Volatility is defined as the price movement of an investment. That means that your portfolio grows over time from a smaller starting point. Investors may find periods of high volatility burdensome, as prices can fluctuate sharply or fall suddenly.
The more risk a portfolio assumes, the more potential return it can generate in the long term. This concept — known as the “volatility brake” — is crucial to understanding why volatility can have a negative impact on your long-term wealth. Volatility also affects your returns over the long term.
How is volatility related to returns?
Funds that focused on low-volatility international equities achieved an average annual return after tax of 2.51% over the last 10 years compared to 5.81% for funds with high volatility over the same period. In addition, yield volatility is responding significantly to negative surprises in GDP and inflation announcements. Volatility is often measured using either the standard deviation or the variance between returns on the same security or market index. The results show that the persistence of intraday volatility is significantly reduced when the impact of company-specific press releases and their sentiment ratings are taken into account.
The stock market can be highly volatile, with far-reaching annual, quarterly, and even daily fluctuations in the Dow Jones Industrial Average.
How to trade volatility
If you want to trade volatility, there is an index called the VIX (or the Volatility 75 Index) that can be traded with many brokers and trading platforms. We have a dedicated article about the best volatility 75 index brokers.