Market Risk vs. Market Volatility What distinguishes two from one another?
Market volatility is not the same as market risk:
The market is characterized by volatility. The market is inherently volatile, rising one day and falling the next. However, a risk is only a component of the market. There is a lot more to it than volatility. The main risk is the potential for unanticipated returns. Although risk cannot be completely eliminated, it can be reduced or unfavorable effects can be avoided.
Market Risk Types
Interest rate risk is the term used to describe changes in interest rates brought on by shifts in underlying variables, such as monetary policy.
Currency risk is the term used to describe a financial loss brought on by a shift in a currency’s value. It typically happens to investors who engage in foreign investment and commerce.
Risk to Equity: It is the risk brought on by fluctuations in a company’s stock price. It is thought to have a highly volatile market.
Commodity Risk: This is brought on by changes in the pricing of commodities like metal and crude oil, which have an indirect effect on stock prices.
Current Scenario Risk: This covers the effects of a shift in the company’s stance brought on by emergencies and political events.
Only a tiny portion of risk is present in some volatile situations, which lowers the market and raises the potential for losses. It is crucial to recognize that even companies with minimal market volatility might experience a sharp drop as a result of unforeseen events, such as unanticipated lawsuits or bankruptcy filings, and turn out to be a hazardous investment.
One cannot be certain that low market volatility is dependable or that excessive market volatility will cause prices to decline. According to a recent Morgan Stanley analysis, when compared to other options like gold, real estate, and fixed deposits, equities has produced the greatest returns in India over five-year periods.
Equity returned 12.9%, gold 8.4%, bank fixed deposits 5.5%, and real estate 6.2% during a 20-year period. This demonstrates that even though it is extremely volatile, it is not always dangerous. Market volatility is only one aspect of risk.
Market risk is not the same as market volatility.
Despite their close relationship, it’s crucial to distinguish between market risk and market volatility. They are not interchangeable. They are interchanged because no one takes the time to understand the fundamental distinction.
In his 2014 annual letter to shareholders, Warren Buffett provided clarification on the concepts of risk and market volatility. “Cash-equivalent holdings will always be less volatile than stock values. However, in the long run, currency-denominated instruments are riskier investments—far riskier—than stock portfolios that are extensively diversified, purchased over time, and held in a way that solely uses token fees and commissions. Since volatility is nearly always utilized as a stand-in for risk, business schools have not traditionally taught that concept. However, this pedagogical presumption is useful.
Every fourth day, stock XYZ advances by 0-0.5%, falls by 0-0.5%, and rises or falls by more than 0.5%. On the other hand, Stock ABC increases by 0.5% every other day, by 1-6% every third day, and by 12% on average every sixth day.
Stock XYZ is riskier because investors would be more hesitant to put money into a stock that declines every four days, even if Stock ABC is obviously more volatile. This illustrates how the two differ from one another.
It’s important to steer clear of the pitfalls that investors make when trading. Instead of concentrating only on the black and white, they ought to start reading between the lines.
How Can Market Volatility Be Optimized?
Market volatility is defined as a security’s propensity to sharply rise and fall in a brief period of time. However, there might not always be a drawback to this movement. People will perceive this occurrence as opportunistic once they cease viewing it as harmful. Short-term anxieties impair an investor’s capacity to make decisions and plan. One must learn to cope with the unavoidable volatility of the market.
There is no need for an evacuation plan when a storm strikes. It’s critical to comprehend the possible benefits of investing possibilities brought about by market volatility. Two methods for using volatility to one’s advantage are listed below.