Most investors understand that the stock market is volatile, but they may not know exactly what that means. Basically, volatility is the full range of price changes that a stock experiences over a specific period of time. If the price doesn’t change much, the stock’s volatility is low. But if the price moves a lot, reaching new highs and lows during the time frame, its volatility is high.
Aren’t all stocks volatile?
Yes, all stocks have some volatility, but some are more volatile than others. True volatility is measured by a mathematical formula that takes into account the return on equity in the stock and the return on equity of the market as a whole. This formula shows whether a particular stock has more, less or the same volatility as the market as a whole.
There are also ways to track overall volatility in the market. The Volatility Index (VIX), created by the Chicago Board Options Exchange, is an index that updates in real time and shows the market’s expected volatility for the coming 30 days. The VIX estimates future volatility by aggregating weighted prices of S&P 500 stocks over a wide range of strike prices.
However, volatility is relative. Stock prices move up and down every day, so not every movement is noteworthy. In general, VIX values that are above 30 are linked to large amounts of volatility in the market and signify increased uncertainty, risk and fear among investors. VIX values below 20 reflect more stability. (At the end of 2019, the VIX was hovering between 12 and 15.)
Is volatility a good thing?
Yes and no. Since stocks experience volatility, which can result in extreme highs and lows, that can provide bigger opportunities for making money than most other investments. When the prices of volatile stocks increase steeply, investors can experience big gains.
On the flip side, the same force that drives those sharp increases can also bring deep lows. That’s why investing in the stock market is characterized by risk: Although the market has made significant gains over time, stock prices go up and down every day. And volatility is the reason why.
When you invest in the stock market as a long-term strategy, buying and holding for an extended period of time, you are generally able to capitalize on the high end of volatility over time. Even though the market will fluctuate, it has generally produced positive returns over the long term. Stocks that have some volatility will experience periodic losses but they are likely to also produce the greatest profits. They also offer opportunities to purchase at a low price and wait for eventual growth.
Which stocks are most volatile?
Certain sectors of the market, like technology, tend to experience more volatility than others. The volatility of certain sectors and specific companies can also be affected by events in the business world and by global political events.
Currently, many of the most volatile stocks operate in the technology, oil and gas, and healthcare/biotechnology industries. Typically, slower economic growth translates into lower demand for oil, and concerns about slowing growth amid trade wars have influenced the market in recent months. However, unexpected geopolitical events, like the attack against Saudi Arabian oil facilities in September, can also cause oil prices to spike. Together, those forces create increased volatility in the energy sector.
The healthcare sector is experiencing volatility because the population is aging, demanding more extensive medical care and drug treatments. Because these demands continue even during economic slowdowns, healthcare stocks are likely to outperform other sectors during low times. But there’s an ongoing threat of legislative changes that could bring new regulations to healthcare and lower earnings, especially with an election coming up. The high potential for ups and downs makes healthcare more volatile. Biotechnology stocks are especially volatile because while the products in research and development may seem promising, they must follow strict regulations and go through extensive trials so may not actually make it to market.
Technology stocks are often more volatile than others because they are often valued based on potential future performance. When the future appears shaky, their prices can drop—and when investors expect the future to be bright, they may spike.
Some of the stocks that experienced the highest percentages of volatility between October and mid-December 2019, according to StockFetcher, include: PG&E Corporate Holdings (PCG) or the Pacific Gas and Electric Company, which filed for Chapter 11 bankruptcy protection in January, the software firm Slack Technologies (WORK), U.S. Steel Group (X), Clovis Oncology (CLVS), a pharmaceutical firm focused on cancer drugs, and ArQule Inc. (ARQL), a biopharmaceutical company.
How should I include volatile stocks in my portfolio?
Including some highly volatile stocks in your portfolio can provide you with opportunities for high returns. But because they also carry greater risk for large losses, it’s important to make sure your portfolio is diversified with some holdings that are less volatile.
Also, remember that investing for a long-term time frame is ideal, rather than attempting to time the market and sell quickly based on market movements. Even with some dips along the way, the market’s long-term trend is one of upward movement.
Because different stocks and sectors of the market experience volatility at different times, it’s important to build a well-diversified portfolio that includes a range of sectors, as well as bonds. (Acorns portfolios are composed of exchange-traded funds with exposure to thousands of stocks and bonds.) By diversifying your holdings, you can help mitigate the downside risk of volatility but still capitalize on the upside.
Investing involves risk including loss of principal. This article contains the current opinions of the author, but not necessarily those of Acorns. Such opinions are subject to change without notice. This article has been distributed for educational purposes only and should not be considered as investment advice or a recommendation of any particular security, strategy or investment product. Information contained herein has been obtained from sources believed to be reliable, but not guaranteed.