Uncertainty and unknowns: the main causes of volatility (2024)

FAQs

Uncertainty and unknowns: the main causes of volatility? ›

Broadly speaking, it has to do with investor uncertainty. Investor uncertainty about what will happen next causes stock markets to rise and fall. So, volatility can be seen as a measure of uncertainty. That's why it often occurs when markets are down.

Volatility is a normal part of long-term investing

There is plenty to unnerve markets and cause volatility, from changes in commerce to politics, to economic outcomes and corporate actions. Yes, it might be unsettling, but it's all 'normal'.

Political and economic factors

Monthly jobs reports, inflation data, consumer spending figures and quarterly GDP calculations can all impact market performance. In contrast, if these miss market expectations, markets may become more volatile.

Although the notions of uncertainty and volatility are often used interchangeably, the two concepts are inherently different: volatility measures the dispersion of short-term shocks around a long-term mean, while uncertainty measures the difficulty to forecast the distribution of returns, including its long-term mean.

Risk is commonly defined as the uncertainty, variability or volatility of an investment's return.

Another key driver of volatility is liquidity. The more traders and investors on the market, willing to buy and sell an asset, the less likely it is that a single transaction will cause a large price move. So, less liquid markets are usually more volatile as prices can change drastically.

In finance, volatility (usually denoted by "σ") is the degree of variation of a trading price series over time, usually measured by the standard deviation of logarithmic returns.

Investor uncertainty about what will happen next causes stock markets to rise and fall. So, volatility can be seen as a measure of uncertainty. That's why it often occurs when markets are down. Investors will try to anticipate what the markets will do next.

Typically, traders talk about four different forms of volatility, again depending on what they are doing in the markets. This chapter discusses the four different volatilities: future volatility, historical volatility, forecast volatility, and implied volatility.

What risk does volatility measure? ›

Volatility is a way to calculate the risk of a particular investment, over a set period of time. A highly volatile investment is likely to experience more frequent, and possibly large, upward and downward movements in price than an investment with low volatility.

This rise and fall in investment values is known as volatility. Volatility is completely normal in the stock and bond markets. But too much volatility can be a sign of risk. It's important to understand how much risk an investment presents so you know if it's the right fit for your portfolio.

Standard deviation is the most common way to measure market volatility, and traders can use Bollinger Bands to analyze standard deviation. Maximum drawdown is another way to measure stock price volatility, and it is used by speculators, asset allocators, and growth investors to limit their losses.

Volatility is indicated by a substance's vapor pressure. It is a tendency of a substance to vaporize or the speed at which it vaporizes. Substances with higher vapor pressure will vaporize more readily at a given temperature than substances with lower vapor pressure.

The volatility of a substance is a physical property that depends on the intermolecular forces holding the atoms or molecules of the substance together. For example, methane molecules have only weak forces holding them together, so the boiling point of liquid methane is -258.9 °F (-161.6 °C).

An important factor influencing a substance's volatility is the strength of the interactions between its molecules. Attractive forces between molecules are what holds materials together, and materials with stronger intermolecular forces, such as most solids, are typically not very volatile.

Volatility is a statistical measure of the dispersion of returns for a given security or market index. It is often measured from either the standard deviation or variance between those returns. In most cases, the higher the volatility, the riskier the security.