Skip to main content
Home
  • English
  • العربية
  • SUPPORT
  • Log in
  • JOIN EXINITY
  • Markets
    • Markets

    Explore global financial markets

    Individual stocks
    • Stocks
    • Stock CFDs
    Forex and commodities
    • Forex pairs
    • Commodities
    Indices
    • Indices
    • Currency indices
  • Ways to trade
    • Ways to trade

    Explore our services at a glance

    • Exinity World

    Get pure investing simplicity and build a global portfolio from just $20

    • Exinity Trader

    Been trading for a while?
    Say hello to Trader

    • Exinity Trader Pro

    Pro, meet pro.
    The service for experienced traders

  • Edge
    Edge

    The markets are full of opportunity, but you won’t find it by accident. Edge puts useful and jargon-free insight at your fingertips.

    Edge library
    • Understanding the markets
    • Analysis and forecasting
    • Understanding risk and returns
    • Learning from experience
    Trading ideas
    • What our experts say
    • Meet our experts
  • About
Markets & Trades

Volatility: what drives it, how to navigate volatility in the markets and make it work for you

Volatility can have a large and potentially dramatic impact on your trading. It is a broad term that is used frequently in the financial press and by financial market analysts. It can be used in reference to the options market, specific events and in relation to risk management. At its most basic level, volatility is the rate at which the price of an asset increases or decreases over time. Volatility is incredibly important for traders for two reasons: firstly, it can tell them how much an asset price will move over a period of time and help them to make a choice as to whether they want that asset in their portfolio. Secondly, volatility can indicate how an entire market moves due to external events. We will discuss the various forms of volatility below.


Volatility in all its guises

As we have mentioned, there are many different types of volatility. Option market volatility or implied volatility, market volatility, risk premiums, and portfolio volatility are all worth understanding in detail to try and enhance your chance of successful trading.

1. Implied volatility:

We have ascertained that volatility measures the risk of an asset; this makes volatility important in measuring the price fluctuations in the returns of an option’s underlying asset. Volatility will help you to understand the pricing structure of an asset, and how the price moves in a short period of time. For example, if the price of a security moves rapidly in a short period of time, then it is considered to have a high level of volatility. If the price of an asset doesn’t move too much over a set period of time, then it is considered to have low volatility. It is worth remembering that an option on an underlying asset with high levels of implied volatility usually results in high-priced option premiums, and vice versa for options with low levels of implied volatility.

2. Market volatility:

This is what most people think of when they hear the term volatility, and it is usually the type of volatility that is referred to in the media. When market volatility is high then whole sectors of asset classes can move sharply. In some cases, market volatility can surge to such an extent that nearly every financial market in the world is at risk. This was the case in March 2020, when multiple asset classes were thumped by the spreading coronavirus. Back then stocks slumped, however, the selloff did not stop there. Even some safe havens started to sell off including gold and US Treasuries, as the event risk linked to Covid-19 sparked a mass liquidation event in financial markets. Other instances where market volatility has risen sharply include the financial market crisis of 2008-2009, which saw a particularly sharp selloff for financial stocks and bonds, and the unexpected result of the UK’s European Union referendum in 2016. When it was confirmed that the UK would be leaving the European Union, the pound slumped at its fastest ever rate, and is still struggling to recover from that sell off more than 4-years’ later.

Market volatility can be brutal, but it is usually a short, sharp shock to markets and they then recover. This was the case for some stock market indices after the selloff in March 2020. Stocks hit multi-year lows, however, some markets, including the main US indices, bounced back to record highs in the months after the sell off. Thus, market volatility can create multiple opportunities for traders and should not be something that traders are frightened of.

Luckily, market volatility is measured by special volatility indices. The most famous of these indices is the CBOE’s Vix index, which measures the volatility of the S&P 500. The Vix is considered the global standard for market volatility. Luckily, most trading platforms allow you to trade the Vix index using a CFD or a spread bet. Thus, due to the flexibility of these instruments, you can easily buy and sell market volatility. This can be a useful trading tool for a couple of reasons. Firstly, it can help you to benefit from various market conditions. If you are long the Vix, then you benefit when the Vix index rises, or when market volatility jumps; in contrast, if you think that financial markets will calm down then you can short market volatility to take advantage of the Vix falling. Trading a volatility index can also help you to protect your trading portfolio. For instance, if you have a long position in multiple US or European shares, which are considered risky assets, then you may want some long exposure to the Vix index, just in case market volatility surges and global stock prices sell off. Conversely, if you are long some safe haven bonds, then you may want to take a short position in the Vix at the same time, in case the market collapse that you may be preparing for never happens.

Market volatility is endlessly fascinating, and we would urge anyone trading to always keep an eye on the Vix, usually if it rises above the 15 level then it can indicate that something is going on that could hurt share prices.

3. Risk premiums:

As we have mentioned, volatility is used to calculate risk premiums in the options market. It is also a key driver of the price of most assets, in particular single stocks. If you look at the price of a stock it is constantly moving as supply and demand for the stock fluctuates and this drives the stock price. One input to supply and demand factors can be volatility. For example, sometimes stocks that traditionally have very erratic price movements can be cheaper to buy than stocks that have more predictable price moves. This is because price predictability is considered attractive when forming a portfolio of stocks, as it is easier to predict what your future returns can be.

Thus, stocks with lower levels of volatility, and more predictable returns, can generate more demand than stocks with less price predictability. This is why, on balance, blue chip stocks, which include some of the largest companies with the most consistent returns, can have lower levels of volatility than their smaller counterparts who do not reside in the blue-chip indices.

