Stock Market Volatility

Volatility refers to the range of price change experienced by a stock over a given period of time. Low volatile security is one whose price stays relatively stable. On the other hand, a highly volatile security experiences rapid increases and dramatic falls resulting in new highs and lows.

Volatility can benefit investors of any stripe. As a conservative strategy, many investors favour a long-term strategy called buy-and-hold over the short-term strategy of frequently buying and selling the security. Under the buy-and-hold strategy, the investor purchases a stock and holds it for a long period, often many years, gaining by the company’s incremental growth. The buy-and-hold strategy is based on the assumption that will generally produce returns in the long-run even if there are fluctuations in the short-run in the market. Usually, for this kind of strategy, a highly volatile stock may be a choice, but sometimes a small amount of volatility can also result in higher profits. With the movement in the prices, it provides an opportunity for the investors to buy stock in a company when its price is relatively very low, and then wait for the growth.

Volatile markets are usually identified by huge price fluctuations and high trading volumes often resulting from an imbalance of trade orders in one direction like all buys, and no sells or vice-a-versa. Some people believed that the volatility in the markets is usually caused by economic releases, company newsletters, a recommendation from a popular analyst, a great initial public offering (IPO) or an unexpected earnings results while others believe that the volatility is due to the day traders, short sellers, and institutional investors.

Under the behavioural approach of the efficient market hypothesis (EMH), it is assumed that the market prices prevailing in the market are correct and are adjusted to show all the information. This approach shows that the volatility in the market resulting from the change of mind collectively by the investors. But there is no definite answer to what causes stock market volatility.

The primary statistics used by the traders and analysts to determine the volatility is the standard deviation. It reflects the average change in the stock’s price from its mean over a specific period of time. It is calculated by squaring the difference computed by subtracting the mean price from each price point which is later summed and averaged to produce the variance. Finally, the standard deviation is calculated by taking the square root of the variance. Since the variance is not in the original unit of measure, it becomes difficult to measure it because of which it is not used as a metric to determine the volatility.

Technical analysts use Bollinger Bands to analyze standard deviation over time. The width of the bands determines the standard deviation. As the width of the band increases, the stock becomes more volatile, and as the band narrows, the stock becomes less volatile.

Investors should be aware of the risks of investing in a volatile market. Being a conservative investor and choosing to stay invested if a person is confident in his/her strategy can be a great opinion, but deciding to trade in a volatile market, one should be aware of the volatility may affect the trade.


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