People who are not used to being on boats may find that the constant up-and-down motion makes them feel seasick. Those who are used to boats, however, just accept this movement as a fact of life. In much the same way, people who don’t really understand the stock market may fear its volatility, whereas more experienced investors just see it for what it is, daily movements which may, or may not, follow the long-term trend they predict for a company. Here are three points you need to understand about stock-market volatility…
The smallest companies can be the most volatile
Think about going into the ocean in a little canoe. You probably wouldn’t last very long because the giant waves would toss you about all over the place. Make the same journey in a modern ocean-going liner and you’d probably barely feel those exact-same waves. The same sort of idea applies to the stock market. Smaller companies can go forwards or backwards in leaps and bounds depending on how the market feels about their situation. Changes which might barely register at a FTSE100 company can have a huge influence on how a start-up is perceived. Astute investors learn to focus on the facts rather than the hype and look for solid value and future prospects.
Some companies operate in highly-cyclical industry sectors
Possibly the classic example of this is the property market, which is often perceived as having four distinct phases, which are given different names depending on what sources you read. Essentially however, the cycle begins with phase one in which property prices are at rock bottom and adventurous investors on a buying spree. Phase two sees prices begin to rise and investors become more confident. Phase three sees a buying frenzy during which experienced investors stay on the sidelines and inexperienced ones drive prices to peak levels. Phase four is the cool down, in which buyers of all degrees of experience recognise that enough is enough with the result that sellers have to reduce prices in order to make sales. This may also be the time when lenders become more cautious about approving mortgages for high percentages of a property price and regulators may step in to try to keep the market in line. After a bit of breathing space, the market goes back to phase one and everything starts all over again. The value of shares in property-related companies can be influenced by the performance of the property-market as a whole and hence rise and fall without any change to the companies’ fundamental value.
Volatility can bring useful buying and selling opportunities
If you can learn to see volatility for what it is, then you can look for ways to make use of it, in other words you zig when the market is zagging and zag when the market is zigging. If you think a company is being unfairly punished with a low share price, then you can back your opinion with your funds and grab yourself a bargain. Similarly, if you think the market is overvaluing a company you own, it may be a good time to evaluate your portfolio as a whole and decide whether that investment is still good for you, personally, over the longer term or whether this surge could be the perfect opportunity for you to rebalance your portfolio. Alternatively, if you really don’t want to have to deal with volatility any more than is absolutely necessary, you could either aim to minimise your exposure to it by putting your funds in larger companies which tend to have lower volatility and/or look to create “pairs” of companies in which the good trading conditions for one are the bad trading conditions for the other and hence create balance in your portfolio.