There are exceptions to this rule. For instance, in March 2020, a little-known company called Zoom saw its stock price soar by more than 800% as the world’s governments started to impose lockdowns to try and supress the coronavirus. As millions of people started to work from home, Zoom’s video conferencing technology was in high demand and its stock price reflected the dramatic and sudden change in its fortunes. This is an example where a high level of price volatility paid off, and Zoom was one of the top performers in the US stock market at the peak of the coronavirus pandemic in Q1 and Q2 2020.

4. Portfolio volatility

When you are trading it is important to look at all of your open trades and try to gauge how exposed you are to volatility. For example, if global stocks tanked tomorrow, would you blow out of your account? The answer is probably yes, if you are long mostly stocks, especially if you have high exposure to “growth” stocks, which tend to do well in market upswings and can be overvalued.

It is important to estimate how exposed you are to volatility, and to address any imbalances. For instance, if you have a lot of exposure to only one sector, or mostly growth stocks, then it may be time to move out of some of your positions to try and balance your portfolio. This was a common concern among some traders in the late summer of 2020. US tech stocks were soaring in popularity after they had a stellar run during the peak of the first wave of the coronavirus crisis.

However, some companies saw their stock market valuations soar to unsustainable levels, for example, Amazon had a price to earnings ratio above 150, at one stage, and there was a similar situation for Apple. Savvy investors could see that these valuations would not last long, and the savviest closed their long positions in these tech companies at the start of September, just as a healthy pullback occurred in the US tech sector.


Don’t ignore volatility

Overall, understanding volatility can help you to ensure that your portfolio remains balanced and that you have a practical risk management strategy in place. Don’t ignore volatility, if you do then you could damage your capital and future profits.

Market Insights
What’s happening in the markets today?

Find your next trading opportunity with the help of our experts.

Check our latest market insight for inspiration.

Market Insights
 
Trading strategies for the month ahead

With Hussein Sayed. Join an interactive workshop exploring opportunities in the coming weeks.

/en-int/edge/workshops
Create a demo account
Build your skills with a demo account

CREATE DEMO NOW

Exinity World

GET THE APP

EDGE INSIGHTS

Analysis & Forecasting

Market analysis and forecasting basics
How do traders and investors predict future price trends and market reversals?
Find out more

Markets & Trades

How trading works
A short introduction to how trading works to get you started.
Find out more

Learn

How to find your trading style
There are tens of thousands of financial markets and almost as many ways to trade them.
Find out more

Markets & Trades

Volatility
What drives it, how to navigate volatility in the markets and make it work for you.
Find out more

Risk & Return

Understanding your risk appetite
Is understanding your risk in trading the most important part of your trading journey?
Find out more

Risk & Return

Risk mitigation strategies
Most professional traders believe risk mitigation and how to manage risk is one of the key fundamentals in trading.
Find out more

Markets & Trades

What are CFDs and what does CFD trading mean?
CFDs allow you to trade on the rising or falling prices of financial markets across the globe.
Find out more

Ready to jump into the markets?

Choose your Exinity experience and create your account in minutes

JOIN EXINITY
  •  
  •  
  •  
  •  
Home
  • About us
    • Exinity Group
    • Careers
    • Company news
    • Meet our experts
  • Useful links
    • Trading platforms
    • Trading tools
    • Trading hours
  • Support
    • FAQ
    • Contact us

The services on the Website are provided by Exinity Limited (exinity.com), regulated and licensed by the Financial Services Commission of the republic of Mauritius with an Investment Dealer License bearing license number C113012295.

Card transactions are processed via Exinity Services Limited (EU merchant company), a company incorporated in the Republic of Cyprus with company number ΗΕ 400404, registered office at 64 Agiou Georgiou Makri, Anna Maria Lena Court, Office 201, 6037, Larnaca, Cyprus and regulated by the laws of Cyprus. Address for cardholder correspondence: [email protected] Business location address: 35 Lamprou Konstantara, Kato Polemidia, 4156, Limassol, Cyprus.

Exinity ME Ltd is registered under the Laws of the Abu Dhabi Global Market (“ADGM”), with registered offices at 16-104, 16 Floor, Al Khatem Tower, ADGM Square, Al Maryah Island, Abu Dhabi, UAE. It is regulated by the Financial Services Regulatory Authority (“FSRA”), Financial Services Permission Number 200015 and is a duly licensed Category 3A Firm authorized to provide financial products and services to persons who meet the qualifying criteria of a Professional Client as defined by the FSRA rules.

Risk Warning: Trading Forex and Leveraged Financial Instruments involves significant risk and can result in the loss of your invested capital. You should not invest more than you can afford to lose and should ensure that you fully understand the risks involved. Trading leveraged products may not be suitable for all investors. Trading non-leveraged products such as stocks also involves risk as the value of a stock can fall as well as rise, which could mean getting back less than you originally put in. Past performance is no guarantee of future results. Before trading, please take into consideration your level of experience, investment objectives and seek independent financial advice if necessary. It is the responsibility of the Client to ascertain whether he/she is permitted to use the services of the Exinity brand based on the legal requirements in his/her country of residence. Please read Exinity’s full Risk Disclosure.

Regional restrictions: The Exinity brand does not provide services to residents of the USA, Japan, Canada, Mauritius, Haiti, Hong Kong, Suriname, the Democratic People's Republic of Korea, Puerto Rico, Cuba, Quebec, Syria, Iran, Iraq and the Occupied Area of Cyprus.

© 2021 Exinity

Terms and agreements   |   Privacy   |   Cookies