Volatility is a measure that highlights the stability of an asset or index (group of assets).
In the securities markets, volatility is often associated with swings in either direction, both positive and negative. Typically, when a market rises or falls more than a few percent daily, we say that that specific market is going through a volatile period. Imagine being on a flight which is experiencing turbulence, it can be a bit nervy but usually only lasts a short period of time. Being invested correctly means one will limit the amount of surprises along the way.
The chart below shows the daily percentage swings of bitcoin, gold and the S&P 500 index from Jan 2016 to Jan 2018. If you look at the huge price movements of bitcoin you can see 20% swings both upwards and downwards. Essentially, you could make 20% profit in a day or lose 20% in a day which really shows just how risky (volatile) Bitcoin really is. Gold and the S&P index are a lot more stable throughout this period with price swings of less than a few percent.
Bitcoin, Gold, S&P500 Volatility
Sources: S&P Global, Citi Private Bank, Bitcoin Charts
Even though the price movements are small this does not mean the price hasn’t risen over this period. Take the S&P500 for example, the index from Jan 2016 to Jan 2018 rose approximately 35%. The volatility of the index being low simply means the growth was smooth and steady during that time. This is the consistency of return that ‘the cautious’ investor should experience. The chart below shows the price change for the S&P 500. I hope this provides some perspective for volatility in relation to markets.
On the other hand Bitcoin which is much more volatile experiences a staggering growth of approximately 4,500% from Jan 2016 to Jan 2018. However, the growth did not hold much fundamental value and was driven mostly by speculators thinking they could make a quick money. Unfortunately, those who timed the market badly experienced the downside of this. As such, the cryptocurrency market is not suitable for pensions although many investors still hold small proportions of cryptocurrency in their portfolio. I would consider this only suitable for those who enjoy the thrill of casino type games.
Market volatility can be seen through Volatility Indexes (VIXs). The Chicago Board of Exchange (CBOE) VIX was created as a measure to gauge the 30 day expected volatility of the stock market derived from S&P500 index options. Simply speaking, it is a measure of future bets investors are making on the direction of the market. A high reading on the VIX implies a volatile market for a certain period.
It’s worth noting that the largest gains and largest losses can both be due to volatile markets. Both can happen from time to time but for those who are planning to remain invested for the long term, this will naturally equal out over time. This is especially assuring for ‘ the growth’ orientated investor who would expect to receive higher returns than ‘the cautious’ investor over time due to the additional return they seek from additional risk they take on.
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