What Is Market Volatility? Understanding What Causes Volatility in the Markets
Volatility is one of the most common words used in the financial markets. It is used to describe how much the price of an asset can change over a given period of time, as well as how quickly and often price changes occur. In simple terms, volatility is a measure of the level of risk in an asset or market. Volatility has both a positive and a negative aspect, as it can result in great profits, but it can also cause huge losses. It is important to understand market volatility and how it affects your investments to make informed decisions.
Understanding Volatility
Volatility is a measure of how much an asset or the markets move. A market or an asset’s volatility is based on the degree of price variation that can occur over a given period of time, such as a day, a week, or a month. When the markets are highly volatile, this means that prices can change rapidly and often, making it challenging to accurately predict market movements. An asset or market that is considered to have low volatility will have smaller and less frequent price changes.
Volatility in the markets can be measured using a range of technical analysis indicators and tools. One of the most common tools to do this is the volatility index, or VIX. The VIX measures the market’s expectation of volatility over the next 30 days, and is frequently used to gauge the level of fear or uncertainty in the markets.
Types of Market Volatility
When discussing volatility, it is important to differentiate between two main types – historical volatility and implied volatility. Historical volatility is a measure of the actual past movements of a market or asset, and is calculated by looking at the variance between the closing prices of each period. Implied volatility, on the other hand, is determined by the options markets and is based on future expectations about market movements. It expresses how volatile the markets are expected to be in the future and is determined by fluctuations in the prices of options.
Factors That Influence Market Volatility
The volatility of the markets is determined by a range of factors such as market sentiment, economic conditions, and political changes.
- Market Sentiment
Market sentiment is one of the most important factors that determine an asset’s volatility. When the overall market sentiment is high, prices tend to increase due to more people entering the market, making it more volatile. Conversely, when the sentiment is low, prices are more likely to decrease and the market will be less volatile.
- Economic Conditions
The strength of the economy and the conditions of the financial markets greatly influence the level of volatility in the markets. For example, when the economy is strong and markets are growing, volatility will increase as investors take on more risks to try and get higher returns. However, when the economy is struggling and markets are weak, volatility will generally decrease since investors become more conservative and uncertain about their investments.
- Political Changes
Political changes can also cause volatility in the markets, as investors become uncertain about how the changes might affect their investments. For example, when elections are coming up or when there is political unrest in the country, investors may become wary of the potential impact this could have on the markets, leading to increased volatility.
Benefits of Volatility
Although volatility can be a risky factor to consider when investing, it can also be beneficial. Volatility allows investors to take advantage of opportunities to make profits quickly, due to the fast price movements. Additionally, it allows investors to trade in more liquid markets, as there is usually more activity in volatile markets compared to less volatile markets.
Managing Market Volatility
Investors need to be aware of market volatility and the implications it can have on investments. One way to manage market volatility is to have a diversified portfolio, as this will spread out your risk across different types of investments. Additionally, understanding a range of technical analysis indicators and trading strategies can help investors identify potential opportunities and take advantage of them.
Volatility is one of the most common terms used in the financial markets, and an important factor for investors to understand. Although volatility carries with it both positive and negative implications, there are several ways investors can manage and benefit from market volatility by having a diversified portfolio and understanding the range of technical analysis indicators and strategies.
