Know the Market Volatility

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Know the Market Volatility

During a period of volatile movements, many investors are frightened and start questioning their investment strategy. This is especially true for beginner investors, who are often tempted to get out of the market at once and wait until it seems safe to enter the market again.

The thing to realize is that market volatility is inevitable. This is the nature of the market to move up and down in the short term. Trying to time the market is very difficult. One solution is to maintain a long-term horizon and ignore short-term fluctuations.

For many investors, this is a solid strategy, but long-term investors should know about volatile markets and measures that can help them cope with this volatility.

What is Volatility?

Volatility is a statistical measure of market trends or assets up or down sharply in a short period of time. This is usually measured by the standard deviation of investment returns. Standard deviation is a statistical concept that shows the amount of variation or deviation that may be expected.

For example, it is possible to see the Standard & Poor’s 500 Index (S & P 500) having a standard deviation of about 15%, while more stable investments, such as certificates of deposit (CD), usually have a standard deviation of zero because returns never vary.

Volatile markets are typically characterized by extensive price fluctuations and heavy trading. They are often caused by an imbalance of transaction orders in one direction (for example, all buying and not selling). Some say the volatile market is caused by things like economic releases, corporate news, recommendations from a well-known analyst, a popular public offering (IPO) or unexpected income. Others blame volatility on day traders, short sellers and institutional investors. One explanation is the reaction of investors caused by psychological forces. This theory fails in the face of an efficient market hypothesis (EMH), which states that market prices are correct and adjust to reflect all information. This behavioral approach says that substantial price changes (volatility) are caused by a collective change of mind by the investment community. It is clear there is no consensus on what causes volatility, however, because volatility exists, investors must develop ways to overcome it.

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