Gauging market volatility

[N.Sukumar]

The stock market movements over the past few weeks can be best
described as unpredictable. It goes a few impressive points up, only
to slide back after a few days. The upward and downward fluctuations
can create panic among investors. Returns on stocks become
increasingly difficult to predict over the short term. It may be a
reaction to global market conditions, high oil prices, world economy
and soaring inflation. Volatile markets torment investors.
How do you measure market stability?

A measure of volatility gives ample information for an investor to
base his decisions . The time to enter, buy or sell, are critical
decisions that depend on market moods. Shrewd investors find volatile
markets or crashes an ideal time for picking value stocks at bargain
prices. Since these are purchased at discounted rates, it gives a
sufficient cushion for the long-term investor. Though scouting for
bargain stocks may appear a lucrative proposition , one must not grab
a poorly-performing stock that is heading downwards.

Investors can use the Beta value of a stock to understand its
volatility. In simple terms, it's a measure of individual stock risk
relative to the overall stock market risk. Hence, if the stock
fluctuates more than the general market, its beta remains greater than
one. On the contrary, if the Beta is less than one, it means that the
stock's price swings are less than the market's .

Consider a stock with a Beta of two. This implies that this stock is
twice as volatile as the market. A Beta value of one indicates that
the stock is moving in sync or proportion with the market in general.

A highly volatile stock means its value can potentially be spread out
over a larger range of values. So its price can be expected to change
dramatically over a short time period in either direction. A less
volatile stock means that its value does not fluctuate dramatically .
Any associated price movement is at a consistently steady pace spread
over a time frame.

Volatility is a measure of dispersion around the mean return of a
security. The statistical unit of standard deviation is a measure of
volatility. This parameter gives an idea of how a stock is tightly
grouped around an average. A small standard deviation means the price
is tightly bunched together. A large standard deviation means the
price is spread apart.

With globalisation, the domestic markets are no longer immune to
global trends and happenings. Further, foreign institutional investor
(FII) inflows and moods impact the market as a whole. The domestic
economy is no longer independent of the world economy. Hence, it
becomes important to understand the cause of volatility and devise a
long-term strategy. Invest in stock markets with a longterm
perspective.

If the market movement exhibits high volatility, investors need to
review the value of their portfolios more frequently. It is usually
observed that when the stock markets are bound upwards, the volatility
tends to decline. Volatility tends to rise in falling markets. The
higher the volatility, the riskier is the security.

N.Sukumar
Research Analyst