Anyone who follows the stock market knows that some days market indexes and stock prices move up and other days they move down. This is called volatility. The more dramatic the swings, the higher the level of volatility—and potential risk.
Volatility can spark different reactions in different types of investors. Buy-and-hold investors—those who invest for the long-term—tend to treat volatility like background noise. The ups and downs of markets and individual securities hum in the backseat, while the long-term investor focuses down the road on incremental growth over years, or even decades.
For investors who need short-term liquidity—for example, to purchase a house or a car—volatility can be a liability and source of anxiety. Those who cannot bear the thought of—or cannot afford—locking in losses due to price drops can explore less volatile alternatives that help safeguard funds when they need them. Diversification is one way to manage volatility, and the anxiety that can come with it.
On the other hand, day traders and options traders tend to focus intently on volatility that occurs over much shorter periods of time, a few days or even mere seconds. Their goal is to profit from volatility using a variety of strategies.
There are also complex exchange-traded products that are linked to volatility.
Beta Basics
When it comes to individual stocks, a common measure of volatility relative to the broader market is known as the stock's beta. This number compares the movements of an individual security against those of a benchmark index, which is assigned a beta of 1.
For example, a stock with a beta value of 1.2 has historically moved 120 percent for every 100 percent move in a benchmark index, such as the S&P 500. In other words, it's more volatile than the broader market index. On the other hand, a stock with a beta of .85 has historically been less volatile than the underlying index. “Growth stocks” generally have a higher beta (are more volatile) than “value stocks”—those of larger, more established companies.
Higher beta comes with higher risk but the potential for higher returns. Lower beta, and the reduced risk that comes with it, means reduced potential for short-term return since the stock price is unlikely to increase very much in that time frame. Read more about risks.
Manage Risk—and Emotion
Volatile markets have become more common in recent years. When markets fall sharply, it’s easy to react on impulse, selling off your stock investments or dramatically changing the allocation of your portfolio.
Turbulent markets tend to be a good time to talk to your investment professional. And to consider the broader consequences of any action you are considering. Ask yourself: How does the action I take in the moment impact my portfolio in the future? What are the tax consequences? How would this action impact my long-terminvestment goals?
When stock market volatility is high, manage your overall financial condition by focusing on the following:
- Set clear, prioritized goals. This will help guide your investment approach, regardless of market conditions.
- Stay diversified across, and within, the major asset classes, keeping in mind that all investments fluctuate in price.
- Take advantage of day-to-day opportunities to build your finances: Pay your credit-card debt on time and in full, keep your eye on other financial objectives such as saving for a home or vacation, and maintain an emergency fund.
- Be on fraud alert. In times of high market volatility, investors may be especially vulnerable to financial scammers touting guarantees of "risk-free" returns. Reduce your risk of fraud by working only with registered investment professionals—using FINRA BrokerCheck to find out if a person is registered to sell securities—and by following your financial plan.
Learn more about key investing topics.
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