How Can Stock Market Volatility Affect You Today

How Can Stock Market Volatility Affect You Today

The stock market is considered to be one of the most vital components of a free-market economy. It provides companies with access to capital in return for giving a share of ownership to the investors.

Volatility is an important factor that you must first consider before getting too deep into investing in any market. It’s the statistical measure of how much price fluctuation an instrument can experience over a certain period of time.

Put these two together and you have stock market volatility. It’s something that most investors tend to move away from as soon as they get wind of it. But what exactly is stock market volatility? And how can it affect you as an investor?

Stock Market Volatility Infographic

What is Stock Market Volatility

Stock market volatility can be seen in the behavior of the stock market. Simply put, if it’s up one day and then down the next three, then goes up again before falling after two more days, that’s stock market volatility.

When the stock market is hit with bad news, the stock prices tend to fluctuate more, which will trigger volatility. It is highly dependent on how the investors react to certain news. During times when investors overreact to certain news, the whole market suffers. It isn’t something that should be taken lightly, neither is it something that has no solutions. You just have to be more prepared for everything that the stock market might experience or throw your way.

Factors that Affect Volatility in the Stock Market

1.      Stability

Stock markets are dependent on economic stability and future growth; it completely abhors any sudden changes that could threaten this. This is why it’s easier to predict the market trend, especially when news of terrorists attack or spikes in the price of oil happens. When bad things happen to the economy, you can expect the stock market to fall.

Political instability is also something that can affect the stock market negatively. This is mostly due to increased difficulty in pursuing strong economic policies.

2.      Related Markets

It’s still important to remember that the stock market is not the only market available out there. Investors may choose to buy government bonds or commodities instead of investing in stocks. The stock market may benefit from any possible negative events that the other markets might suffer.

A fall in other markets can strengthen the shares. For instance, if bond yields fall, investors might be encouraged to turn to shares where the given dividends are relatively better.

3.      Confidence and Expectations

One of the key factors is the mood of investors. When they receive good news, it boosts their optimism, therefore leading them to buy more shares. On the other hand, receiving bad news could make them more likely sell their shares.

The investors love trying to predict the future. This can greatly help in times when the stock market is in the depth of a recession. The stock market can rally if investors feel like the worst has passed, even if the economic fundamentals are still low.

4.      Price to Earnings Ratio

Some investors and economists believe that the price-to-earnings ratio is the best guide to the long-term performance of shares. According to this, if share prices rise significantly above historical averages, then it acts as a sign that the shares are becoming overvalued. They can then draw the conclusion that corrections are due at some point in the future.

5.      Interest Rates

Or more specifically, lower interest rates. Lower interest rates can boost the attractiveness of shares for two reasons. When interest rates are low, economic growth is boosted and makes firms more profitable. Additionally, investing in shares become more attractive when compared to saving money in a bank or holding bonds, especially in times when the interest rates are lower.

6.      Economic Growth

Higher economic growth can have various effects on a company and its shares. It can boost a firm’s profits since demand for goods and services will be greater. This can then provide support to company dividends and therefore the share prices.

7.      Bandwagon Effect

There are times when the stock market will seemingly overreact to a certain event.

This can result to disasters such as the stock market crash in 1987, where it fell 25 percent due to a relatively little bad news. There were no known economic problem that occurred which might have caused the fall. The stock market actually regained lost footing soon after.

One of the main problems is that people follow the mood. When they see the prices begin to fall, people tend to feel like they should follow suit. They then start removing themselves from the stock market, worsening the situation.

close-up printed report of stock market volatility

Effects of Stock Market Volatility

There are various ways that stock market volatility can affect the economy as a whole. Companies are no exception, so are their dividends and their shares. We’ll be listing down three ways that stock market volatility might affect a company.

There is usually a close and strong relationship between volatility and market performance. When the stock market begins to rise, the volatility will start to decline. Meanwhile, it will rise during times when the stock market falls.

You should note that, with the increase in volatility, risk will also increase while returns decrease.

1.      Consumer Behavior

Despite some companies no longer needing to borrow or having consumers that pay in cash or other methods, like Bitcoin, they will still be faced with the fact that they need to sell products. This is mostly where consumer confidence comes in.

There are three categories that classify why consumers decide to spend money for the product or service. First is spending on what they need. Second, spending on what they think they need but just really want. Lastly, they’re spending on stuff they want but don’t know they need. During times when the stock market is filled with uncertainty, the last category is usually the first one to go. This is soon followed by the second category. These two are where most company profits come from.

2.      Competition

During times when the stock market remains volatile, some company heads will be reassuring their staffs that they remain unaffected and should stay on course. But in reality, they’re hoping that competitors are scared enough to move from prudence to anxiety. There is a chance that borrowing will raise cost and lower revenue if the consumers begin shying away from spending. If a company is affected by the volatility, there is also a big possibility that those in the same sector are going through the same. The company can then end up fighting over a much smaller demographic.

In a situation like this, a company might be forced to cut prices and margins in order to attract more customers. This solution can result to lost profits in the short term. Price wars are then possible, wherein a company will have to face the other but with a better offer. Companies aren’t merely competing for customers. They are also fighting for lenders and business partners in times when the stock market remains volatile.

3.      Funding

If a company is in the middle of a funding round when stock market volatility hits, it can result in negative effects. A funding round might need to be delayed, lowered, or cancelled.

Even if funding does come, it will most probably be smaller.

Whenever high volatility strikes the market, the first ones to get hit hard are those in the IPO market. Uncertainty kills initial public offerings in a snap. This is mostly because they are the riskiest equity play that any investor can make since they can’t offer any track record as a stock to back them up. Back in 2000, the Nasdaq Composite suffered its first major fall. During that time, the IPO calendar went from being the strongest in history to nothing. All this happened in a matter of weeks.

the word volatility spelled on typewriter keys

3 Ways to Reduce Effect of Stock Market Volatility

1.      Diversify

Many experts recommend diversification as a strategy that can help weather down effects of market volatility. Other than helping you reduce the risk that your portfolio undertakes, it can also boost the return potential.

A great diversification strategy involves investing in various asset classes, regions, economic sectors, as well as portfolio management styles.

2.      Think Long Term

The stock market normally experiences high volatility but they normally don’t last long. It can’t be helped that the markets tend to be unstable sometimes.

Keep in mind that the stock market will usually rise over the long term despite major fluctuations. Staying in an investment over a certain period of time can prove that the impact of market fluctuations on a portfolio will soon fade.  It is best to adopt a long term strategy and stop your emotions from clouding your rational judgments.

3.      Never Forget Your Goals

There are various factors that can affect your investment needs. Some of the factors that you have to consider are you risk tolerance, savings objectives, as well as investment horizon. You should remember that risk and returns are closely related. If you wish to gain high returns, then you should expect higher fluctuations in your portfolio.

It’s not wrong to contact your advisor in times when the stock market volatility worries you till late in the night. He or she can help review your investment profile as well as make changes to your portfolio while taking your profile into account. Annual reviews of your investment profile are enough to help keep your portfolio in optimal condition.

FSMSmart - 5 dice with buy and sell options on stock market graph

Conclusion

Volatility isn’t something that you can escape, but the stock market will remain safe despite such events over the long term. There are various factors that can help you determine how the stock market volatility might affect you. Likewise, there are steps you can take to prevent or, at the very least, reduce your exposure to volatility.

Just make sure to stay updated when it comes to current events and anything that might trigger volatility. Take measures to combat the damage that your portfolio might take when it comes to stock market getting hit with high volatility. Don’t forget that you can ask a professional for help when things get too much for you to handle.

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