Why Market Volatility Creates Investment Opportunities
Volatility is typically seen as a feature of the markets that investors should avoid. These fluctuations in stock prices are often uncomfortable for investors and can impact the decisions that are made with funds. Yet, experienced investors often view market volatility differently. Volatility is typically an opportunity for investors to purchase quality assets at more attractive prices.
Financial markets are constantly reacting to a range of factors that impact the markets. Many of these factors are outside of the control of the companies whose shares are traded in the markets. Yet, these factors do not usually impact the long-term business fundamentals of those companies. Recognizing the difference between these two concepts is the basis of most successful investing strategies.
For many professional investors, market volatility is not a reason to avoid the markets; instead, it is an opportunity to purchase quality companies at lower prices.
What Is Market Volatility?
Market volatility is a measure of the price movement of an asset during a given period.
During periods of high volatility, markets may experience:
Rapid price changes within a day
High trading activity within the market
High levels of uncertainty of the price of specific assets
Wide ranges within the prices of assets
Rapid changes in the sentiment of the market
Volatility can impact most asset classes, from equities to digital assets.
What Causes Market Volatility?
Markets continuously react to new information that emerges within the economy.
Some of the most common factors that cause volatility in the markets include:
Economic data
Earnings reports
Interest rates
Inflation
Geopolitical events
Market expectations
Markets quickly change the prices of assets in response to this information.
Why Investors Shouldn't Fear Market Volatility
While market volatility can create discomfort in investors, it is a normal part of the markets.
During periods of market volatility, investors may find opportunities to:
Purchase quality companies at low prices
Rebalance their investing portfolios
Increase diversification within their portfolios
Review their investing strategies
Identify which companies have the best business fundamentals
Investors who achieve the best long-term returns typically focus on the companies that they invest in rather than the volatility of the markets.
Volatility and Market Liquidity
Market volatility can also have an impact on the liquidity of the markets.
During times of volatility in the markets, investors may experience:
Wider bid-ask spreads
Increased trading volume
Faster price discovery
More activity within the market
While volatile markets may make it more difficult to quickly purchase or sell assets, the markets remain liquid the majority of the time.
Liquidity remains a key consideration for investors during volatile markets.
Sector Performance During Volatile Markets
Not all markets and industries exhibit the same volatility as others.
During volatile markets, some of the best industries to invest in may include:
Health Care
Consumer Staples
Utilities
Industries that may experience increased volatility include:
Technology
Industrials
Consumer Discretionary
Financials
Volatility of different industries allows investors to recognize which industries to invest in or avoid during specific periods.
Risk Management During Volatile Markets
Professional investors often have a strategy for managing risk within their portfolios during volatile markets.
Some of the most common approaches to risk management include diversifying investments, managing how much of their portfolio is invested in individual companies, adhering to a long-term asset allocation strategy, maintaining the liquidity of their investments, and reviewing their portfolio regularly.
Rather than focusing on the movements of the markets during volatility, experienced investors focus on maintaining their portfolios in accordance with their long-term investing goals.
The Importance of a Long-Term Perspective
Markets may experience volatility and downturns in their returns from time to time.
Yet, long-term investors tend to focus on the fundamentals of the companies in which they invest.
Factors that impact long-term investors include:
Business fundamentals
Earnings
Cash flow
Competitive advantages
Valuation
By maintaining a long-term perspective on their investments, investors can avoid making poor decisions during periods of high market volatility.
Volatility Is Part of Price Discovery
Price fluctuations within markets are essential to the functioning of efficient markets.
Volatility is a component of:
Price discovery
Capital allocation
Market efficiency
Investment opportunities
Risk assessment
While it may appear that the price movements of assets within markets are random, the volatility is essential to the incorporation of new information into market prices of those assets.
Key Takeaways
Market volatility is a sign of changing market expectations and newly released information in the markets.
A wide range of economic and financial reports can cause price fluctuations for the companies whose shares are traded in the markets.
Volatility often presents investment opportunities for long-term investors to purchase quality companies at low prices.
Investing in a diversified portfolio helps to manage risk in an investor’s portfolio.
Some industries are more volatile than others during specific market conditions.
For long-term investors, the fundamentals of the companies that they invest in are far more important than market volatility or price movements.
Conclusion
Market volatility in the financial markets is inevitable for investors. While many see volatility as a negative occurrence, there are benefits to volatility in markets for investors. High periods of volatility allow investors to purchase quality companies at low prices, diversify their portfolios, and focus on the business fundamentals of the companies that they invest in rather than the temporary sentiment that is driven by market volatility. By focusing on the business value of their investments rather than the market sentiment around those stocks, investors can better navigate periods of volatility and stick to their long-term investing strategy.