What is market volatility?
Editorial staff, J.P. Morgan Wealth Management
- Market volatility refers to the degree of variation in asset prices (such as stocks, bonds and commodities) and can affect investors' strategies, returns and emotions.
- Volatility can be estimated in different ways, including standard deviation and the Cboe Volatility Index (VIX).
- Volatility can be unsettling, but it may also present opportunities – for example, lower stock prices and new investment ideas.
Market volatility describes the degree of price variation or fluctuation of financial instruments (like a stock, bond or currency) over a specific period. Essentially, it measures the amount of uncertainty or risk associated with an investment.
In other words, volatility refers to the speed and magnitude of changes in an asset's value. When a stock price is highly volatile, it means that the stock is experiencing significant price swings, either up or down, in a short time frame. On the other hand, low volatility means that the stock is experiencing minor fluctuations in price.
While market volatility can be unsettling for some investors, it is a natural part of investing and can present opportunities. Understanding volatility and how to manage it is crucial for investors looking to navigate the financial markets. Next, we'll cover how volatility can affect investors, how it’s measured and ways people try to manage it.
Get up to $1,000
When you open a J.P. Morgan Self-Directed Investing account, you get a trading experience that puts you in control and up to $1,000 in cash bonus.
How volatility can affect investors
Volatility can have a significant impact on investors, affecting their investment strategies, returns and emotions. Here are some of the ways in which volatility can affect investors:
- Risk tolerance: Volatility can affect an investor's risk tolerance, or their willingness to take on risk in pursuit of potential returns. During periods of high volatility, some investors may become more risk-averse, while others may see it as an opportunity to take on more risk.
- Investment strategy: Volatility can affect an investor's strategy, as they may need to adjust their portfolio or time horizon in response to market fluctuations.
- Returns: Volatility can have an impact on an investor's returns, as market fluctuations can lead to significant gains or losses in a short amount of time. Investors who have a longer-term investment horizon may be better equipped to weather these fluctuations and benefit from potential long-term gains.
- Emotions: Volatility can also influence an investor's emotions, leading to fear, anxiety or panic. These emotions can lead investors to make rash decisions or panic-sell their investments, potentially resulting in significant losses.
Managing volatility
While market volatility can be unsettling, it is a natural part of investing, and investors can take steps to manage it. Here are a few strategies for managing volatility:
- Diversification: One of the most effective ways to manage volatility is through diversification. By investing in a range of assets across different asset classes, sectors and geographic regions, investors can spread their risk and reduce the impact of volatility on their portfolio.
- Rebalancing: Rebalancing is the process of periodically adjusting the allocation of assets in a portfolio to maintain a desired level of risk. This involves selling assets that have performed well and buying assets that have underperformed to bring the portfolio back to its original allocation. Rebalancing can help keep your portfolio’s risk level closer to what you intended. However, selling appreciated investments could have tax consequences, so you need to factor that in and speak to your tax professional.
Asset allocation/diversification does not guarantee a profit or protect against a loss.
Measuring volatility
If you’re trying to understand risk in a portfolio, it can help to measure volatility. There are different methods of measuring the level of volatility in the market. Two common approaches are standard deviation and the Cboe Volatility Index (VIX).
Calculating volatility
One way to measure volatility is by determining the standard deviation of a financial instrument’s returns over a particular period. Standard deviation is a statistical measure that indicates the degree to which an investment’s returns vary around their average return over a period. A higher standard deviation indicates that the investment’s returns have experienced more significant fluctuations.
Volatility Index (VIX)
Another way to measure market volatility is through the Cboe Volatility Index (VIX). The VIX estimates the market's expectation of annualized volatility over the next 30 days, based on S&P 500 index option prices. It is sometimes called the "fear index" because it tends to rise when investors are fearful and fall when investors are confident.
The VIX is calculated using the prices of options contracts on the S&P 500 index. Options are contracts that give the buyer the right (but not the obligation) to buy or sell an underlying investment at a set price on or before a certain date. By looking at the prices of options contracts, traders can gauge market sentiment and expectations for future volatility.
The bottom line
As you develop an investment strategy, it’s important to keep in mind that you will encounter volatility along the path to your financial goals. Speaking with a financial advisor could be one way to plan for – and perhaps even benefit from – the inevitable fluctuations in the market.
Invest your way
Not working with us yet? Find a J.P. Morgan Advisor or explore ways to invest online.
Editorial staff, J.P. Morgan Wealth Management
