Stock Market Volatility Explained

What is Stock Market Volatility?

Volatility in stocks is a measure of how much the price of an asset fluctuates over time. High stock market volatility implies major and often unpredictable price changes. Lower volatility, meanwhile, indicates that prices are stable and changing gradually. In simple words, volatility shows the level of uncertainty.

Why Does Stock Market Volatility Matter for Investors?

Here are the benefits of understanding stock market volatility —

• Better understanding to evaluate the investment’s risk level
• Helps with price options and derivatives more precisely
• Assists you in building balanced, diversified portfolios
• Gauges overall market sentiment
• Helps in adjusting strategies to meet the prevailing conditions

Types of Stock Market Volatility Measurements

There are several ways to measure market volatility. Each measurement type offers a different lens on market movement –

• Historical Volatility - A backwards-looking measure, it tracks how much an asset’s price fluctuates over a specific period. In plain words, it helps you understand how rough the recent market fluctuation has been. 
• Implied Volatility - This one is a forward-looking measure. It reflects the market expectations for future price fluctuations. A rise in implied volatility indicates that investors are buckling up for potential turbulence. 
• The VIX Index - The VIX, also called ‘fear gauge’, measures the expected 30-day volatility of the S&P 500. A high VIX shows concern or uncertainty, while VIX relates to stability. 

How is Stock Market Volatility Calculated?

Stock market volatility is computed using variance and standard deviation. Since volatility implies changes with time, it takes the standard deviation and multiplies it by the square root of the number of periods. 

Here is the math behind market volatility calculation –

vol = σ x √T, 

Where, 

• vol - Volatility over a certain interval of time
• σ - Standard deviation of total returns
• T - Total number of periods in the particular time horizon

Factors Deriving Stock Market Volatility

Several elements influence stock market volatility. Let’s get an understanding of the major factors —

1. Economic Indicators - Inflation rates, GDP growth, and interest rates affect market sentiment
2. Geopolitical Events - Policy changes, wars, or elections usually increase market uncertainty
3. Supply and Demand - A sudden rise in buying or selling pressure directly influences stock prices
4. Company Performance - Corporate actions, including mergers or earnings reports, can lead to volatility

How to Benefit from Stock Market Volatility?

Volatile stocks can lure you into reacting emotionally. You can sell out some promising stocks or buy value-destroying shares, causing more financial setbacks than profits. Rather, here are some practical ways to surf through the stock market volatility waves. 

#1 Keep Your Long-Term Plan in Mind - Markets recover with time. It is smarter to stay invested and avoid making panic exits. This way, you can balance out temporary volatility, 

#2 Think of Volatility as an Opportunity - Tenures where the prices fall offer solid entry points. Several strong companies trade at lower valuations, offering long-term investors the opportunity buy purchase stocks at a discounted price. 

#3 Maintain a Healthy Financial Cushion - Keep an emergency fund that covers at least 3 to 6 months of your expenses. This way, you would not have to sell your investments to meet the urgent needs. 

#4 Rebalance Your Portfolio Regularly - Review your asset allocation and make adjustments as per your financial goals. Your investments will align with your goals and risk appetite, even when the market is fluctuating. 

Frequently Asked Questions