If you’re an experienced investor, then you’ll probably be all too familiar with the concept of risk. And hopefully, reward too!

The value of your investments will go up or down over time, in line with market conditions. The extent and frequency of this price movement is known as volatility. In other words, volatility is the measure of how quickly the markets move and how much this impacts the value of your investments.

Volatility is to be expected when investing, at least to a degree.

And whilst that volatility can be managed, through the choice of investments selected, most investors should expect to endure fluctuation in the value of their investments at some point.

What is market volatility?

A volatile market is one in which the listed investments are subject to rapid price fluctuations, due to an imbalance of the forces acting upon it.

Volatile investing markets are often characterised by heavy trading. As investors look to take advantage of a disparity between the current asset price and its perceived longer-term value.

Traders will look to take advantage by buying investments they believe are underpriced, or selling investments that have either hit their price target or are no longer considered a good long-term prospect.

What are the causes of market volatility?

There are many potential causes, but some common causes of stock market volatility are as follows:

1. Economic factors

The overall level of stability, or potential for economic growth, has a big impact on the level of confidence when assessing investment risk.

The role of government will inherently play an important role in nurturing a healthy economy. That’s because they’re responsible for regulating industries and creating legislation, policy and trade agreements. Alongside this, central banks set interest rates to manage inflation, which can impact the markets.

2. Industrial factors

Specific events (including anything from the weather to government policy) can cause market volatility that’s limited to a particular industry or sector.

For example, recent events that have destabilised the global economy, resulted in the prices of oil initially soaring. This could impact the profitability of businesses and industries heavily dependent on oil or petrol etc., and therefore the market value of the companies.

3. Company-specific factors

So far, we’ve seen how global politics and industry trends can impact volatility, but the causes can also be much more immediate.

The direct performance or actions of a business itself can also create volatility in the price of its shares. An innovation could suddenly sky-rocket their stock price overnight…

Or, conversely, an unfavourable technological advance could see the value of a business decimated very quickly if they’ve not foreseen the change and adapted accordingly (does anyone remember Blockbuster video?).

How to handle market volatility?

The first and most important thing to remember during times of market volatility is that it’s a normal and expected aspect of long-term investing.

Volatility can cause investors (particularly those who are new to investing, or who lack experience) to sell at a time that is less than ideal.

It may help you to remember that volatility is not necessarily a bad thing. The period before a market correction can provide an entry point for investors with a cash reserve, who are waiting to invest in a financial market.

It may seem natural to sell out an investment that’s losing money, but doing so consolidates that loss. Instead, if the investment is still considered to have good long-term prospects, this could even be an opportunity to buy more units while the price point is at a relative low.

Of course, it’s very easy to promote the virtues of staying calm in theory… But it can be harder to stay cool in practice when it’s your money on the line. Ultimately, short-term market volatility might not even be relevant to you if you’re working on a longer-term strategy.

Whether you see market volatility as a good or bad thing, your outlook will be dependent on your own financial position. Each individual will need to make their own decision about the best strategy for a volatile market, but here are some points to consider:

1. Resist impulse urges

Over the long term, it’s natural that you may wish to adjust your strategy and reflect this in the asset allocation for your investment portfolio.

However, it’s rarely a good idea to make decisions about the strength of an investment in the heat of the moment, or when the choice is being guided by emotion caused by recent market adjustments.

If you sell an investment that’s currently down, you lock in that loss and forgo the chance to recoup some of your investment should the price rally again. That’s if you still believe in the underlying investment.

2. Review risk levels

Whatever your investment goals, you may already have some degree of diversification in the securities selected for your portfolio. A diversified portfolio helps to spread risk and lower volatility in its overall value.

When you review your investing strategy you should be considering how well protected you are from risk. Often, the decisions you make to manage risk will be guided by how soon you think you’ll need to access your money.

The aim is that, as you anticipate you’ll need access to cash, you can manage volatility by picking opportune times to move money between investments (i.e. by switching out securities perceived as higher risk, in favour of more stable asset classes). Which leads us to...

3. Rebalance and adjust

When making investment decisions the aim is to try and ensure we buy ourselves as much time as possible to make considered choices.

If you invest, then you will almost certainly need to adjust the composition of your portfolio at some point.

What we want to avoid is having to sell investments when markets are down, simply because we need sudden access to our money.

This means, that for any short-term investments (less than 3–5 years), consider moving money from volatile stocks and into asset classes that have historically been considered more stable.

So Bonds with shorter times to maturity or funds containing high-quality investments backed by the Government (like Plum Interest) could be the order of the day if you’re not investing for the long haul.

How is market volatility measured?

In statistical terms, volatility is the standard deviation in the market price of a given investment. That could be anything from stock in a single company, to a fund that’s indexed against a whole financial market or geographic region.

To calculate market volatility, the price of a security is tracked over a given period of time. When the price fluctuates to such a degree that new highs and lows are recorded within a short period, the market for that investment is said to be highly volatile.

However, there is no set measure of what defines high or low volatility across different investments. A given percentage of deviation for a particularly stable investment (like a government bond, for example) would be considered more volatile than the same percentage recorded for a startup or young business.

No matter how you choose to deal with market volatility, always remember that your capital is at risk when investing. The value of your investments can go down as well as up, and you could get back less than you invested. This content is for informational purposes only, and you should not construe any such information or other material as investment, financial, or other advice. Plum does not provide investment advice and individual investors should make their own decisions or seek independent advice. Fees and T&Cs apply.

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