Volatility measures how far stock prices veer away from their average every year. It can be calculated either using historic volatility or implied volatility (which evaluates expected price movements based on derivative contracts traded on markets such as options).
Investors may experience recency bias during periods of high market volatility, leading them to make hasty decisions based on short-term market movements rather than keeping their long-term goals in mind. This could hinder their progress.
1. Economic Conditions
Market downturns provide an ideal opportunity to invest in companies you admire at reduced costs, lowering both the average cost-per-share and improving overall portfolio performance.
At times of high market volatility, investors may try to reduce losses by selling stocks before prices decline further – this goes against their basic investing philosophy of purchasing low and selling high.
Market fluctuations often depend on global events and political uncertainty, such as wars, terrorist acts or tension between countries that lead to investor anxiety. When fear sets in among investors, stock prices often retreat in an attempt to reach safety.
Acknowledging the natural cycles of the market can help you avoid emotional reactions during turbulent periods. Stay focused on your overall financial goals and stick with your investing plan; your financial professional can assist in setting realistic, prioritized goals with specific costs and timelines.
2. Monetary Policy Changes
Different factors can cause stock prices to fluctuate quickly. An abrupt shift in monetary policy, especially one designed to expand or restrict the economy, can spark significant price swings and volatility – for instance during the initial stages of COVID-19 pandemic in 2020 stocks experienced significant fluctuations due to uncertainty as to whether government would take measures to stop its spread.
Researchers conducted extensive research into stock market volatility by searching millions of archival news articles for keywords like “volatility.” They discovered that investors respond to economic uncertainty as well as events like oil spills or interest rate hikes by reacting with investments accordingly. While macroeconomic output volatility has steadily decreased since the 1980s, changes in stock market volatility have not followed this pattern – likely because investor reactions depend on several factors and more comprehensive information sources than just macroeconomic output volatility alone. The study authors speculate that investor responses vary depending on factors like economic uncertainty as well as events like oil spills or rate hikes by reacting with their portfolio investments accordingly.
3. Political Uncertainty
There are various factors that may exacerbate stock market volatility beyond normal fluctuations. Wars, terrorist attacks and political tensions all have the power to affect global economies – having an immediate and direct effect on share prices.
Government policy changes can also increase volatility. When countries introduce new trade or tax policies that cause investors to reconsider whether to invest in that market or increase taxes, their uncertainty could cause larger price fluctuations and lead to price swings.
Large drops in the market can provide investors with an opportunity to purchase stocks they believe will experience future growth at discounted prices, thus decreasing overall costs and increasing long-term returns. Unfortunately, however, investors often get caught up in panic of turbulent markets and make decisions which compromise their bottom lines instead.
4. Industry Specific Events
Sometimes volatility doesn’t arise on a market-wide level but within particular industries or sectors. For instance, an event which increases oil prices can cause companies with significant business activity in that industry to experience stock price increases while news that an issue exists at one company could make investors flee shares that have significant business activity in that sector.
Market corrections often lead to stock declines, giving investors who believe in the long-term prospects of a company an opportunity to buy additional shares at reduced costs and boost their portfolio’s return as markets rebound.
Market fluctuations can be unnerving, yet they’re an integral part of investing. Understanding their causes is vital in devising and adhering to an appropriate long-term investment plan and avoiding emotional decisions which could derail their goals. Behavioral biases become particularly potent during periods of volatile market movements and can lead to hasty investments that result in costly mistakes.
