Market volatility is a part of the investment experience and seasoned investors understand that acting emotionally can be more harmful than helpful. It is always appropriate to understand and prepare for market volatility and downturns, even when markets are going up. Investors should not let market movements force them to lose focus. A knowledgeable investor understands that markets go up but they also can go down.
Volatility is a statistical measure of the distribution of returns for a given security or market index. For example, when the stock market rises and falls more than one percent over a sustained period of time, it is called a “volatile” market.
The U.S. economy is not supposed to be highly volatile, but equity markets are a different story. Market volatility doesn’t mean that stocks are headed for a down or bear market. Even if there are market corrections along the way an investor can still potentially experience reasonable returns over a long period of time.
What is stock market volatility?
Stock market volatility is a measure of how much the stock market’s overall value fluctuates up and down. Just like equity markets, individual stocks can also experience volatility. An investor can calculate volatility by looking at how much an asset’s price varies from its average price. Standard deviation is the statistical measure commonly used to represent volatility.
Some stocks are more volatile than others. Shares of an established large blue-chip company may not make very big price swings, while shares of a high flying and newer tech company may do so often. Stock market volatility can occur, especially when external events create uncertainty.
Why is volatility important?
By understanding how volatility works, you can put yourself in a better position to evaluate stock market conditions as a whole. You can then analyze the risk involved with any particular security and construct a stock portfolio that is a great fit for your growth objectives and risk tolerance.
It’s important for investors to be aware that volatility and risk are not the same thing. For stock traders who look to buy low and sell high every trading day, volatility and risk are deeply intertwined. Volatility also matters for those who may need to sell their equities in a short time-frame, such as those who are older and closer to retirement.
For long-term investors who tend to hold equities for many years, the day-to-day movements of those equities need to be understood. Volatility is part of the noise that could come while you are allowing your investments to compound long into the future.
Long-term investing still involves risks, but those risks are usually related to being wrong about a company’s growth prospects or paying too high a price for that growth — not volatility.
Remember, no matter what equity markets are doing, your plan should always align itself with your investing goals, your financial timeline, and your risk tolerance.