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What causes volatility in the market?

By Valerie Medleva

14:00, 20 March 2019

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If someone has ever been interested in the stock market and the way it works then, most likely, they know how volatile it can be. Over the past several years, we have witnessed the way stocks have gone from the bottom of the Great Recession to hitting new all-time highs – blinkered by many ups and downs in between.

The recent market volatility caused by the outbreak of the Covid-19 pandemic has caught many investors off guard. Many were forced to rearrange asset allocation in their portfolios in order to add much-needed diversification and, if not to fully eliminate, then at least reduce the risks.

For that, we believe that to become a successful investor, it is extremely important to know what causes the market’s wild fluctuations and how to handle market volatility like a pro. 

Driving forces behind fluctuations: what causes market volatility?

A volatile market may often be the result of an imbalance of trade orders in one direction – all buys and no sells, for instance. However, market volatility is caused by a host of several other factors.

What causes volatility in the market?
  • Economic crises. It is obvious that any financial market is very sensitive to major economic situations. Typically, they react negatively: the worse the crisis, the bigger its influence on the market’s overall performance.
  • Changes in national economic policy. For example, the short-term changes in the monetary policy of the Federal Reserve System, or simply the “Fed”, almost always cause a sharp movement in markets like the US Dollar Index. The market tends to go up when the Fed eases monetary policy, and down when the institution tightens the policy.
  • Economic indicators. Economic data serves as a window for traders to have an overlook on the economy: when it is doing well, the market tends to react positively; when it is not hitting its forecasted targets, the market may tumble. This is why economic reports serve as a volatility indicator and are often awaited by traders with bated breath. Monthly jobs reports, inflation data and consumer spending figures can all impact market performance. Traders usually try to predict the reports before they come out and sell or buy their assets accordingly. If the report differs from the expected number, the market may quickly fluctuate.
  • Volatility overseas. A modern economy is globally connected, so, whatever happens in the world might have an impact on a market closer to home. Wars, regime changes and revolutions are all likely to have the potential to be reflected on trade, the flow of money and investments between countries and multinational corporations. 
  • Political developments. Politics are a key factor affecting market performance. Governments make decisions on trade agreements, taxes, tariffs and federal spending – all of which play a major role in regulating industries and have an impact on the economy overall. Even political speeches can cause market volatility. President Trump announcing tariffs on imports from China as a part of an escalating trade war in 2018 is a great example of it, causing the Dow, S&P 500 and NASDAQ-100 indices to tumble more than 2 per cent. Since then, the US President has changed his stance several times, but the announcement itself majorly contributed to the financial market volatility of that time.
  • Public relations. You may be surprised, but volatility is not only market-wide. It also depends on the public image of an individual company: its stock performance can climb or jump off the hill on the back of PR-based hits and disasters. The scale matters: the larger the company, the more likely its performance will affect the markets.

The stock market will always have its ups and downs. Meanwhile, increased market volatility can be beneficial for savvy traders as it offers an opportunity to profit. However, it also boosts the risk of loss.


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So, is there a rule of thumb on how to handle the turbulence?

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How to deal with market volatility: stay calm and seize the opportunities

The human temperament makes it rather hard to focus on fundamentals once you see the quoted price of your asset wobbling wildly. However, there is still a way to tame your emotions and keep from panicking when market volatility shows up on the horizon.

For starters, it is important to understand that any asset you choose comes with volatility: stocks, commodities, cryptocurrencies – all of them. Every market will always have its ups and downs, and there is no use trying to predict every step it will make. It takes experience and discipline to have the determination to ride through the turbulence and capitalise on arising opportunities. In fact, there are a few simple rules to follow when investing in volatile markets.

Refer to history. During the bad times, it is easy to forget that market downturns, even steep ones, are only a natural part of the economic cycle. Since 1926, on average, stocks have slid into bear market territory every six years, with losses averaging almost 40 per cent. With that perspective, if your investing time frame is years or even decades from now, it may be best to sit tight and stay invested. Those short-term fluctuations are definitely not something you should be worried about.

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