally re-entered a bull market, and in 2021 the S&P 500 saw a 26% return.
So, the good news? Despite so many ups and downs, historically, the stock market has recovered and continued to climb to new highs in the long run.
Greenlight’s top tips on navigating market volatility ✍️
If you’re constantly checking on your portfolio and getting hung up on the plunges in prices — here are some friendly reminders. Just for you.
1. Keep a long-term perspective.
Over time the market has trended up, despite downturns from time to time.
2. Know your risk tolerance.
Your tolerance for risk will change over time, and that’s actually quite common as you go through different phases in life (like purchasing your first home or getting ready for retirement). As an investor, it’s important to adjust your asset allocation strategy, or how much you own of what, to reflect your new risk tolerance.
Spreading your investments over a wide variety of asset classes can help you ride out the ups and downs of the market. (More on this later!)
4. Build an emergency fund.
If you have savings set aside for emergencies, you may be less likely to react to market fluctuations. Keep your peace of mind with money ready to use in case of an emergency.
5. Talk to a financial professional.
Navigating the ups and downs of the market doesn’t have to be complicated. Enlist the help of a financial professional. Together you can create a plan to help meet all your money goals, despite what’s happening in the market.
What is diversification and why does it matter?
Diversifying means investing in different things so that your money is spread out over multiple investments. But why does diversification matter? Well, diversification lowers your investment risk and can keep your investments safer.
Smart investors diversify their tangible assets (physical items of value) and their intangible assets (non-physical items of value). They spread their money across multiple types of assets to reduce the risk of losing money — building a diversified portfolio.
Let’s take a look at an example of a non-diversified portfolio. Imagine you invested all of your money in individual stocks of GAMER (GMR).* This would mean that 100% of your equity (or stocks) is in the gaming sector of the market. This is a risky approach because if GAMER stock prices were to go down suddenly, your whole investment portfolio might suffer losses.
You might diversify within the gaming sector by investing in other gaming companies, but if the whole gaming sector is negatively impacted, your portfolio may still take a big hit in the short term.
So, how can you diversify your portfolio to keep your money safe and lower your risk? That’s up next!
How to diversify your portfolio like a pro 🧺
To truly diversify a portfolio, include ETFs and stocks from different companies and industries. You may also want to consider adding bonds or other fixed assets (items of value for long-term use) to the mix.
Many investors will blend several of these types of assets together, so their portfolio isn’t focused on one individual asset class or market sector. By doing this, your money is better protected against a dip in the stock market as a whole.
Friendly reminder: Investing involves risk and may include the loss of any money you invest. However, with proper research, planning, and diversification — you can reduce your risk and see gains in the long term.
By diversifying well, you are protecting your money from market uncertainty. But remember, diversification may look a little different for each investor. Different factors like time and risk tolerance will ultimately determine what the right portfolio looks like for each person. Luckily, plenty of tools are available to help diversify your investment accounts through smart asset allocation.
Investing during market volatility and timing the market ⏰
As an investor, you may have heard the words — timing the market. So what does timing the market really mean? Timing the market means trying to predict future market price movements for buying or selling assets.
However, research has shown that timing the market perfectly is nearly impossible. So, for the average investor, the best strategy is not to try to time the market at all. Instead, consider making a smart investing plan and get started as soon as possible. With a consistent investing strategy, you’ll be best prepared to meet all your financial goals on time. Nice!
Try dollar-cost averaging for smart investing 💸
One smart investing strategy you can consider following is dollar-cost averaging. Dollar-cost averaging is investing a consistent amount on a regular basis, regardless of the share price. Investors use this strategy to develop good investing habits and become disciplined — instead of panicking over the market’s performance.
Let’s talk about a real-life example of dollar-cost-averaging. Meet Sam 👋 Sam started investing in January of 2002 — when she was 18 years old. Despite the Great Recession and the Covid-19 pandemic, Sam consistently invested $100 into the S&P 500 each month.
Today, Sam is 38 — and she’s weathered two major market crashes. But, in January 2022, Sam reported a total investment balance of $87,536.57! Woah. That's around an 11% annualized return on her investments. Way to go, Sam!
Invest with Greenlight 📱
It’s impossible to completely avoid volatility if you’re invested in the stock market, but — friendly reminder — on average over the long run, the US stock market has gone up. And that’s not all we can help you understand. We’re talking all things investing and inflation in our money and investing app for kids, teens, and parents.
Now that you know what investment options are available to you — try putting your knowledge to the test. Parents can use Greenlight's Investing for Parents to save money for their kid’s future.
And for kids and teens, Greenlight's Investing for Kids lets them use their app to research, explore and learn about the world of investing. Kids can request for parents to buy or sell stocks or index funds and parents can place each trade with just one tap.
The best part? Find more than 4,000 stocks and ETFs, backed with industry research in the app — and explore the world of investing together. Sign up today! Get one month on us.
*GAMER is a made-up ticker for a made-up gaming company.
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