How Market Volatility Affects Investors and Traders Worldwide

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What is market volatility? Put simply, it is defined as the rate at which the value of an asset (e.g. share price or forex) increases or decreases over a specified timeframe.

Volatility is often used to determine the level of risk an investor or trader will incur when placing an order in the market on an asset. The savvier investors will always price in the volatility to understand the probable price fluctuations and approximate potential returns and losses.

The problem with market volatility is that it can spook more inexperienced traders and investments, forcing them to question their trading plans and investment strategies. The whole point behind trading strategies are to equip investors with the tools and information necessary to cut through the market ‘noise’ and make swift, logical trading decisions.

Examples of extreme market panic

Extreme market panic occurs when traders lose confidence in their positions, resulting in significant sales of an asset on an exchange. The ‘blip’ of multiple sales in the market can trigger an even bigger sell-off of an asset, causing the value to collapse.

The best example of extreme market panic is the Wall Street crash of 1929 on America’s New York Stock Exchange. The price of the Dow Jones, an index of the 30 biggest publicly listed companies in the US, lost 50% of its value in the space of two months. It sparked the ‘Great Depression’, resulting in a decade of financial hardship for most of the western world.

It happened again on the New York Stock Exchange in 1987 when the Dow Jones experienced its worst single trading day since 1929, falling by 22% in only a few hours. In more recent times, the price crash of oil last month occurred due to the ongoing price war between world-leading oil exporters. The value of Brent crude fell to just over $33 – a 24% drop. The global economic aftershock of the ongoing COVID-19 pandemic has also resulted in a crash of major stock market indices such as the Dow Jones and the FTSE 100, with national and regional economies effectively put on ‘standby’ during the outbreak.

Examples of market rebounds

In the most recent times, the Dow Jones has been of interest for stock market rallies. The Dow Jones has experienced several days of the biggest daily point gains in the history of the index. On 24th March, its value soared by 11.37% off the back of positive noises regarding the US government’s handling of the COVID-19 crisis, including fiscal measures for citizens and businesses alike.

Looking at the foreign exchange (forex) markets, the pound has been very volatile against both the Euro and the US dollar in recent years, due largely to the uncertainty created by the Brexit vote. The pound soared to its highest point in five months against the dollar ($1.30) after the Brexit withdrawal agreement was reached between the UK and the European Union; thereby underlining the importance of fundamental factors in the markets.

How investors and traders handle market volatility

  • Take a long-term approach to investments
    The most philosophical way to handle market volatility as an investor is to accept it as part and parcel of the markets – they move up and down in the short-term. Those traders that can outlast market volatility are those that ignore short-term volatility and focus on the long-term, staying true to their trading strategies. While other traders seek to panic sell during volatile periods, profitable investors look to buy the dip i.e. buy when the market uncertainty is at its highest and profit when values recover during more stable times.
     
  • Diversify, diversify, diversify
    One of the most effective ways traders can minimise the chance of substantial losses during market volatility is to avoid putting all their eggs in one basket. Diversification is a useful strategy, which means splitting your risk across multiple assets and markets. Preferably look to take a position on one market that could rise to counterbalance another that could fall. This is known as hedging and is an effective way to limit your downside.
     
  • Accept there is no return without risk
    Finally, if you aren’t prepared to accept any level of risk, you probably aren’t cut out for financial investing. There are always twists and turns in the financial markets, caused by fundamental external factors as well as technical support and resistance factors. Acknowledging and embracing the risk is a huge hurdle to overcome to allow you to trade with confidence.

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