Understanding Market Volatility

Volatility is a good thing
Conventional, conservative investment advisors hold that your stock investments should be steady, and show gradual but reliable and predictable increases over time. And indeed, if you are building for retirement, these are the types of stocks to buy.

There are however, two broad types of stock market investment strategies. The “buy and hold” strategy calls for a heavy reliance on a company’s strong fundamentals to show long-term strength. While this type of strong equity may fluctuate from day to day, over time, it will generally increase, and at a rate higher than the investor would receive investing in the money market. When making these types of strategic long-term investments, stocks that do not have large short-term price swings are generally considered the best investment.

In years past, the “buy and hold” investor not only enjoyed an increase in equity as share price rose over time, they also enjoyed quarterly dividends. Today, many corporations are either offering only minimal dividends or no dividends at all, in favor of things like stock buy-backs. This theoretically helps to increase the share price, but in fact, it takes away half of the incentive that “buy and hold” investors have historically enjoyed.

Trading and Volatility
Day traders and intra-day traders, on the other hand, look at shorter-term fluctuations often more than the fundamentals of an equity in order to try to understand how the stock moves up and down over the short term. Things like media reports, message boards, market newsletters and analyst reports can cause short-term ups and downs in share price.

Within these short-term ups and downs lie the primary difference between the two strategies, and the potential for very large profits for short-term traders. While a long-term investor may be satisfied if his or her equity’s share price goes up 10 percent every year, the short-term trader has a different set of rules. It would not be unusual for example, for some stocks to fluctuate in share price by 10 percent or more over a week’s time. The short-term trader believes then, that it is better to take a greater risk in order to get a chance at earning a ten percent return over a week’s time, as opposed to taking less risk, but waiting a year to get the same return.

That is primarily why short-term traders often trade in small-cap stocks and start-ups, and companies that are inherently volatile such as biotech, pharmaceuticals and technology. These stocks have a much greater risk over time, but it is precisely this risk that causes the large short-term swings to occur. And if played right, the short-term trader is able to analyze the charts and other information, spot a low trend and buy cheap, and sell the same equity during a price spike a few days later.


Information is for educational  purposes only and is not be interpreted as financial advice. This does not represent a recommendation to buy, sell, or hold any security. Consult your financial advisor.

Categories Economics, Finance, Investing and Financial Planning, Uncategorized

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