Market volatility refers to the size and frequency of price movements in specific securities or market indices. It is often unsettling for investors, but it is a natural part of investing. Keeping a clear eye on long-term goals and diversifying across asset classes can help cushion the impact of volatile periods and make it easier to remain invested.
There are many ways to measure volatility, but the most common is standard deviation. This statistic measures how far an asset’s returns are from their average over a period of time, and it is typically reported in percentage terms.
Several factors can cause market volatility, including disappointing economic developments like company earnings or overall manufacturing output that falls short of expectations. Sudden government policy changes can also increase market uncertainty, especially when they are unexpected. For example, the Federal Reserve’s recent interest rate hikes have increased investor concerns about inflation and future growth.
While it can be unsettling, market volatility doesn’t necessarily presage a broader decline or an upcoming recession. However, if prices rise and fall in dramatic and unpredictable fashion, they’re more likely to trigger emotional investment decisions that may result in more rapid losses than usual. Volatility tends to cluster around events and take some time to decay back to normal levels. This creates an inherent time lag in estimating volatility, which can complicate modeling and forecasting. Fortunately, more sophisticated methods that incorporate both the continuous and discrete components of volatility can yield better results than simpler estimation models.
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