STOCK MARKET VOLATILITY

Stock Market Volatility



Stock Market Volatility

Introduction

When observed in very minute detail, the short-term performance history of investments in the stock market closely resemble the path of a thrilling roller-coaster ride -- many unpredictable ups-and- downs and sharp turns in every direction(Brunnermeier Nagel 2007 pp23-34).

This unpredictability is what creates the market's penchant for volatility. If we could accurately predict the size and timing of the markets' movements, then there would be no uncertainty, and, no volatility. However, the higher returns that have accompanied this enduring environment of volatility would probably vanish. Because some people are willing to accept a higher level of principal risk and uncertainty, they have invested in equity-based funds and have historically been rewarded with higher returns over the long-term than those who have invested in safer and less-volatile, fixed- income investments. (Fornari Mele 2006 pp.78-82)

As returns increase, so too does the volatility and risk. This is the paradox by which market volatility has been defined. An investment's performance potential is usually directly correlated to that investment's volatility. As the return potential of a specific investment grows, the likelihood that the investment could experience a loss of principal correspondingly increases.

Historical data has shown that wild market movements precede a change in the market's direction. A high VIX appears just before a market rally, and a low VIX usually augurs a slide.

Bearish types argue, however, that any value to the VIX's past behavior ended on September 11. They say the market is up against too many things, including the economy, wary investors, and ongoing fear of terrorist attacks. Others blame volatility on 24/7 financial news on cable and the Internet, since people can watch the market move in front of their eyes(Corradi Distaso Mele 2008 pp112-119).

Historical data has shown that wild market movements precede a change in the market's direction. A high VIX appears just before a market rally, and a low VIX usually augurs a slide. Bearish types argue, however, that any value to the VIX's past behavior ended on September 11. They say the market is up against too many things, including the economy, wary investors, and ongoing fear of terrorist attacks. Others blame volatility on 24/7 financial news on cable and the Internet, since people can watch the market move in front of their eyes(Campbell 2003 803-887).

Stock Market Volatility and Its effect on Business activity and Profitability

Stock market volatility is significant and understanding it is imperative to investing in stocks that suit your investment or trading style and risk tolerance level. Stock prices rarely move in a straight line(Mehra Prescott 2003 889-938). Most of the time they move up and down and, some of the time, they trend higher or lower. More volatile stocks tend to chop more intensively and have a larger high-low range than their less-volatile cousins. Some short-term traders prefer to trade volatile stocks because they can make an impressive profit quickly, while conservative longer-term investors usually like to stay away from volatile securities.

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