Is Price Volatility in Stock Market actually risky?
Before we take up this topic, let’s understand what price volatility actually is. The term ‘price volatility’ is used to describe the price fluctuations of a commodity in the market, it is measured by the day-to-day percentage difference in the price of a commodity. This degree of variation, and not the level of prices, is what defines a volatile market. So, putting it in simpler terms, volatility provides a measure of price uncertainty of various goods in the market.
If the price remains reasonably stable, the security will have low volatility. Highly volatile security is the one which hits new highs and lows abruptly, moves erratically, and can be defined as the one with rapid increases and dramatic falls.
I’m sure we have all witnessed the way stocks have gone from the bottom during the times of recessions like the 2008 financial crisis to hit all-time highs during other times, blinkered with many other ups and downs in between. This is why we often refer to stocks as volatile.
Let’s take a recent example of extreme price volatility which was caused due to the COVID-19 pandemic, this market volatility has caught many investors off-guard. This volatility forced many investors to re-allocate the assets in their portfolios in order to introduce some amount of diversification in their portfolios.
Now, prior to discussing why price volatility might not be risky, let’s understand what leads to price volatility in a market.
A volatile market might most often be the consequence of imbalance in trade orders in one direction, for instance, all buys and no sells. However, there are several other factors that might lead to price volatility, like changes in economic policy, or the public relations of a company, political developments all over the world, volatility overseas, economic crises, and many more.
Finally, let’s take up why price volatility might not be risky.
Stock market volatility is arguably one of the most unappreciated concepts with regards to investing. I understand why a volatile stock might seem like an unnecessarily risky proposition, considering how people often tend to experience the pain of loss more acutely than the happiness that comes from a gain.
However, what there is for us to know and understand and what experienced investors are already aware of is that market volatility actually provides numerous money-making opportunities for a patient investor. Investment is inherently about risk, and for every trade, there is a risk for success and failure. And, without volatility in the picture, there is a lower risk of either.
So, for years volatility is almost universally believed to be a proxy for risk. However, volatility is far from being synonymous with risk. This concept only represents the shorthand version of reality rather than tools that always work, or even usually, are beneficial.
While many more conservative investors tend to favor a long-term strategy popularly known as buy-and-hold, wherein stock is purchased and then held for long periods of time, to reap the profits of the company’s growth. This approach is based on the assumption that while there may be ups and downs in the market, it generally produces returns in the long-run.
While a highly volatile stock may be a more anxiety-producing option, a small amount of volatility can actually lead to greater profits for an investor. As the price rises and falls, it provides an opportunity for the investors to buy stock in a concrete company when the price is very low, and then wait for cumulative growth down the road (perhaps in the near future).
And, for the short-term traders, volatility can even be more useful. These traders are constantly monitoring the change in prices, second-to-second, minute-to-minute, and if this doesn’t happen, there won’t be any profit. Even for swing traders, who work with a slightly longer time frame, probably days or weeks, market volatility is important for them as well.
Volatility can bring points of entry for someone whose investment strategy and time horizon are for long periods of time. When it comes to bullish investors, who imagine markets will achieve better in the long-run, downward market volatility provides the prospect to buy more shares at comparatively lower prices.
By increasing investment in securities when there’s a discount, one would lower the mean cost per share and increase profits from it over time. The stage of market volatility can prove to be a good time to put money in some extra additional funds and liquidate some underachieving assets.
We cannot just disregard volatility, it is an important part of the market. The up and down of prices form the DNA of the market. One needs to understand that the process of fluctuations in price, might not always have a downside. Once people stop seeing this simple inevitable phenomenon as disadvantageous, they will start seeing it as opportunistic.
For people who have been in the investing business for a long, volatility is a friend rather than a foe. Daily variabilities of price or volatility shouldn’t act as a disturbance in the work of evaluating the intrinsic value of enterprises. However, an investor makes use of this sharp volatility as an opening to buy cleverly when prices fall abruptly and to sell smartly when prices finally rise, which won’t take very long.
So, when markets turn volatile, you shouldn’t panic, and keep stocking up equity assets, and build a diversified portfolio for yourself. You should always try and use the market conditions to your advantage because it’s important to understand the probable benefits of investment opportunities that surface from price volatility in the market.
Written By- Palak Batra