Since market volatility can lead to sharp changes in investment values, it is possible that your asset allocation may deviate from your desired divisions after periods of intensive changes in both directions. When volatility rises, it may be possible to make above-average profits, but you also run the risk of losing a larger amount of capital in a relatively shorter period of time. It can help you deal mentally with market volatility if you think about how many stocks you can buy while the market is in a bearish, downward state. Although volatility is usually defined as a bad guy, it is an important organ for a healthy stock market, and there are also positive or increasing price fluctuations.
What happens when volatility is high?
Volatility is also used to evaluate options contracts using models such as Black-Scholes or binomial tree models. Volatility is an important variable in option pricing models. It estimates the extent to which the return on the underlying asset will fluctuate until the option expires. In general, bullish (uptrend) markets tend to be associated with low volatility, and bearish (downtrend) markets are usually accompanied by unpredictable price fluctuations, which are generally downward. This means that the price of the security can change dramatically in either direction over a short period of time.
Lower volatility means that the value of a security does not fluctuate dramatically and tends to be more stable.
Do you want high volatility or low volatility?
Since people tend to experience the pain of a loss more than the joy of gains, a volatile stock that rises as often as it falls may still seem like an unnecessarily risky endeavor. As a rule, the trader assumes that the underlying asset will transition from a state of low volatility to a state of high volatility due to the imminent release of new information. When a stock is highly volatile, you can expect sharp price fluctuations and therefore a higher probability of making or losing money. A volatile market is characterized by sharp price fluctuations and often large trading volumes, as people panic to sell stocks or buy stocks because they have good news or because they are afraid of missing out.
The Volatility 75 Index
There is an index known as the Volatility 75 Index or the VIX that measures the volatility of the S&P 500 index. The index has a value between 0 and 100. A low value means low volatility, while a high value means high volatility. Anything above 20 is considered a volatile market.
More resources about the Volatility 75 index: