Stock market volatility measures how often and how much the stock market’s value rises and falls. You can also measure the volatility of individual benchmarks (like the S&P 500), funds (like ETFs) and stocks.
Knowing that volatility will happen means that investors can profit from volatility. After all, without the stock market’s ups and downs, there would be no opportunity for profit.
Stock market volatility measures the frequency and range of the market’s price changes over time. A volatile market is a period of larger, more frequent price swings. Shorter, less frequent price swings generally mark periods of low volatility. Bear in mind that volatility doesn’t guarantee the direction of change – just that change happens.
Often, several factors contribute to market volatility at once, like:
But why is the stock market so volatile?
The answer comes back to uncertainty, fear and occasionally excitement. When investors aren’t sure what their future holds, they’re more likely to quickly sell some investments and buy others. And when a company or sector receives a positive boost, investor excitement may cause a rush to enter new positions.
All stocks see volatility, but some swing more than others, or at different times. For instance, quarterly and annual earnings reports, industry announcements and anticipated corporate or government announcements can all impact stock prices.
Even then, some stocks are prone to greater price swings than others. Often, high-flying growth investments like tech, biotech and oil and gas stocks see more volatility than the broader market. Penny stocks are also renowned for their incredible volatility.
By contrast, sectors like utility, healthcare and consumer staples may see less volatility than others. Aside from always selling in-demand goods and services, they may also pay steady dividends.
Larger companies – particularly blue-chip stocks – are also likely to see smaller price swings on average due to their sheer size. (Though it can happen, especially on big news.)
Economists measure market volatility by analyzing the standard deviation of prices over time. The actual equation is somewhat complex, and we won’t cover it here. The important part is the end result.
Effectively, the calculation determines how far prices differ from an average, or baseline, value over time. Generally, when prices move rapidly or far from a baseline, the stock market is said to be volatile. But when prices move slowly or remain somewhat flat, they’re less volatile.
Rather than learning how to calculate stock market volatility yourself, you can rely on a set of existing tools.
Individually, you can measure a stock’s historical volatility by its beta, which compares the stock’s price performance against a benchmark. (Usually the S&P 500 Index.)
A beta of 1+ shows the stock is more volatile than the S&P 500; under 1, the stock is less than. For example, a stock with a beta of 0.7 will rise 0.70% on average if the S&P 500 rises 1%.
You can measure the broader stock market’s volatility with the VIX, or Chicago Board Options Exchange Volatility Index. The VIX, also called the “fear gauge,” uses a complex calculation to measure expected volatility for the coming month.
When the VIX spikes, investors may be worried about massive price movements ahead. But when the VIX is low, investors predict smooth(er) sailing ahead.
Volatility is a guarantee in investing. While it’s impossible to predict that X year will experience Y volatility, you can assume that the market will see some level of volatility each year.
On longer time horizons, the stock market trends upward, but not in massive chunks. Instead, stock prices generally make small price movements day-to-day, with some months or periods experiencing greater volatility. Sometimes, that may lead to massive spikes; others, enormous declines that could claw down gains.
In other words: yes, stock market volatility is normal. However, the same level of volatility won’t always be present. And when it does happen, it’s important to ensure you’re ready for whatever the market throws your way.
Stock market volatility comes with both upsides and downsides. Knowing how to capitalize on price swings – and stay your course – can make all the difference.
On the negative side, volatility can lead to massive paper losses, which you may realize if you sell out. But volatility is also the key to seeing larger long-term growth – the underpinning of most successful portfolios. After all, not all volatility droops downward; once in a while, you can catch an updraft, too.
Generally, bear markets (when the stock market plunges) come with higher volatility. Most investors see higher risks during bear markets, as you stand to lose more money during wild price swings.
Many investors seek profits in downward markets by purchasing stocks at a “discount” compared to their “true” prices. For instance, you might spend $50 on a stock that’s recently dropped from $100 in the hopes that its price will recover. Buying discounted stocks lowers your average per-share cost, improving your long-term performance when the market eventually rebounds.
By contrast, bull markets (when the stock market trends upward) are generally associated with lower volatility. Though prices do rise broadly, they usually slip upward, rather than spike suddenly. Still, it’s possible to see higher volatility during a bull market.
When stocks rise quickly, you might take advantage by selling some stocks at a gain. (For instance, any stocks you purchased at a discount during the last bear market.) Alternatively, if you expect stocks to continue rising for a few months or years, you might buy in now to sell for profit later.
When a big stock swing or market swing occurs, you may be tempted to cut your losses and shield what dollars are left. But if you sell at a loss, that’s exactly what you’ll realize: a loss. Emotions like fear and greed can feel amplified in volatile markets, and acting on them will undermine your long-term strategy.
It’s important to remember that stock market volatility is a given in any portfolio. And when – not if – it happens, preparation makes all the difference.
Some steps to help prepare for – and respond to – stock market volatility include:
Investing is a long-term game, and building a diversified portfolio can help you weather volatility. While no portfolio is volatility-proof, many do take advantage of volatility when it comes around. Whether you increase your positions in low-cost, high-quality securities or short a declining stock, volatility doesn’t have to be the end of the world.
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