Volatility is important to investors in the stock market, especially investors dealing with derivatives. Volatility is the demographic estimation of changes in the cost of a stock. Investors believe volatility and risk are different. Millionaire Investor Warren Buffet says, ” Volatility is far from synonymous with risk. Risk comes from not knowing what you are doing”.
Now, let’s try to know the factors causing volatility and its result on equity market and few mistakes to avoid.
What is volatility?
In short, the inequality between buyers and sellers in the stock market cause volatility. If there are more buyers than sellers, the stock cost will decrease and vice versa. Changes in risk opinions also cause this inequality. Doubts about the future is also a key factor behind the rise in risk aversion. One recent example of uncertainty caused by sudden risk allergy is the economic crash in March 2020 caused by the COVID-19. Some other factors also cause volatility.
Stock markets are very susceptible to economic conditions. Bigger the crisis, bigger the fall in the market. The market crash in 2008 caused by the Global Financial Crisis, early 2000s bear market resulting from 9/11 and the correction of year 2011 are examples of the result of economic slowdown on stock markets.
Change in Government Plans:
Demonetization is an example of uncertainty in the economy caused by doubt about the result of the Government’s policy on the market.
In India, markets have reacted to political volatility. The market fell more than 20% after the Lok Sabha election of 2004. The market was betting an NDA win, but the Congress Government came to power. However, the market quickly recovered and luckily we have had stable Governments in all the elections after 2004.
With an increasing global union, global events also have an impact on stock market. The revision in FY 2015 – 16 was largely motivated by global factors like Eurozone debt crisis (Greece, Portugal etc.), economic slowdown in China etc.
Mistakes to prevent
Do not panic:
Volatility makes you feel stressed. No one wants to see savings made with their hard-earned money go down. But if you panic and sell, you will make permanent damage. Being patient is very important.
Do not try to time the market:
Many investors sell in bear markets hoping to buy back at lower prices when market falls. It is very difficult to predict market fall. Take the market fall in March 2020. The market started recovering in April when we all were predicting a gloomy future.
The speed of recovery depends on the nature of uncertainity. For instance, volatility caused by short-term demand and supply inequality is short-lived. If the market is hit by strong factors like recessions, it takes longer to recover. You need to understand its nature to ride it.