What is Market Volatility? Explained
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Investing in any market—the US included—can feel like a gamble. There's no saying with certainty which way it's going to swing. Being a smart investor means understanding market volatility, including common causes, how black swans impact the market, and whether or not the market will always be volatile.
What is market volatility?
Market volatility is the continuous movement of publicly traded securities.
Volatility indicates the security's performance according to a benchmark. That benchmark is usually a leading index like the S&P 500.
There are a couple of types of market volatility: historical and implied.
Historical volatility examines the security's volatility in the past.
Implied volatility looks at how volatile the asset will be in the future.
High volatility can indicate breaking news, asset-specific events, a possible upcoming crash, black swan events, and more. It also shows investors when the right moment for entry is.
Common causes for market volatility
Tons of things can cause market market volatility, including:
Economic factors and news (company news or a popular IPO, for example)
Interest rate changes
Sentiment (how people feel about the stock)
How 'black swan events' contribute to market volatility
A black swan event is unpredictable, usually infrequent, and beyond normal expectations of a situation, with potentially severe consequences.
Black swan events can be catastrophic to economies by negatively impacting markets and investments. Just look at what happened toward the start of COVID-19 when global markets crashed with a vengeance.
Standard forecasting tools and modeling usually cannot predict such events. Black swans are not as common in other regions, like the Middle East, but there's still a sizable list of them you can look through to get a better sense of their magnitude and impact.
Will there be more market volatility?
There will always be market volatility. This is the fun of trading in the market—you never quite know what's going to happen.
Over time, you can learn to hedge against it with diversification and still get great returns.
You can choose to navigate volatile markets by using some specific strategies:
Test your strategy in volatile conditions before you go live. If you did your research and proved that your strategy could work in volatile markets, stick to it.
Track to see how you've navigated previous periods of volatility, and what – if anything – you could change next time around.
Minimize your position size and go for smaller, more diverse profit goals.
You don't have to stick entirely to fundamentals, because sometimes they're not reliable during erratic markets.
Focus on charts and short-term indicators to navigate the muddy waters of volatility.
If your focus is more on short-term trading, many strategies suggest taking out your profits immediately instead of dealing with the volatility.
Stick to what you know, and don't focus on missed opportunities. FOMO investing (fear of missing out) may be a trend, but you don't have to follow it.
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