What is volatility and why is it important for investors?

Volatility is used by the markets as a measure of movement in an asset’s price and reflects the level of risk associated with that particular asset or market. When looking at volatility in any given market, investors can get a feel for the level of risk currently related to that market as gauged by investor sentiment in either direction. Most commonly, big swings in volatility in a market reflect short and medium term uncertainty while markets with low volatility are seen as more reliable, stable and secure, representing longer term investment opportunities. Volatility is crucial for investors as it can help them identify key opportunities as well as entry and exit points in the market. The greater the volatility in a market, the more potential opportunities there can be for investors, especially if they’re trading over shorter time frames or are looking to short the market.

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Gauging volatility and understanding opportunity

Understanding how volatility works and what it means for the markets is extremely important in helping you make smarter investment decisions. An appreciation of how and why volatility impacts markets can not only support you in finding new opportunities but can also serve to protect your current open positions and improve your risk management strategies. One of the most widely used measures of market volatility is the CBOE Volatility Index or VIX. This is one of the market’s most reliable indicators of volatility and is used by investors across the globe as a bell weather for current market conditions. The real-time VIX volatility index measures short term market volatility based on trading patterns called ‘puts’ and ‘calls’ in the S&P 500 US Options Stock market. The S&P 500 is an index broad enough to give a contextual overview of total US stock sentiment. Most experienced traders and investors track changes in the VIX regularly as a guide to market conditions and as an early earning system ahead of periods of increased volatility.

Why volatility can be good for investors

There is a reason that the VIX is sometimes referred to as the ‘fear index’ as markets in general prefer stability and relatively predictable market movements as opposed to bigger price swings that could dramatically affect portfolios and longer term positions. Because the VIX is an accurate interpretation of investor sentiment (and because sentiment in the US Stock market influences so many other global markets), investors can use this as a gauge for identifying market opportunities. For example, a rise in the VIX reading may indicate short trading opportunities on markets like Wall Street, major currencies like the greenback or individual stocks like Amazon or Facebook.

What type of events can cause increased market volatility?

Different markets are affected in different ways by global events which can trigger an increase in volatility. Understanding which types of market events and data releases to watch out for in each asset class will help you to anticipate upswings in market volatility and identify key trading ideas. Here are a few of the types of market events and major data releases which can lead to greater volatility within markets.

Currencies

Forex markets are amongst the most liquid markets in the world, with huge daily volumes traded around the globe. Currencies can be impacted by a number of events like political upheaval, natural disasters and changes in economic policy. Events to look out for include:

  • Changes in political fortunes including things like votes, referendums, major resignations and policy speeches
  • Central bank decisions on things like interest rates, the introduction of new money and stimulus packages
  • Data releases like unemployment figures, inflation data and GDP

Shares

Volatility in share prices can be down to a number of factors like changes in legislation around a specific industry to trade tariffs, company news and more. Volatility driving events often include:

  • Changes in company ownership or leadership, mergers and acquisitions and the release of new products or services
  • Company earnings data, for example Christmas earnings in the retail sector
  • Macro events like changes to supply chain availability, major financial stories and changes in trade policies

Indices    

Indices can be particularly sensitive to changes in volatility and are impacted by things like political uncertainty, changes to economic policy and major news around specific industries or sectors. Look out for volatility events like:

  • Economic data including unemployment figures, inflation and GDP releases
  • Major events impacting a specific sector of companies within an index
  • Changes to government monetary policy, especially on trade or interest rates

Commodities

Commodities are also very sensitive to increases in volatility and there are a number of factors to bear in mind depending on the asset you have chosen to trade. Some of the biggest drivers of market movement in commodities include:

  • Major changes to supply and demand within a sector
  • Natural disasters like droughts, floods, disease or bad harvests
  • Changing global economic outlooks and political unrest

Cryptoassets

Cryptos are amongst the world’s most volatile markets and generally see bigger prices movements in a shorter timeframe than most other financial instruments. Events that drive crypto price movements include:

  • Any news about potential government or central bank regulation
  • Blockchain community events/disagreements which can lead to a hard fork
  • Major hacks on coin exchanges or digital wallet providers

Please note that due to market volatility, some of the prices may have already been reached and scenarios played out. This is not investment advice.

Cryptoassets are a highly volatile, non-regulated investment product. No EU investor protection. Your capital is at risk.

CFDs are complex instruments and come with a high risk of losing money rapidly due to leverage. 65% of retail investor accounts lose money when trading CFDs with this provider. You should consider whether you understand how CFDs work and whether you can afford to take the high risk of losing your money.

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