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“If you don't find a way to make money while you sleep, you will work until you die.” - Warren Buffett

Market Volatility and How To Measure It


Market Volatility is a word that do not goes unheard when you are into the investing world.

Volatility is something that which creates a lot of anxiety within investors, however, is the hype really worth it?

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Here, we will have a detailed look into market volatility and how we can stay ahead of the game.

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Introduction

Market volatility in simple terms is the drastic movement of any market index or security within a short span.

What Is Market Volatility?

Market volatility is a statistical calculation of the distribution of any returns for any specific market index or certain security.

Market VolatilityIt is actually the market or security’s tendency to go up or down in a very short time span.

Market volatility is often calculated by the standard deviation of an investment’s returns.

In layman terms, the more market volatility is, the riskier is the market index or security.

This standard deviation is calculated on the annual returns of an investment.

This helps to determine the range of a security price by which it may go up or down within a specific time span.

You may also consider it as a variable in the formulas of option pricing.

Market volatility aids in determining the fluctuation in the price of underlying assets right now and at the expiration time.

Volatility is percentage co-efficient in option pricing calculations that generates from regular trading.

Hence, it is pretty simple to guess that the co-efficient value depends on how volatility is calculated.

This behavior pattern is useful when it comes to safe trading and predicting the upcoming market condition.

Types of Volatility

Volatility is the rate of price movement and how drastically it could swing.

It can be the price of anything, and has been extensively analyzed, measured and elaborated.

1. Price Volatility

There are three distinct aspects that leads to the volatility of price.

These 3 aspects create wilder swings in the demand and supply chain leading to drastic price movements.

The first aspect is Seasonality.

The price of a hotel can go up during winter when people want to stay in.

On the other hand, the prices go down during summer when people are more comfy traveling outside.

This brings the change in demand.

The second aspect is weather.

Price of agriculture increases with the supply and is dependent on how much the weather is favorable to crops.

The final aspect is Emotions.

When traders are in worry, they exasperate the volatility.

This is the reason why the commodity market is so turbulent.

In 2012, US and Europe wanted to sanction Iran for developing weapons grade uranium.

Iran, retaliating back wanted to close the important Straits of Hormuz, which would restrict oil supply.

Although there wasn’t any oil shortage, yet bidders bid a whopping $110 during March.

However, by the time of June, that same price went down to $80 for a single barrel.

During this time, traders were worried with the slower growth in Chinese market.

2. Volatility in Stocks

Some stocks do have a highly volatile price.

This unpredictable price movement makes the stocks a riskier trade.

Hence, investors demand for a higher returns due to this increased risk.

Organizations with high volatility stocks ought to expand profitably and hence, must manage increased earnings.

They also do need to pay higher dividends to investors.

This volatility can be measured with Beta.

Important Volatility Types

1. Historical Stock Volatility

Going by the name you can understand it is a stock’s past nature.

If a stock is volatile for long or has been volatile, it is considered risky and is less attractive to non-risky stocks.

You need to hold the stock for long before you could sell it for profit.

However, if you can predict studying the chart that it is low point, you could sell it off when it gets high.

This is known as market timing and works splendor when you get it right.

It’s definitely unpredictable.

2. Implied Volatility

This implies to describing the thoughts of traders on how much volatile it could be.

If the prices of options go up, it denotes to an increased implied volatility, other factors remaining equal.

3. Market Volatility

This is the drastic price movement of any security in a short time, including the Forex, Stock and Commodity markets.

It signifies whether a market top or bottom is at your hand.

Bullish traders bid for higher prices on good news while bearish traders goes down when there is bad news.

VIX or Volatility Index is actually used to measure the implied volatility of S&P 500, using prices of stock index options.

Created in 1993, by Chicago Board Options Exchange, it measures the sentiment of investors.

It also goes by the name of Fear Index.

When VIX is high, stock values go down and vice-versa.

More on Market Volatility (Higher & Lower Volatility)

Breaking it down, market volatility is actually the risk or uncertainty in a security’s value.

A higher volatility denotes that the price may be spread over a large range potentially.

Hence, you can assume that the price could go either ways drastically in very short time.

On the other hand, lower volatility is risk averse.

It means the price may not change drastically, but could so at a steady pace within a specific time frame.

One such volatility measure of a certain stock is known as Beta.

Beta, generally calculates the approx. volatility of specific security returns in contrast to relevant benchmark returns.

In this case, S&P 500 is generally used.

A stock having 1:1 Beta value, means, it has moved 110% based on each 100% shift in its benchmark, depending on the price.

Similarly, one with 0.9 value indicates it moved 90% on every 100% activity of the underlying index.

One important thing is that market volatility varies and can impact all markets at distinct times.

How to Measure Market Volatility

1. Knowing What Volatility Is and Identifying It

When investors pick a security, they look at the historical volatility to understand the risk of the potential investment.

There are several distinct ways for measuring the volatility in terms of varying contexts, however, each trader has their own preferences.

Irrespective of the measuring metrics, understanding the volatility concept and how to measure is the path towards success.

In short words, volatility is the rate of price movement of a stock.

A certain stock with drastic price changes and acquiring new highs and lows every now and then is highly volatile.

On the contrary, one with stable price swings is considered a less volatile stock.

Although a volatile stock is riskier, it cuts risk either ways.

When you invest into a volatile stock, just like the success risk goes up, same applies for failure too.

Traders having higher risk tolerance always lookout for distinct measuring metrics to get informed strategies on their trade.

2. Primary Market Volatility Measure

Standard deviation is the method to measure the market volatility by traders as well as analysts.

This measuring metrics shows the price movement of the stocks from its base price in a specific time frame.

