Market volatility can be a challenge for investors. But, by understanding what causes volatility and using tools and strategies to ride the waves, you can take advantage of opportunities for above-average profits without jeopardizing your long-term returns.
Volatility is the degree to which a stock market fluctuates over a given period of time. It can be measured with statistical tools like standard deviation or variance, which help to gauge how much a price move deviates from the average. Historical volatility trends offer a glimpse of the bumpiness of an investment, and a rising trend could be an early indicator of growing market uncertainty or investor anxiety.
Other tools, such as implied volatility (which is based on options pricing), can estimate expected future price movements. The Cboe Volatility Index (VIX, or “fear index”) is one of the most commonly followed indicators. When VIX is high, it indicates that investors expect bigger price swings over the next 30 days.
Some traders focus on capturing short-term profit opportunities from volatility, using a variety of strategies and exchange-traded funds or exchange-traded notes (ETNs). Dollar-cost averaging is another way to reduce the impact of volatility by investing a fixed amount regularly over a long period of time. But, it’s important to remember that these tools and strategies can carry unique investing risks. They can also lead to emotional responses, such as panic, which may result in decisions that hurt your long-term investment goals. For example, selling stocks when they’re at a peak can trigger capital gains taxes and limit your overall return.