Why is Market Volatility Important?

While markets usually fluctuate incrementally without much impact on investments, sometimes they change drastically. This market volatility poses a significant risk for investors, but it also offers insights that can help them make wiser investment decisions. To help you navigate the investing landscape, Park Place Financial provides an overview of market volatility and discusses what affects the stock market.

Defining Market Volatility

Market volatility measures how the price of a particular stock moves over a set period. High-movement stocks indicate greater volatility, while lower movement stocks represent more stability. Additionally, a 2020 report by Crestmont Research found that volatile markets have a higher likelihood of declining and steady markets have a greater chance of rising.

When investors see increased stock price volatility, it can help them predict future changes to the market. This information can help them adjust their portfolios to match the returns they expect to see on investments.

Measuring Market Volatility

Financial experts determine volatility for a specific market by calculating the standard deviation of price fluctuations over a set amount of time. This unit of measurement allows them to see how much these prices will diverge from the average stock value and give an outline for when deviation will occur.

There are two distinct types of volatility that investors measure — historic and implied. Investment professionals use past market costs to figure out historic volatility and look at potential stock changes to find implied volatility.

Factors Affecting Stock Market Volatility

Multiple aspects impact how businesses operate, from the government to the weather. Whether these factors augment productivity or cause a significant loss, they ultimately affect company market value. Some of the most common elements that influence market volatility include:

Government Regulation

Elected officials routinely set forth regulations that impact how companies conduct operations. Their policies and trade agreements can also alter the economy, prompting businesses to adjust to their current structure. Sometimes, a speech from a government representative alone can cause changes to stock market prices.

Economic Conditions

Investors look at inflation, gross domestic product (GDP) values, and consumer spending to determine economic health. If the results indicate a booming financial situation, people are often more inclined to invest in stocks. Conversely, an economy with more uncertainty may lead to heightened volatility.

Industry Changes

Some factors cause fluctuations in stock prices for companies within a particular industry. For example, if a natural disaster destroys the property of a farming business, the crop they produce may increase in price. In turn, the stock of farming companies that create the crop will rise in value. However, businesses that rely on the crop to manufacture goods may experience a drop in stock prices.

Company Success

Specific events that occur within single companies can affect their market value. If a business has a trending product or a positive earnings report, investors may be prone to buy stock in it. On the other hand, a recall, security issue, or public relations incident can drive investors away from the company, reducing its stock price significantly.

Withstanding Market Volatility

Although market volatility can be worrying, there is often little reason to panic sell, or make other hasty decisions with your stocks. If you are worried about market volatility, consult your adviser. He or she may use the following investment strategies to help keep your portfolio on course:

Rebalance Your Portfolio

Rebalancing your portfolio can realign your investments with your goals and desired risk level, mitigating the effects of market volatility. When reallocating your assets, it may be recommended to sell investments that take over your portfolio and use the profits to invest in an area that has diminished in value.

Set Up an Emergency Fund

People liquidating their investments often struggle with market volatility because it compels them to sell stocks when prices are low. To guard against this situation, ensure you have an emergency fund with enough resources to last several months. It’s often recommended that investors reaching retirement age should have a larger emergency fund that includes two years or more of non-market assets.

Follow Your Long-Term Investment Plan

If you invest in stocks long enough, you are sure to encounter market volatility over time. This reality should not keep you from buying stocks but remind you that fluctuations are commonplace in long-term investing. Decreased stock prices often bounce back, leading to increased profits if you hold on to your investments.

Take Advantage of Volatility

Many people focus on the downsides of market volatility without recognizing that it offers several benefits. When market prices increase dramatically, you can sell and invest the profits in stocks with more potential. In contrast, you can buy additional stock in businesses projected to perform well when prices are low. Either way, market volatility presents numerous opportunities to receive long-term returns on investments.

Seek Investment Advice from Park Place Financial

It’s important to recognize market volatility and make well-informed decisions with your investments. If you need help understanding what makes stocks go up and down, turn to Park Place Financial for assistance. Our investment planning services help clients achieve short and long-term objectives to ensure they are financially secure. We work together to determine a client’s risk before offering recommendations for added assurance. Contact us today to learn more about market volatility and investment planning.