The stock market has long been a top choice for investors looking to build wealth and grow their capital.
But sometimes it can be very volatile with massive swings throughout weeks, and even days.
What makes equities volatile, and what is happening behind the scenes to push equities in this direction?
In this post, I'll explore what volatility is, how you can protect yourself against volatility, and I'll answer the question “why are equities volatile?”. Let's get started!
What Does It Mean to Be Volatile?
If you are a passionate investor or even a beginner investor, you've probably heard of the term “volatility”.
What does it mean to be volatile? Does it mean something bad or something good to the average investor?
Volatility is when a specific market experiences sudden increases or decreases in value.
This effect brings positive and negative factors to equity investors. Whether it's good or bad for you depends on the way you invest.
Most people only consider the poor side of volatility, which means that value falls to the ground in the stock market.
However, there is another piece of the puzzle. Sometimes, volatility increases the principal investment instead of destroying it altogether. It's a risky, yet rewarding, aspect of equities.
Volatility means either good or bad for investors in different asset classes.
What Makes Equities Volatile?
Equities are volatile for one reason – investors.
Most believe that this factor is a result of fundamentals and the economy, but it has more to do with the choices the investors make in the market.
The supply and demand of some equities changes quickly thanks to what the investors do with their funds.
The equity market can have a higher risk profile than other asset classes.
They flex and change dramatically based on national and global economies through public and private sectors.
Here are a few other factors that can impact the stock markets:
- Global and national events: The shift of a law or something as small as a sentence in a speech can impact equities.
- Company changes: The success, policy changes, and even leadership shifts can cause volatility.
- Industry shifts: There might be a factor in the industry that impacts the stock market volatility, such as an oil leak or a policy change.
- Inflation rates: As inflation rates rise or sink, stock price movements follow.
On top of the unpredictability of human behavior, several other factors can impact market volatility.
So why are equities volatile?
Equities are volatile in the stock market because the world as we see it is always changing.
Humans are unpredictable, and so are the companies and countries everywhere. Volatility is not uncommon the further you dive into the market index.
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How Do You Measure Volatility?
When working with equities, it's critical to note the volatile journey.
For your best interests, it's helpful to keep track of volatility as it occurs.
You might be wondering how to measure volatility. There are several ways to go about this process.
Here are three ways to measure volatility:
- Standard deviation: This item measures the average amount a stock has shifted over a designated period, allowing a visual of how volatile the asset might be in the market.
- Maximum drawdown: This technique measures from the lowest low for the stock to the highest high in an allowed period.
- Beta: This item measures the volatility of the security as it relates to the market as a whole.
But there's one easy way to check how volatile markets are. This is called the VIX.
According to IG.com, the VIX is a real-time volatility index, created by the Chicago Board Options Exchange (CBOE) in 1993.
This index can help you easily tell investor sentiment towards equities.
A high score on the VIX means that investors are expecting more volatility in the markets, while a low score indicates stability.
How to Avoid Negative Volatility
There's no doubt that equities have greater volatility than other asset classes like bonds or even real estate.
So how can you avoid the negative factors of volatility?
Invest in Different Asset Classes
The easiest way to reduce the negative affects of volatility in your investment portfolio is to spread your money across several asset classes.
This could include investments like real estate, bonds, or alternative investments like art or wine.
Experienced investors know how important it is to have a diversified portfolio to produce strong returns.
Invest in Multiple Industries
If you want superior returns and to avoid extra risk, spreading your money across many industries will be helpful to optimize your stock returns.
In the same way it's important to spread your money through other asset classes, investing in many different industries can help you achieve the same results.
For example, if you're heavily invested in tech stocks, it might be wise to invest in a variety of other industries like financial institutions or healthcare.
Invest for the Long Term
Long term investors are much less likely to experience the negative effects of volatility.
This is because they're not focused on short term fluctuations but rather the long term growth potential of their investments.
If you're looking to invest in equities, make sure you have a long term strategy in place.
Make Smart Investments
The share price of a company is based on the underlying asset that it backs.
This means prices fluctuate depending on how the company performs.
If a company performs better or worse than expected, share prices react with higher volatility in the share price.
This is why it's important to analyze the stocks you plan to invest in and find companies that are poised for growth.
Why Are Equities More Volatile Than Bonds?
On average, bonds tend to perform more positively and experience less dramatic shifts than equities.
Why do equities experience greater volatility in the stock market? Why are equities more volatile than bonds?
In shorter time frames, bonds typically experience less severe successes and failures than equity investments.
The average standard deviation is typically higher in equities than for a bond with a fixed income, meaning there isn't much change in the bonds as opposed to the stocks.
