Market volatility is an investment term that describes when a market experiences a period of unpredictable and sometimes sharp price movements. People often assume market volatility is to blame when prices fall, but it can also refer to sudden price rises too.

Keep a level head

Market volatility is a normal part of investing, but it can bring powerful emotions and tremendous pressure. Unfortunately, we don’t usually make our best investment decisions when under pressure.  

But you can manage these turbulent emotions by improving your knowledge as an investor. The more you know about a given situation, the greater your control over it will be and the less emotion can then affect our decision making under pressure.

Diversification

Many investments may surpass or fail to meet our expectations. Sometimes an investment will take much longer to become profitable than expected, and other times you may not see any returns from it at all.

Market volatility can exacerbate these situations, so it is important for us as investors to defend against such sudden market changes. Diversification into a wide range of markets, with stocks held in various industries, can shield your investment portfolio from some of the most damaging effects of market volatility.

For example, if you chose to invest in some riskier tech start-ups, you could diversify your portfolio into more established technologies with less risk of failure, so if some of the start-up tech companies fail then this may be counter-balanced by your more mature tech companies. Either way, you must still do the necessary checks and balances.

Market volatility can sometimes impact entire asset classes, not just individual companies, so diversifying into as many different asset classes such as stocks, fixed-income investments, cash equivalents (gold) and alternative assets like real estate and land, provides your investment portfolio with an additional line of defence.

Potentially turn market volatility to your advantage

When market volatility impacts a specific market or sector of industry, companies both good and bad suffer the consequences. Market volatility tends to put us on the defensive, as avoiding potential losses can soar to the top of our priority list, but an investor well versed in stock market trends can instead go on the offensive when such volatility occurs.  

For example, the hospitality sector suffered tremendous market volatility throughout the COVID-19 pandemic, initially decimating stocks within this sector no matter how well established the company or brand.

An investor looking to turn this volatility to their advantage would have watched the prices of stocks for well-established hospitality companies eg hotels, restaurants, and music venues when this volatility occurred and then snapped up the stocks for these companies at a cut-price, speculating that these companies would probably bounce back later.

Price-conscious professional investors will have a ‘shopping list’ on hand, so they are better able to analyse downturns caused by market volatility, enabling them to decide quickly whether to invest or walk away.

Analyse

Warren Buffett famously said: “If you aren’t ready to see your portfolio drop by 50% you aren’t ready to invest” and this can be a useful reminder in analysing how you may react to sudden changes brought about by market volatility.

Looking over your current investments when the market is stable and making predictions on what may occur when volatility occurs can be a powerful tool for an investor to possess.

How you apply these insights will be highly dependant on your own investment position, the kind of stock or asset class you are dealing with and your level of investment into the market in question, but the simple act of creating hypotheticals and predicting how you will react to certain situations will potentially improve your odds of surviving or thriving through periods of increased market volatility.

IMPORTANT NOTICE

Investors should recognise and accept the risks associated with investing.

Certain investments may require you to keep your holding for periods of many years with limited or no ability to resell unless there is a strongly regulated secondary market.

You may also have limited access to periodic reporting, see your holdings decrease and increase in value, or even lose your entire investment.

Investors should decide for themselves whether to make any investment, basing this on their own independent evaluation after consulting with financial, tax and investment advisors.

The Knowledge Hub does not constitute financial advice whatsoever, but rather provides basic general industry information.