Market volatility: A threat or an opportunity for investors?

Volatility is an unavoidable aspect of equity markets, yet it is often misunderstood. While volatility represents short-term fluctuations in stock prices, it is not synonymous with risk. Learning to navigate through periods of volatility can turn market unpredictability into a long-term opportunity for wealth creation.

Let’s explore volatility in detail, understand its causes, and how you can manage it effectively.

What is volatility, and why is it inevitable?

Volatility refers to the rise and fall of stock prices over a short period. It’s intrinsic to equity as an asset class due to factors such as investor sentiment, global economic events, and corporate performance.

For instance, the Nifty 50 Total Return Index (TRI) grew at an annualised rate of 19.9% over the last five years (2019–2024). Despite this robust growth, the journey was marked by periods of sharp corrections and recoveries. These fluctuations, while unsettling, are temporary and highlight the need for a long-term perspective.

How stock prices move: The demand-supply dynamic

Stock prices are influenced by demand and supply in the market.

• When demand rises and supply falls, prices increase.
• When demand falls and supply rises, prices decrease.

What causes demand and supply to change?

1. Economic Cycles: Equity markets react to corporate earnings, which are tied to economic growth. For example, during the COVID-19 pandemic, the sudden halt in economic activity led to a market crash as earnings forecasts declined.
2. Inflation and Interest Rates: Rising inflation can reduce consumer demand, impacting corporate earnings. Central banks often raise interest rates to curb inflation, which increases borrowing costs for businesses and impacts sectors like real estate and automobiles.
3. Policy Changes: Government initiatives such as demonetisation or new taxation rules often trigger market volatility. For example, the capital gains tax changes in the 2024 Union Budget caused a temporary dip in equity markets.
4. Global Events: Geopolitical tensions, oil price fluctuations, or central bank actions in major economies can ripple through global markets, impacting local equity performance.

Volatility vs. risk: What’s the difference?

While often used interchangeably, volatility and risk are distinct concepts:

How to understand risk in investments

Asset class risk profiles

Different asset classes have unique risk profiles. Within equity itself, the risk varies across categories.

Key Metrics to Measure Risk

1. Standard Deviation
   • Measures how much a scheme’s returns deviate from its average over a period.
   • Higher standard deviation = Higher volatility.
2. Beta
   • Measures a scheme’s sensitivity to the market.
   • A beta of 1 indicates that the scheme moves in sync with the market. A beta greater than 1 means higher volatility relative to the market.

Strategies to Deal with Volatility

1. Understand Volatility: A lack of understanding often leads to panic. Educate yourself about the causes and nature of volatility to make informed decisions.
2. Stay Calm: Market corrections are temporary. For example, the markets recovered strongly after the COVID-19 crash. Selling during such dips locks in losses, whereas staying invested allows you to benefit from recovery.
3. Avoid Market Timing: Predicting the exact bottom or peak of the market is nearly impossible. Consistent investment is a more reliable strategy.
4. Ignore Rumors: Social media often amplifies unverified information. Make decisions based on factual, verified data, and consult your financial advisor for guidance.
5. Stick to Your Financial Plan: A solid financial plan anchors you during turbulent times. Focus on your long-term goals and avoid reacting impulsively to short-term market movements.
6. Focus on Asset Allocation: Diversifying your investments across asset classes reduces risk. Rebalancing ensures your portfolio remains aligned with your goals and risk appetite.
7. Leverage SIPs to Your Advantage: Systematic Investment Plans (SIPs) are a great way to navigate volatility. Through Rupee Cost Averaging, SIPs automatically buy more units when prices are low and fewer units when prices are high, reducing the average cost of investment.

Conclusion

Volatility in equity markets is unavoidable but not something to fear. By understanding its causes and leveraging strategies like asset allocation, disciplined investing, and SIPs, you can turn volatility into an advantage.

Remember, the markets reward patience and discipline. Stick to your financial plan, focus on long-term goals, and avoid reacting to short-term noise. With the right mindset and strategies, you can navigate market volatility and achieve your financial aspirations.

(The author is Cofounder & Executive Director, Prime Wealth Finserv Pvt. Ltd.)

Disclaimer: The views and recommendations above are those of individual analysts or broking companies, not Mint. We advise investors to check with certified experts before making any investment decisions.