This is done by calculating the base price for that time and then subtracting from each of the price point.

In order to get the variance, the difference values are added, divided and eventually averaged.

Since, variance is the result of squares, it cannot be considered the actual measure unit.

Because price is always calculated in Dollars, it is not that easy to interpret a metric that implies dollars squared.

Hence, standard deviation is evaluated from variance’s square root.

This makes it the value similar to the underlying data set measure.

Bollinger Bands and Uses

Chartists improvise an efficient technical indicator known as Bollinger Bands for analyzing the standard deviation.

This chart known as Bollinger Bands comprises of three distinct lines.

One line is the Simple Moving Average or SMA along with couple other bands.

One band is placed above the Standard deviation and one under the SMA.

The SMA is actually a moving average that alters with every session to comprise of that particular day’s activities.

The outer lines or bands reflects that activities to showcase the associated harmonization to its standard deviation.

The Bollinger Bands Width denotes the standard deviation.

The wider this Bollinger Bands are, the more volatile is the price of the stock at that instance.

Less volatile stocks are the narrow Bollinger bands that shows up very closely marked to the SMA.

To measure the risks in a more comprehensive way, improvise distinct market volatility forms.

Standard deviation is used to measure the price movements in contrast to the average over a specific time span.

On the other hand, Beta measures the volatility associated to a wider stock market.

A stock with Beta 1 volatility denotes the degree as well as direction of the entire market.

It means that in case the S&P 500 goes through a sharp dip, the stock will follow the same.

On the other hand, securities which are stable have less than 1 Beta value representing less volatility, such as Utilities.

High volatile stocks such as technology stocks have more than 1 Beta value.

Stock with 0 value means null volatility; for example, cash, assuming zero inflation.

Cramer’s Strategy to Deal with Market Volatility

Volatility is the new Market norm as said by Jim Cramer, the famous host of Mad Money.

His tips have proved to be highly beneficial to investors and this time he has come up with one more.

Cramer’s market volatility strategy is nothing other than one of the best proven methods to deal with volatility.

Volatility is ever-growing amidst geopolitical threats, worry of increased Technology sector regulations and most importantly, 10 years high Treasury growth.

Cramer says the market is wild one now and is not so easy to grab the bull by its horns.

Market watchers always stay on the edge and hence, few strategies would be of importance prior to making a move.

1. Facebook

Facebook does not have a lot of Chinese exposure as suggested by Cramer on a large cap technology company.

At the same time he informed that many large-cap tech organizations do have Chinese exposure.

Hence, investors should always be prepared for any kind of retaliation.

2. Recession Fears

Cramer says that if it wasn’t about retaliation by the US President, then we wouldn’t have approached any close to recession.

Cramer suggested if the tariffs comes to place, then it would not spread past Chinese market in case of retaliation.

3. S&P Oscillator Index

S&P Oscillator Index is one favorite of Cramer, which he says is used for conducting technical analysis.

It also helps to reflect the exact position to which the stock market is heading into.

Lessons to Learn from Market Volatility

Market volatility is the drastic fluctuation of the investment returns of a stock.

Market volatility teach us some precious lessons, however, some learned it the hard way.

Let us see what we can learn for the volatility of a market and how to stay ahead of the game.

1. No Risk = No Reward

Over the course of 9 years, investors have received wonderful returns despite of low volatility.

It reminds us of the deals we go through while investing.

We like to go for short term uncertainty in order to amass higher returns over a long term period.

You cannot ignore the chance of failure and always have to stay ready for ‘trouble-ahead’ situation.

However, we should not put away with this uncertainty since it procures us higher returns over long term.

2. Stock Market Is Not up at All Times

Since, it has been long since market crash, people seem to have forgotten that market can dive low at times.

Investors who traded post 2012, have been fortunate enough to not witness the market go down.

It stayed uninterrupted and never went Bearish, which is 20% or more low.

However, this typically occurs over a time span of 5 years approx.

Temporary market decline of 30% or higher may not be that uncommon.

Although, you will survive the down market, but remember, the sailing may not be so smooth always.

3. Remain Invested Always

Drastic swings up and down tells us that majority of the profits happen on explosive market days.

It may be tempting to engage in timing the market and predicting at those times.

However, you run into the risk of ignoring that 3% rebound market days that make the majority of the market.

This 3% rebound days make up for the most returns generated over long period of time.

Investors always like to stay at the sidelines unless the market condition gets going better.

However, when things get better, unfortunately, the stock prices go up and practically you missed your chance.

You can’t get the time back and missing out on this price sail is not good for your investments.

How Young Investors Profit from Temporary Market Declines

Temporary market decline is like a blessing to young investors.

Market volatility makes the market pretty bearish and is the right time to double up your investments.

You definitely want to procure as much ownership as possible in the biggest companies of the world.

It is unnatural to not wish that the stocks you think of buying goes for a flat 30% off on sale.

Not just for young investors, but anyone who intend buying stocks and selling it high would want to grab the opportunity.

Bearish market should not seem scary to you, but a great time to buy more stocks to sell it high later.

Is Advisor Important?

Investing is not that easy stuff to go through; at times it might be very difficult.

Some investors do not go well with investing emotions and fall prey to volatility fear.

However, this bearish market is the best time to get going high.

These are important periods to invest your money always and not miss out on the chance to earn high returns.

This is why it is extremely important to get an advisor whilst this financial crisis to stay ahead in the game.

An advisor who understands your emotions and stops from hurting your investment at these times is priceless.

Always stay ahead of the game by stay aware of the market volatility and the latest updated news.

Tracking the market updates and conditions at all times is the best way you could be successful in terms of investing.

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