Volatility refers to the upward and downward movement of price. The more prices fluctuate, the more volatile the stock market is, and vice versa. A higher level of volatility means that prices can change dramatically over a short time period in either direction.
For a market participant to benefit from a trading environment that is volatile and changing fast, the investor must either be willing to navigate all the twists and turns, or step back a bit and play the long game.
But how volatile is the stock market, really?
- A volatile stock market is one in which there is a fair amount of liquidity and price valuation.
- Not all markets are volatile, or not all markets are volatile at all times. There are variations in volatility that are seasonal, news, or event-specific, or even based on broader trends like election years and the general direction of fiscal policy.
- Volatility is often indicative of day-to-day market trading, but longer-term, the markets tend to move in one direction or another for a year or more.
- Investors seeking to navigate the market benefit from either being in the thick of it, such as a day trader, or standing back and investing for the long term, such as someone planning for retirement or another big goal.
Is the Stock Market Really Volatile?
Yes, the stock market is sometimes volatile, but the degree of its volatility adjusts over time. Over the short term, stock prices tend not to climb in nice straight lines. A chart of day-to-day stock prices looks like a mountain range with plenty of peaks and valleys, formed by the daily highs and lows. However, over a period of months and years, the mountain range flattens into more of a gradual slope.
This implies that if you are planning to hold a stock for the long term (more than a few years), the market instantly becomes less volatile for you than for someone who is trading stocks on a daily basis.
For example, as of August 2020, the S&P 500's five-year return was just more than 50 percent, the Dow Jones Industrial Average's return was around 50 percent, and the Nasdaq Composite surged over 110 percent.
How Volatility Affects Short- and Long-Term Investors
In some cases, short-term volatility is seen as a good thing, especially for active traders. The reason for this is that active traders look to profit from short-term movements in the market and individual securities—the greater the movement or volatility, the greater the potential for quick gains. Of course, there is the real possibility of quick losses, but active traders are willing to take on this risk to make quick gains.
A long-term investor, on the other hand, doesn't have to worry about this day-to-day volatility of the market. As long as the market continues to climb over time, as it has historically, your good investments will appreciate and you'll have nothing to worry about. Because of this long-term appreciation, many choose to invest in the stock market.