What is Stock Market Volatility?
Updated: Oct 31, 2022
Stock market volatility can be defined as the rate by which stock or equity prices rise or fall over any particular period of time, be that a day, a week, a month, or a year.
Higher stock price volatility is often a cause for concern to investors, and especially new investors or those investors who have not experienced significant stock market volatility in the recent past.
As we pass the end of the first quarter of 2022, it is fair to say that higher stock market volatility has now returned, but by understanding the reasons for volatility, and considering our long-term goals and horizons, we will understand that market volatility is all part and parcel of the investing game, and not to be something that we concern ourselves with on a day to day or week to week basis.
What is causing this recent stock market volatility?
As long term investors, we have seen time and again that there is always something to worry about in the world, whether it is a domestic problem or an international problem, or a collection of problems.
Whilst there is no one particular concern we can attribute the recent volatility too, we do know that there are several factors influencing markets both here and abroad in a generally negative way. As I write this blog today for my eToro copiers and followers community, the main problems causing market uncertainty appear to me to be as:
1. there is much uncertainty around the ultimate outcome of Russia's war in the Ukraine and whether it will resolve itself quickly or rumble on for many more months or even years.
2. there are supply chain issues both globally and locally causing businesses both large and small significant difficulties.
3. inflation is running at 30-year highs both in the UK and in the USA, leading to the assumption that interest rates will rise faster and further than had been initially predicted.
4. fuel and energy prices are increasing rapidly, putting increased costs pressures on both consumers and businesses.
5. world stock market markets including the USA hit all time highs in early 2022, and the UK hit a two year high just a week ago, which can increase volatility due to high valuations.
6. whilst the current COVID-19 variant omicron appears to be receding, there is always the chance have another variant springing up at anytime now causing further disruption.
What else can drive stock price volatility?
More generally, the following areas can often drive market volatility:
1. Company performance
It should be remembered that stock volatility is not always a countrywide or market wide problem, and can often relate to single businesses.
If a company posts some really positive news, such as a new product or a significant new contract that excites current and future investors, then the company's share price will be extremely volatile to the upside as the share price increases rapidly. A recent example would be Entain just after it said it was in acquisition talks with a U.S. company.
In contrast, If a company declares some negative news such as a significant loss, a departure of a senior key figure, poor behaviour by directors, or even a data breach, stock prices will show significant volatility to the downside as the share price plunges. A recent example of this would be countrywide properties, just after they announced that their CEO was leaving.
2. Political and economic factors
Governments around the world can have significant impacts on businesses and companies as they can chop and change rules and regulations which will have an impact on the economy. A recent change in the UK was the future increase in company taxation rising from 19% now, to 25% in the future. There has also been a planned tax increase confirmed for the general public, which will mean consumers will have less to spend on business products in the near future.
The economic situation of the country, and consumers of that country can also play a role with market volatility, for example employment levels, personal taxation, house prices, and ultimate take home pay, will all impact consumer spending habits.
3. Industry and sector factors
Certain events can also cause volatility within an industry or market sector. For example when betting and gambling companies were threatened with tighter regulation and higher taxes the whole sector share price valuations collapsed.
Oil companies are often subject to specific industry factors such as large polluting events, green policies and levies, and disruption with their supply chain when Middle Eastern countries threaten war with each other.
However – market volatility can mean opportunity
Volatility shouldn't always be considered a bad thing, as it can provide the opportunity for some discounted entry points to take advantage from.
if the whole stock market plunges by 10 to 15% in a short period of time, then there may be the opportunity to buy good solid companies at a discount, that will ultimately prevail in the long term. Think about the significant short term drop of the initial COVID pandemic back in March 2020 when UK markets plunged by 40% in the space of a few weeks.
Those who took advantage of those low valuations and bought more at the March lows, indeed I was one of those such investors, quickly made back the initial losses plus some further significant gains when the markets did eventually rise over the period of three to six months later.
Positive volatility can also provide opportunity, for example if one of your stocks received some very positive news that increases the price by a significant margin on the day such as a potential acquisition or buy out, then you could sell that stock immediately and reinvest the increased valuation elsewhere.
Whilst market volatility is sometimes seen as a bad thing, long term investors know that investing when the stock markets are most volatile, can often generate great entry points and lead to stronger long term profits. Indeed, that is why I always have a cash pile to hand in my eToro popular investor trading account to take advantage of this exact situation.
Thinking long-term is important in investing
Investors who tend to think longer term are generally far less concerned with stock market volatility on a day to day or month to month basis. They are focused on the long term end result, and understand that in fulfilling their long term investment strategy, volatility will happen from time to time along the way.
The following 4 reasons can highlight why long term investment strategies are the best way to go:
Timing the market is difficult if not impossible
If Warren Buffett says he cannot time the market with any degree of accuracy, then there is not much hope for the rest of us. History teaches us that nobody knows when the top of a market or bottom of a market is here and so trying to buy at the bottom and sell at the top is a fools errand.
Once we have made the decision to invest in the stock market we need to take the plunge, and then understand that it is time in the market that will eventually lead to our profits and not the continuous attempting to buy low and sell high, which very often ends up being the exact opposite due to human nature.
Monthly compound income payments enjoy volatility
If you have any stocks or equities that pay monthly or quarterly income, then market volatility can often work in your favour, whereby on downward cycles your reinvested income is buying more units each time at a lower price. Even if this goes on for month after month before eventually turning the corner, you would have had the benefit of buying cheaper stocks for all this time prior to the eventual recovery where by your returns and profits will have been increased.
The best days can have a big impact
History generally demonstrates that following significant downward corrections in the market, at which point some investors bailout crystallizing their losses, the following recovery and bounce back more often than not, is very important in the eventual recovery of the stock market and individual portfolios.
So instead of selling out at what you think is the appropriate time, it is better to remain invested when markets are volatile as this usually benefits you if you take a long term view.
Give good quality companies time
Good quality companies will usually do much better when economic conditions slow down or market volatility increases. Therefor long term investors may be better off to weather the financial storm, as these businesses often come out even stronger, although it can take some time for this quality to be ultimately reflected in the share price.
Stock market volatility conclusion
The key point to understand and remember is that it’s entirely normal for all stock markets to move up and down, and market volatility should not be the deciding factor on whether or not to sell your investments.
Through fully understanding market volatility and its causes, investors can very often take advantage of the investment opportunities that it provides to generate far better long-term results across their investment portfolios.
I very much hope this market volatility summary blog has assisted with any concerns you may have had.