Market volatility guidebook: Calculations, reasons and solutions explained

Price movements in financial markets often fluctuate over time, reflecting the changing level of risk and uncertainty for investors. Market volatility, the unpredictable swing in asset prices, signals investment risk.

What is market volatility?

Volatility is the swing or fluctuation in the prices of securities or indices in a specified duration. It is calculated in terms of the dispersion of returns of the asset from its average return in a defined period.

High volatility indicates a high degree of price fluctuation, while low volatility means the prices remain steady during the given period. Hence, volatility indicates the risk associated with a security, with higher volatility pointing to higher risk, and vice versa.

How is it measured?

Volatility is typically calculated using standard deviation. This measures the dispersion of a security’s price around its average or mean price for a given period. A higher value indicates higher volatility, and vice versa.

Reasons for volatility

Volatility can be triggered by political, economic, even emotional factors, and can be both macro and micro.

Global events: International developments, such as hostilities and natural or man-made calamities, can lead to market fluctuations. Some such events that have caused market fluctuations in the past include the Covid-19 pandemic, tariff changes by the US and Russia-Ukraine conflict, while the ongoing West Asia crisis has led to strong market reactions recently.
Political: Changes in the ruling governments, political instability or other developments that increase uncertainty can lead to volatility.
Economic: Increasing inflation, interest rate movements or monetary policy announcements can also trigger fluctuation.
Market: Corporate earnings, companyspecific announcements or industry developments can create investor panic and lead to fluctuations.

How to deal with volatility

Market volatility can lead to panic among investors, but there are ways to ensure stability in the portfolio.

Diversification: Spreading one’s investments across uncorrelated assets can help reduce volatility because the fall in one asset can be balanced by the growth in another asset.
Systematic investment: Instead of being distracted by short-term market noise, one should continue to invest for one’s goals through systematic investment. Consistent, periodic investment via systematic investment plans (SIPs) can help tackle volatility by averaging out the purchasing price over the long term.
Rebalancing: Adjusting asset allocation in tandem with the market fluctuations can help restore the original risk level and bring stability to the portfolio.