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If you are already an investor or a first-time investor, you have likely heard the term ‘market volatility. So first, let us understand this term in brief.
Market volatility describes the changes in any security valuation as we all know that the stock and bond market are uncertain. If stock prices undergo drastic changes within a short span, they are termed as ‘High market volatility’. Changes can be upwards and downwards. If the stock prices do not undergo any major fluctuations and remain at the same level, they are termed as ‘low volatility market.’
Market volatility is an estimate of fluctuations of securities market price. It is calculated as an average difference between the range of the securities highest and lowest prices over a specific period.
Many investors take ‘market volatility as a risk factor for investments. However, it pertains to how the stock or bond price will react to a risk event.
High volatility is usually observed when the market sentiments drive the security price or in case there is a lack of clarity to the investors where a company is headed. High volatility is when there are sharp and frequent movements in the performance of the asset.
Market volatility can give investors the impression that they are losing their money. And that is why many investors withdraw from mutual funds when they see that money is not working. This step damages your investment intentions as financial performance can go back and, in the long run, can bring you huge profits. Therefore, it is always advisable to invest for at least five years to get a good return.
The short-term volatility can be temporary, and as an investor, one should not bother much about it. This is because it is for a limited time and can also give good returns. Short-term volatilities shall stabilise with time.
Before we discuss diversification, let us understand the difference between hedging and diversification. Both are different approaches and would affect your portfolio differently. Diversification usually refers to investing in securities that are not correlated with each other. Correlation explains how a fluctuation in one stock or security might affect the stock prices of other stocks. Correlation can be positive, negative or no-correlation. Hence, an investor should consider the impact of correlation while diversifying.
Hedging refers to investing in negatively correlated security, meaning a fall in one stock price might lead to rising in another, thereby covering the investor from the loss. As hedging is a beneficial tool, it comes with its own risk when there is overall stress in the market, like the times of COVID pandemic.