What is Market Volatility?

"Market volatility" is a financial term used to describe the likelihood of frequent changes in value in a specific investment or investment market. Volatility is easily affected by many different factors, and can greatly affect both risk and return levels. Eliminating volatility is impossible, but reducing or balancing highly volatile investments with safer, lower-risk investments may help create a more stable investment portfolio.

Often, market volatility is used in reference to short-term changes in price or value. If a stock costs $15 US Dollars (USD) on Monday, $18 USD on Tuesday, $11.50 USD on Wednesday, and $24 USD on Thursday, it might be considered highly volatile. Stocks or investments that rarely experience changes in value are considered to have low volatility. Volatility levels on publicly traded stocks are rated by several different independent financial companies, which can give a relatively fair picture of the level of short-term changed considered normal for each individual stock.

Market analysts blame high market volatility on many, many different factors. In different situations, an increase or decrease in volatility may be due to political issues, such as new legislation, economic shifts, natural disasters, wars, scandals, management changes in large companies, or the introduction of a new product. Some experts argue that the majority of volatility shifts is actually due to completely irrational reasons, namely, fear and panic in investors.

The fear and panic theory of market volatility suggests that emotions, rather than strategies, often rule the market. If an investor who holds an enormous amount of stock in one company suddenly decides to sell, other investors may become irrationally worried that this may signal an impending drop in value, damaging announcement from the company, or sudden market shift, and want to sell their stock as well. In truth, the initial seller may have decided to sell for completely personal and unrelated reasons, but it does not matter: the snowball of fear and panic may already be rolling down the mountain, causing large shifts in value through reactionary behavior.

Dealing with market volatility is never easy, for it often involves trusting a long-term, intellectually-based investment strategy rather than giving in to understandable anxiety over a crash or surge in the market. Some experts recommend reducing potential damage from volatility by creating a diversified investment portfolio that balances assets across both volatile and non-volatile markets. Others suggest sticking to long-term investment plans like glue, in order to avoid sacrificing the long-term returns for a short-term gain.