How Important is it to Understand Volatility in Modern Investment?

Recent events in financial markets have served as a stark reminder of how volatile they can be. For example, just when people were betting big on Bitcoin to smash past its all-time high on the 6th of October, a few days later there was a sharp seven per cent correction in a single day.

Volatility is everywhere and can even be found in well-established assets like gold. In modern investment, there are many ways to mitigate against this to make more reasonably informed investments. Investors need to know how to manage risk and put the correct systems in place to counter mor extreme volatility.

 

What is Volatility and Where is it Found?

Volatility is a measure of variation in predictability, and in financial markets it’s related to how big price swings are over time. For investors, there are countless places where you’ll encounter volatility, and the levels vary depending on the asset. For example, the forex market generally has lower volatility, while the crypto market has higher levels.

For some, this is all about perspective. For example, if you zone in on the crypto market and compare the different tokens available, you could say that Bitcoin could be considered low volatility when compared with memecoins like Pepe.

Volatility can be found in other places as well. Energy bills, for instance, have had volatile swings in recent years. Weather patterns can even experience volatility too, with unpredictable weather occurring and affecting sectors like farming. Casino games online also come with volatility built in. When players spin the reels on slot games, the higher volatility titles are generally said to pay out larger amounts but more infrequently, while lower volatility titles may pay out more regular, moderate wins.

Basically, anywhere where you can find unpredictability, you’ll find volatility. Some may find unpredictability itself unsettling, but it’s a very important concept to face head-on if you intend to dedicate significant time and resources to the finance sector.

How Important Is It to Understand Volatility in Modern Investment?

If you gointo investing without a good understanding of volatility, the market will chew you up and spit you out with no remorse. Recognising volatility helps investors avoid panic during downturns and identify when opportunities are undervalued. Market movements often reflect emotional reactions such as fear, greed, and optimism. These have the potential to drive prices beyond their true worth.

Understanding volatility means that you realise that these swings are all part of the system. You need to identify the timeframes that you want to invest over, and be comfortable with the volatility between those. For example, if you trade Bitcoin on the hourly chart, you’re going to face a lot of sharp swings. But if you only look at the monthly chart, you won’t see all this.  

Other than clearly setting investing timeframes, smart investors manage volatility by employing balance in their portfolios. Using the barbell portfolio strategy, most investments are in less risky asset classes. They’ll only put a small percentage of their portfolio into risky investments, and they’ll always ensure that they have stops in place to protect against unexpected crashes. Another key lesson is to avoid or only use light leverage, as this amplifies volatility greatly.

Volatility will always be a part of investing, because investing is always a risk, and you’re never guaranteed to succeed in the sector. If you want the best chance, however, you’d better get used to the concept. As long as you have a good understanding of the market and put risk management measures in place, you may learn to appreciate the unpredictability as a welcome challenge.