When markets become rocky, the term volatility gets used a lot. For some investors, it’s a bit of a scary word, often used to describe sharp declines in the markets (which can be even scarier). On a scale of pleasantness, we’d guess that experiencing market volatility is up there with public speaking and going to the dentist for most people.
For all the term gets thrown around, volatility is rarely defined. So, what is it?
As described by one investing expert, volatility “is merely a synonym for unpredictability; it has neither negative nor positive connotations. “Volatility” simply refers to the relatively large and unpredictable movements of the equity market both above and below its permanent uptrend line. Equities can be up 20% one year and down 20% the next, randomly. Bonds very rarely behave like that.”
An analogy might be useful. If the weather is 22-24 degrees and sunny all summer long (we’d be okay with that!), it’s not very unpredictable. You could say it’s not volatile.
The same is true with financial markets. Markets that are calm are low on the volatility scale; markets that are seeing wild swings are said to be highly volatile. Volatility is always there; sometimes it just becomes way more pronounced.
Some people think that volatility in markets is a bad thing, probably because it’s associated with falling prices. This is a mistake. Here are some reasons why volatility isn’t nearly as scary as it seems:
How to Deal with Volatility
There are a couple ways that investors can deal with market volatility:
So to sum up: it may not be pleasant when it’s happening, but volatility is perfectly normal and, (like going to the dentist!), actually great for you in the long-run.