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Volatility is a key measure of risk in financial markets. Learn what causes it and what it means for financial investments.
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An asset’s volatility is a key risk indicator for capital investments. There are various ways to measure fluctuations in value:
Volatility is a metric used in financial markets as a measure of uncertainty in market developments. It indicates the typical range within which the price of a security, market index or asset class fluctuates. This range gives investors a benchmark for estimating the potential gains and losses of an investment. It captures deviations from an average value, both upwards and downwards.
Volatility always refers to a specific underlying asset – be it a security, commodity or alternative investment. High volatility means that prices fluctuate significantly over time, which can mean higher risk but also greater potential gains. Low volatility, on the other hand, indicates a more stable investment.
Two types of volatility measures are commonly used in the market. Historical volatility shows how much the price of a security has deviated from its average value in the past. Statistically speaking, this is the “annualized standard deviation” of an investment’s returns. Daily or weekly prices are converted into an annual average. This figure describes past performance and is useful for analyzing the volatility of stocks, bonds or commodities over specific periods, but not for predicting future fluctuations.
Implied volatility is used for the purposes of forecasting. This indicator reflects the expectations of market participants as revealed in option prices. For example, the VSMI volatility index of the Swiss stock exchange takes into account the trends in option contracts relating to the Swiss Market Index (SMI) of the country’s 20 largest stocks. Other widely watched market indicators include the Volatility Index (VIX) of the Chicago Board Options Exchange (CBOE), which shows the expected price fluctuations of the S&P 500 stock market index over the next 30 days, and the VDAX for the German stock index.
Investors pay attention to long-term market trends or pursue short-term goals. However, when market players’ expectations change, they also reassess their investments and buy or sell accordingly. If many players act at the same time, the prices of securities and other underlying assets fluctuate and volatility increases. Triggers for sudden market trends can include:
Use volatility as a risk indicator. It shows you how stable you can expect certain investments to be. The higher the fluctuations, the more uncertainty and the less predictability. How you respond depends on your risk appetite: Do you welcome opportunities in turbulent times or do you worry about potential losses? Risk-averse investors tend to avoid highly volatile asset classes, which in turn attract more speculative investors.
Volatility affects the risk/return profile of your portfolio. Your personal risk profile and investment horizon play a role here. The longer your investment is held, the more time you have to make up for short-term losses. Conversely, the shorter the term of your investment, the greater the impact of current price fluctuations.
When investing in publicly traded products, investors receive what is known as a “basic information sheet”. This document includes an overall risk indicator, which is partly based on the historical volatility of the investment product. This information is used to derive seven risk classes, which indicate the level of risk and associated opportunities for a typical holding period. Interest-bearing investment products such as savings accounts and money market funds experience the lowest fluctuations in value. Beyond this first risk class, the volatility of asset classesGo to article Overview of types of investment. increases.
Bonds and equities differ significantly in terms of volatility. Nevertheless, the following applies to both: individual securities are more volatile than investments such as funds and ETFs, which contain several stocks or bonds.
Changes in supply and demand cause even supposedly stable tangible assets like real estate or gold to fluctuate in value.
Cryptocurrencies and alternative investments are among the most volatile asset classes. They constitute the highest-risk groups and are subject to the greatest fluctuations.
If you want to invest despite price fluctuations, you can follow these five practical tips:
Volatility in financial markets is inevitable. As an investor, find your own approach to dealing with price fluctuations by:
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