Market volatility is probably one of the most misunderstood areas of finance. Even just hearing the word “volatility” is enough to strike fear into the hearts of investors.
Prices in financial markets are constantly moving, but sometimes these prices ebb and flow more rapidly from one moment to the next. The degree or speed of the price change of a security is what establishes a volatile market.
When people think about volatility, it incites feelings of fear and panic because they anticipate the worst. They worry these erratic fluctuations will drain their investments and cause them to lose all their money, destroying their progress towards meeting their financial goals.
It's true that volatility increases risk. Investing is inherently tied to risk, after all. Yet, volatility works both ways. It can cause distressing lows, but it also produces the momentum that makes it possible for investors to yield above-average profits.
Investors are only anxious about volatility because the potential of loss often overshadows the pleasure of gain. Every time you invest your money, your investment carries the risk of success or failure. Without volatility, the risk of failure is lower, but so is the opportunity for success.
Financial consultants spend a significant amount of time talking to their clients about volatility, especially now during a time of market instability. There's not only still room for solid returns for patient, astute investors, but volatility is also healthy for the stock market for a number of reasons, which I dive deeper into below.
Volatility Evens The Playing Field
Volatility can be advantageous for many investors, but it tends to favor those with long-term investment strategies who don't mind waiting out downward fluctuations in the market. Under these circumstances, investors can enjoy a more even playing field against bigger institutions and professional traders who use high-frequency algorithms to make their investing decisions for them.
Investors with access to more innovative technology and information are typically at a higher advantage, but this isn't necessarily true in times of volatility. Algorithms are fueled by numbers and trends tied to past market performance and a smaller subset of data, therefore, they are more focused on short-term movements and might quickly buy or sell based on momentum.
Retail investors, on the other hand, are not only able to take a long-term approach to the market, but they can recognize elements and patterns that may not be integrated into these algorithms.
Volatility Provides Valuable Feedback For Companies
In a capitalist system, new and established companies are constantly testing out new business strategies to leverage their influence in their industries. If the stock market continued to advance higher and higher regardless of what strategies companies employed and where they spent their budgets, it would give the impression that every idea a company had was ingenious.
However, we know that this isn't the reality of the business world — and it shouldn't be either. There would be no innovation or ingenuity if this is how the market worked. Instead, market volatility puts pressure on companies so they can identify their strongest ideas and align their infrastructure and growth plan accordingly. The best business ideas are what allow investors to make the most profit over time.
Volatility Helps Keep Excess Under Control
Whenever there is excess in financial markets, it can be a predictor of an economic recession. We're currently experiencing market volatility, which begs the question: Are we currently in a recession? While the housing market is cooling sharply, income and spending are lagging behind inflation, and layoffs are still on the rise, it seems that we're trending towards a recession but aren't officially in one yet.
Regardless, we typically see excess building up during times of low risk in the stock market, and then market volatility occurs as bubbles burst. But market volatility can also help to prevent bubbles from developing in the first place. While investors do enjoy the benefits of a boom in the market, it's important to keep these bubbles from forming because they have the potential to be incredibly destructive.
Market volatility can be terrifying, but investors with a plan have less to worry about, especially if working with a financial consultant who can help be a guide through these unsettling times. With careful planning, volatility can yield greater returns and get investors closer to meeting their financial goals.
Not only that, but volatility is also advantageous to the stock market, which can also be a benefit. Don't let volatility be a cause for panic; instead, see it for what it is: a worthwhile opportunity.