No matter what your investments are, it’s likely that at some point, you’ll have to face the question of how to avoid risk. With so many factors potentially affecting market volatility, it can be tough to find the course of action that gives you peace of mind. That’s why we’ve put together this post all about what factors trigger changes in market volatility. We’ll give you the information you need to make an informed decision on how to invest for yourself and your family’s future!
Here are some key factors which trigger changes in the volatility of the market:
1) The market is going through a major drawdown (i.e. extreme loss).
- The market has arrived at a level, price, or pattern that many investors feel will act as a turning point.
- This typically results in increased volatility as traders reposition and hedge.
- Or they may be looking to capitalize on the perceived weakness by buying at lower levels to sell at even higher ones.
- The longer the market stays in a drawdown cycle the more likely these events will occur.
The Federal Reserve (also called ‘the Fed’) can have a significant effect on volatility depending on their monetary policy decisions relating to interest rates and inflation.
2) A change in investor psychology is taking place.
- New investors are entering an asset class, which can potentially drive up demand and prices.
- Long-term investors are ‘burnt out’ or panicking about too much risk, which can cause them to take profits and sell assets.
- There is a general feeling of euphoria or panic to either enter or exit an investment.
3) A fundamental change in events is occurring.
- A new economic data release has the market reacting to its implications.
- A commenting event occurs, with many investors making big moves to get ahead of the event.
- Oil prices suddenly spike and supply chains are altered as a result.
- Companies report earnings and the market reacts accordingly to their performance. – One or more countries’ central bank makes a policy change that leads investors to reposition their portfolios based on expectations for interest rates and inflation.
4) The market is entering a new window.
- Investors normally have a certain amount of time to react before they make the news public.
- Most investors react to these events even though they have no way of knowing what’s coming.
- This can often lead to irrational behavior and panic selling as investors try to sell before the news hits.
- This can cause an ‘over-reaction’ with prices rising too high or falling too fast due to investor expectations being triggered.
5) The market has entered a ‘swing’ phase which ends with a reversal of direction.
- It moves through phases with irrational higher lows and lower highs – as traders flip from trading in hopes of reaping massive profits to selling from fear that they’ve lost money already.
- Once the lows and highs have been met, the market will turn around.
- The longer the market spends in that phase, the more traders focus on it.
- This usually means more buy orders are being placed at higher levels, while sellers also raise their prices.
- As these expectations are met and surpassed, they often result in a reversal of price direction.
Some additional Factors which trigger changes in the volatility of the market:
1) It’s important to note that anything can cause a change in volatility – even relatively small events can have big implications for traders and investors. Since the market reacts to so many factors, it’s important to be aware of what news is coming out and how it might affect your investments.
2) There are certain times of the year that can affect market volatility. For example, July and August often see companies reporting earnings or issuing guidance for increased or decreased profits, which could cause investors to make changes in their portfolios.
3) The Federal Reserve can have a significant effect on volatility depending on its monetary policy decisions relating to interest rates and inflation.
4) The media can also ‘make’ a story when there isn’t one – but even if it’s not a huge issue – all it takes is for someone to react quickly out of panic. Fear mongering is a common tactic that media use. It can lead to increased volatility in the markets. We saw this in the recession months after 9/11 when many companies were forced to close and report losses for several consecutive quarters.
The constant coverage of the incident caused investors to quickly sell off their stock and commodities holdings – even though they didn’t get any new information since before the attacks took place.
Changes in investor sentiment can have a big effect on market volatility as well.
What are the key things you need to keep in mind during a volatility change?
1) When you change your investment strategy – your changes should be long-term, based on your chosen risk tolerance.
Also, keep in mind what your strategy was before the change in volatility occurred. If you’re an aggressive investor and the market is suddenly going through a drawdown, it’s important that you don’t panic and sell all of your assets to cut losses. This is one of the biggest mistakes investors make when their investments are going down and they think their portfolio will only go lower from this point forward. The reality is that the market will eventually go up – and this is often just a normal part of the market’s cycle and shouldn’t be your reason to panic.
2) Be patient when volatility increases before you make any decisions!
Once these changes have occurred, you will want to re-evaluate your investments and make sure that your portfolio is still in line with your original risk tolerance. Depending on what triggered the change in volatility, you may even consider taking some profit off of the table if things are overvalued.
3) Don’t just rely on your emotions to invest and trade!
While this may make you feel like you have time to see the market through a period of volatility, in reality, it can cause you to miss key opportunities. Most investors who panic and snap off their trades tend to lose much more than they would if they kept an even keel and waited for the markets to turn around. Always remember that the markets are irrational at times – but this doesn’t mean you should act irrationally.
I often re-read Warren Buffet’s letter outlining his investment philosophy which he posted on his website. I like to use this to remind myself of what can happen when things seem off track – and I think you should too!
Bottom Line
Asset prices and market volatility have often a direct connection to investor behavior. If you want to benefit from the financial market, you will need to know everything about volatility and be able to pre-predict the market volatility. It’s important to understand how these factors can change so you can make the best possible investment decisions for yourself.
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FAQs about the volatility of the market:
1) What is the volatility of the market?
- In fact, volatility is a measure of how much the price of a security fluctuates over time. The level of volatility will often depend on the market in which traders trade the security. And we can measure it by using different types of indexes.
2) Is stock market volatility good or bad?
- It depends on your investment objectives. Volatility, when trading or investing in stocks and options, can be a good thing or a bad thing. It’s important to know how to recognize it, understand it and then use it to your advantage.
3) How do I measure volatility?
- There are many ways to measure the volatility of a stock or a market. The most common measurement you’ll come across is historical volatility. It compares the frequency and magnitude of price changes over a specific period of time. Traders use other types of indexes including implied volatility and realized volatility. We can also measure volatility in terms of global markets, individual stock prices, or market sectors.
Or like anyone else, you can use the ATR indicator to measure volatility…
4) What does historical volatility mean?
- Historical volatility is when you measure the frequency and magnitude of price changes over a specific period of time. If this number is high, it means there has been a great deal of movement in the price of the security over time. The results can be alarming if they indicate that the market or security will move in the wrong direction soon.
5) What does implied volatility mean?
- To be precise, implied volatility is a calculation based on events or information that’s known by traders and investors before they make a trade or purchase an options contract. Traders use these events or information to predict future prices and achieve returns for traders known as arbitrageurs.