Here are a few more reasons why equities are more volatile:
- An uncertain future
- Non-specified return
- High correlation to the economic environment
- Possibility of legislation affecting the stock price
- Prone to systematic risk
- Shifting projections
These all add a level of risk and reward to equities that bonds do not have.
There is still some volatility that comes with bonds.
It's also critical to note that, if kept long term, many stock values will meet a similar volatility as bonds.
Equities are more volatile now, but as they mature, they become just as volatile as bonds.
Are Equities Riskier?
When it comes to assets, equities are the riskiest of all.
There are no guarantees with equities!
The success or failure of your money depends on how the public business operates, and the marketplace is a crazy world of competition.
It's can be challenging to put your money in the hands of a larger organization and let them handle it.
As with any investment, it's critical to consider everything before putting money down on the company.
Investing Strategies for Volatility
If you are working with volatile equities, it's critical to go about it strategically.
There are good and bad qualities that come with volatile equities – so you need to go in with a game plan. Large swings can cause headaches for many investors in this asset class, so it's important to invest carefully.
Here are a few of the best investment strategies when dealing with a volatile market:
- Long positions are best placed when volatility is low
- Work with an index fund to invest in the entire market
- Diversify away from equities to balance your portfolio
- Get help from a professional when needed
Volatility is overwhelming for those new to the world of investing but it's critical to go into equities with a strategy so you can make the best choices with your money.
Is Volatility Good or Bad in the Market?
This question can go both ways.
There are moments when volatility is bad in the market, but those are balanced by instances where volatility is a good thing for the market. And, there are strange cases where it is neither.
Why is this the case? Why isn't it one or the other?
How you invest often determines the way you view volatility.
Some investors are more short-term, while others want to hold on for the long haul.
Determine the style in which you trade, buy, and sell equities to determine how volatile equities impact your financial future.
Many invest and then hold on to that investment, so little spikes in a short period don't matter. They're in it for the long haul and random increases and decreases won't change anything.
On the other hand, you might invest for short periods. In this case, the volatile journey of a stock matters a lot! A random shift up or down can make or break the success of your investment.
Are Bonds More Stable Than Stocks?
Bonds are traditionally more stable than stock prices when it comes to investments.
Why is this the case? Why are bonds more likely to stay put while stocks tend to fluctuate up and down as time goes on?
Here's the main reason why bonds are more stable than stocks – if bankruptcy occurs, the bondholders have priority over the shareholders.
Bonds also have a fixed price and a maturity date for the benefit of future earnings.
On the other hand, stocks have more variable earnings attached to their value.
You don't know how long the stock will last or when a terrible drop could happen.
As an investor, there is a much higher risk that comes with putting your money in stocks instead of bonds.
However, with risk comes reward.
Investing in asset classes like equities is likely to provide much more lucrative returns to investors than other asset classes like bonds or annuities.
Are Bonds a Better Investment than Stocks?
If you want to invest, you might wonder – are bonds a better investment than stocks for the long run, or is the opposite true?
The truth is, both have the potential for success. It depends on your tolerance for risk.
Bonds tend to be safer than stocks and are less risky.
As a result, you will find that most bonds bring a lower return on your investment than stocks do.
You sacrifice more comfort for a lower return.
Bonds are more conservative and provide a way to diversify your portfolio.
Stocks are not nearly as safe as bonds. However, you have the chance to make a massive return on the money you invest in a company as a result.
What Drives Stock Prices?
Stock prices constantly fluctuate up and down, a volatile state that is a normal part of the stock market.
What causes these changes? Who is driving the stock prices and influencing the direction they go?
Here are a few factors that influence the stock prices in the market today:
- Investor demand
- The news and public figures that know the market
- Public perception of the company
- The income of the company
- The reliability of the company
- The desire for the stock
It's critical to consider what drives the stock market before you invest in equity.
This knowledge will help you make the best choice for your money, rather than diving into something that falls to a minimal value right away.
Note Your Comfort With Risk
It's critical to note your comfort with risk before you invest in equities.
They are an asset with one of the highest risks in the investing world. You have the potential to earn big, but you can also experience wild losses.
Bonds are a less volatile investment, but they won't bring you as much reward when all is said and done.
If you want to make the most out of your investment, it may work better to be heavily weighted in equities. It's a risk that may pay off big at the end of the day!
Final Thoughts on Why Are Equities Volatile
There are many different reasons equities are volatile.
From global economics, to an individual company's performance – volatility is normal throughout the stock market.
However, volatility isn't always a bad thing. For some equity investors and active traders, swings in share prices can be a blessing for their portfolio and income.
There is risk that comes with any asset class, but equities tend to have an increased risk level compared to more safe investments like bonds or annuities.
Ultimately, it's up to you to decide your risk tolerance and your investing strategy to grow your money.
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