WHAT IS VOLATILITY AND HOW TO DEAL WITH IT?

WHAT IS VOLATILITY?

Volatility is the measure of fluctuations in the price of a stock. Way back in 1953, Henry Markowitz, Nobel Prize winning economists, introduced the concept of volatility as a measure of risk in investment. Volatility is of great importance to traders in investors in the stock market, specifically those who trade in derivatives (F&O). Nevertheless, risk and volatility have very different connotations. Remarkable investor Warren Buffet also quoted “Volatility is way beyond from synonymous with risk. Risk comes from uncertainty about what you are doing.”

Here in this article today, we will try to evaluate and understand what causes volatility and how to cope up with the same. 

WHAT CAUSES VOLATILITY?

In crux, volatility is caused by the imbalance between buyers and sellers in the market. If there are more buyers than sellers in the market, then the share price will rise and vice versa. Change in sentiments of risk causes this imbalance, Uncertainty about the future is the prime reason for this increase in risk aversion. The most recent instance of extreme volatility caused by the Sudden risk aversion was the market crash of March 2020 caused by the Covid 19 outbreak and lockdown. Sensex almost fell by 35%. Volatility can be caused by other factors as well which are:

1. Change in government policies:

Demonetization is a prime example of volatility in the market caused by uncertainty about the fallout of the policies on the economy. Market volatility after the government introduced GST and tax surcharge on FPIs in the interim budget of 2019 which was subsequently rolled back is another instance of the same.

2. Crisis in Economy:

Markets are very sensitive to economic scenarios. Nigger the crisis is, bigger the fall in the exchange. The market crash of 2008 as a result of the Global Financial Crisis, early 2000s bear market caused by the economic slowdown globally in the aftermath of 9/11 and the correction of 2011 are examples of the impact of recession and economic slowdown on the markets. 

3. Global events:

With the increase in global integration, global events also have an impact on the markets. The correction of FY 2016 was largely driven by global factors like slowdown in China, Eurozone debt crisis among others. The last US elections is another instance of the impact of global events on the stock markets. India was also impacted by the bout of global volatility in the US presidential run. 

4. Political Uncertainty:

In India, Political uncertainty has reached the markets. The market fell more than 20% after the 2004 Lok Sabha elections. The market was expecting a win by the NDA, but the UPA government came to power. Nevertheless, the market quickly recovered and fortunately we had stability in all elections held after 2004.

HOW TO COPE UP AND DEAL WITH VOLATILITY?

1. Stay Invested

It is very well known that a sudden downfall in the market indices may lead to major implications. Nevertheless, it is very significant to hold on and stay invested. Investors can connect with our financial advisors and experts at ZFunds and discuss the goals, time frame and strategy to adopt so as to ensure that things are in place. 

2. Review of Investment Plan and Strategy:

When investors observe market fluctuations, they should review their financial goal and check whether their short and long term strategies are well in place. Redetermine the financial goals if required, understand the scenarios and compare it with the investment strategies and check if any of them needs to be revised. 

Further the subsequent step is to make sure that they do nor abandon their investment journey haphazardly and keep monitoring it regularly to ensure that they are on track.

3. Diversification

As the stock markets change, the investor portfolio must also change and adapt. In fact, market volatility and fluctuations provide a  really great opportunity to diversify the stock holding and allocate the funds into different asset classes. Stay diversified in the asset mix as much as possible to beat the fluctuations in volatility. For instance, debt markets tend to be more stable when the equity indices fluctuate and vice versa. 

4. Embrace the volatility:

The main vision of this article is to convey that you must accept and expect the market volatility and fluctuations wholly. Sometimes, doing nothing is also a very significant aspect of the strategy and can play a vital role. So it is better to adopt a do nothing strategy sometimes.