Tags: Volatility, ETF, Financial, Stock Market, Index Mutual, Investment

What is the meaning of Volatility in Financial Markets?

1 August 2020

Volatility in Financial Market!

The dispersion of returns for a market index or security is called volatility. The riskier the security or market index the higher the volatility. When it comes to the securities market the term volatility often refers to how big of a swing is in the market in either direction. For instance if the stock market falls or rises more than a specific percentage point over a period of time it is referred to as being “volatile”.


When pricing options contracts, the volatility of the asset is considered to be a crucial factor to take into consideration. In addition, if a security’s value is expected to change dramatically (in either direction) in a short period of time it is considered to be highly volatile.


On the contrary, if the volatility is low it means that the price tends to be relatively steady. A number representing volatility is given without the unit of currency and is given in percentages. Volatility can be reported on a daily basis as well as weekly, monthly, and annually. It is usually calculated by using the standard deviation and variance. 



Volatility in Financial Market



1. Volatility in the stock market

One place that is characterized by a high degree of volatility is the stock market. For example, Dow Jones Industrial Average can swing dramatically on annual, quarterly and even daily basis.


On the one hand, some shrewd investors can harness this feature of the stock market and make a significant return on their investment. However, at the same time, stock market volatility presents a significant risk for the investors


A 2011 report that studied the historical relationship between volatility and stock market performance found that the higher probability of stock market declines corresponds with higher degrees of volatility. On the contrary, the investment has a higher chance of growing if the volatility is low. This study on stock market volatility can be used by investors to align their portfolios with proper expectations of returns. 


2. What affects stock market volatility

There are many factors that can affect the change in the direction of the stocks, or the volatility. These can be national economic factors (or even regional ones) such as interest rate policies and tax policies, trends in inflation, trends in various industries and sectors, major weather events that can disrupt the production and extraction of various commodities.


All of this has an influence on the stock market. For instance, if a disruptive weather event occurs in an important oil-producing region and the extraction of oil is hindered this will cause the increase in oil-prices. In turn it'll cause a spike in many stocks that are connected to oil. 


3. What is an ETF? 

ETF stands for an exchange-traded fund. Simply put, it is a bundle of securities (for example stocks) that you can sell or buy on a stock exchange through a brokerage firm. It can be said that ETFs are extremely valuable for individual investors as they offer a number of benefits and can help an investor achieve their goal. ETFs that have an innovative structure may help an investor avoid short-term capital gains taxes, short markets and gain leverage. It is estimated that nowadays the total amount invested in various ETF structures exceeds $1 trillion.


There are approximately one thousand ETF products traded on stock exchanges in the United States. There are many different types of ETF products. Some of them are: Bond ETFs, Commodity ETFs, Foreign market ETFs, Inverse ETFs etc. Similarly to a stock, an ETF has a ticker symbol and it can be bought or sold when the stock exchange is open, just like a stock (however there are some differences as well). 


4. ETF vs Mutual Fund. Key similarities and differences

There are a lot of similarities between the exchange-traded funds and mutual funds. Both of them enable the investors to diversify and consist of the mix of different assets. However, there are some significant differences in the way they are managed. Mutual funds can be purchased based on a calculated price at the end of the day whereas an ETF can be traded in a similar manner to a stock. As well as this an ETF is usually managed passively and based on a market index; while the manager of the mutual fund makes active decisions about the allocation of assets within the fund.


ETFs also tend to have lower expense ratios and lower fees than mutual funds (due to the fact that they are mostly passively managed). Moreover, the minimum investment requirement is usually higher in the case of a mutual fund than in case of an ETF. The requirements differ in accordance with the company and the type of fund. In addition, because of the way ETFs are created and redeemed they are more tax efficient than mutual funds. 


5. Different kinds of mutual funds and ETFs

There are two types of mutual funds: open-ended and closed-ended. The mutual funds marketplace is dominated by the open-ended variety. In case of such funds funding companies and the investors buy and sell the fund shares directly between themselves. The number of shares the mutual fund can issue is not limited. More shares are issued as more investors keep buying into the fund. Closed-end funds issue a specific number of shares. They do not issue new funds even if the investors’ demand grows. 


As for the ETFs there are three legal classifications:


1. Exchange-Traded Open-End Index Mutual Fund. Derivatives may be used in the fund; securities lending is permitted and the shareholders are paid every quarter.


2. Exchange-Traded Unit Investment Trust (UIT). These must limit investments to 25% or less in a single issue. They also have to set weighing limits to both non-diversified as well as diversified funds. UITs pay dividends quarterly and do not reinvest the dividends automatically.


3. Exchange-Traded Grantor Trust resembles a close-ended fund. The shareholders have voting rights. Dividends are paid directly to shareholders and not reinvested. 


It is predicted that new and unusual ETFs will be introduced in the near future since innovation has always been the hallmark of this industry ever since its beginning. That being said, you should investigate the ETF you’d like to invest in very carefully as not all of them are created equal. 


In fact, we provide subscriptions that focus on individual holdings rather than any mutual funds and very few ETF. The reason why is because ETFs are NOT actively managed. Thus, you could be stuck with hundreds or thousands of holdings in your ETF or index; and end up losing because there isn't a fund manager on call on ETFs.


Mutual Funds, on the other hand, have management fees even when it doesn't seem like it; the added on fees are embedded in the 12b1 fees and commissions from selling certain holdings. There's been alot of compliance issues as a result. If I were investing I would also use a registered investment advisory that is objective; doesn't have any brokerage or third party ties and thereby the need for mutual funds is eliminated.


What's best for highest profits in the stock market are stocks and bonds with some ETFs; and ongoing advice as to how much to buy for your recommended asset allocation based on your specific goals and risk tolerance


To conclude, both mutual funds and ETFs offer investors bundles, but they do have some differences some of which can be presented in the chart above.


For more ideas on how to become financially free, start our DIY investment portfolio subscriptions or go to investingprofits.pro


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Lea Wiviott Boracchia, Co-Founder, FinancialPlans.Info and InvestingProfits.Pro, both apart of the renowned Boracchia Wiviott Wealth Partners

We are a registered investment advisory focused on accessible wealth planning for everyone. Our mission is to help women, men and people of all ages, races, locations, and anyone plan and secure their most successful future. We were originally established in 2005 by way of 3 firms before my husband Marc and I registered our independent advisory in California.


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