One mistake that those who are new to investing may make is to confuse the terms “volatility” and “risk”. While they may seem similar, they’re two very different beasts – and it’s important to understand the difference between them if you want the best possible chance of success.
What exactly is volatility, and what causes it?
While risk is defined as the likelihood of investments losing their value, the term “volatility” is used to describe how share prices move up or down each day, in turn moving the stock market up and down – and affecting the value of your investments.
Volatility describes the degree to which these fluctuations happen, and can be caused by a range of things. Market experts predict where markets are going to go and these markets can fluctuate based on their analysis and decisions. Political instability – as well as events like war and pandemics – can also cause volatility, as can economic factors like recessions, inflation and interest rate changes.
Startups can also experience huge swings in volatility: their newness and lack of track record make them more likely to fail.
What should I do in times of volatility?
The prospect of volatility may be daunting to some, but volatility can’t be avoided completely when investing. There are various ways in which investors deal with market volatility.
Many focus on the longer term. Short-term volatility doesn’t necessarily equate to longer term losses. Periods of higher volatility are often short-lived: many investors choose to ride out periods of turmoil in the hope of greater returns down the line.
Some choose to diversify. During a period of volatility, investments are affected in different ways: while some show enormous falls in value, others are barely affected at all – and others may actually gain.
Others choose to take advantage of falling share prices, buying stocks when their price has dropped in the hope that they will climb again down the line.
Volatility is inevitable. What’s important is that you’re prepared for it to happen – and know what your strategy is when it does.
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