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Understanding Volatility

Over the last few months, you have probably heard the term volatility being widely used when talking about investments and the stock market. But what exactly does volatility mean?

What is volatility?

When it comes to investments, the term volatility refers to the level of fluctuation, either up or down, of the value of an investment over a time period. High volatility means that the value of the investment swings dramatically in either direction. Low volatility means that the value of the investment does not fluctuate significantly, and therefore tends to be more stable.

Volatility is commonly used as a measure of the risk born by an investment – the higher the investment’s volatility, the less predictable its price is expected to be and, therefore, the higher the risk of experiencing losses. However, the trade-off is that investments with high volatility tend to offer higher growth and profit potential over time. On the other hand, the potential for both growth and loss is more limited for investments with low volatility.

What causes volatility to rise?

Anything that creates uncertainty can increase volatility in the stock markets; from economic crises, to changes in government economic policies, political tensions or news affecting a particular industry, sector or company.

Is volatility bad?

Volatility is neither inherently good nor bad. It is something inevitable in a healthy market and even though periods of unpredictable and significant rises and falls in the stock market may be unsettling, they are a natural part of investing.

How to deal with market volatility

It is important to realise that volatility comes with the territory when you decide to invest. The stock market will always have its ups and downs so if you are investing for the long-term, there is no use trying to predict its every move. By choosing an investment strategy with a level of risk that you feel comfortable with and best suits your time horizon and your individual needs and circumstances, you will be less likely to react spontaneously to short-term market movements and instead stay focused on your long-term goals.