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Making Sense of Volatility in Financial Markets | Unpacked | J.P. Morgan - YouTube
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Dramatic spikes, wild swings,
extreme uncertainty.
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We hear phrases like these
whenever the stock market
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is in a heightened state of volatility.
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But what does that mean
and how does it impact the market?
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This is Volatility: Unpacked.
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In March of 2020,
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the coronavirus pandemic
caused spikes in market volatility
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similar to the 2008 global financial crisis.
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U.S. equity markets
saw the largest single day drop
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since 1987's Black Monday
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and global indices
entered bear market territory
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which is when the market falls
more than 20% from its recent peak.
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Volatility is a measurement of price movement
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and it's fundamental to how
the stock market works.
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The price of a single asset,
like a stock, option, or bond,
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can change millions of times a day.
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This perpetual fluctuation
describes normal stock market conditions
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and it's driven by supply and demand.
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When demand to buy shares is high,
the price goes up,
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and vice versa.
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Investors' desire to buy or sell
a company's shares
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is typically influenced by things like
earnings reports,
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perceived growth potential,
economic trends,
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and company news.
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Volatility describes
an asset's potential to rise or fall
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from its current price.
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It's expressed as a percentage
and measures the variability of returns--
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money made or lost
over a period of time.
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Assets with higher volatility
are generally considered riskier.
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The more uncertainty about an asset's value,
the more the price fluctuates.
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A state of heightened market volatility
results from two key drivers.
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The first, anything that causes macro uncertainty
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which makes it difficult
for the market to value assets.
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And the second,
a lack of liquidity.
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Liquidity refers to how easy it is
to buy or sell an asset
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without affecting its market price.
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Not enough buyers means
you have to sell at a lower price
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and vice versa.
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There are two types of volatility:
realized and implied.
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Realized volatility is all about the past,
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how an asset's price moved
over a historical timeframe.
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Implied volatility is how much an asset's price
is expected to move in the future.
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Implied volatility is related to options
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which give holders the right to buy or sell an asset
for a certain price in the future.
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Just like interest rates,
volatility is quoted on an annualized basis
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which means it's converted into a yearly rate.
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This helps investors by making the volatility
comparable over different time periods.
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To assess the level of risk and uncertainty
in the market,
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investors commonly use
a market-wide volatility gauge called the VIX.
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It indicates expectations of volatility
over the next month
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based on the prices of options
on the S&P 500 Index.
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When the VIX reaches
high levels of uncertainty,
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fewer investors are willing to trade.
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Liquidity drops, volatility rises even more,
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and a negative feedback loop is created,
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making it very hard to trade.
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The VIX recorded the three biggest volatility spikes
in 1987, 2008, and 2020
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where the negative feedback loop
and reduced investor holdings
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caused a bear market each time.
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But heightened volatility
can also hit bull markets.
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During the 1990s' dot-com boom,
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volatility rose alongside stock prices.
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The growth expectations placed
on the exciting but untested internet technology
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also gave rise to increased uncertainty,
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especially as the bubble grew unsustainably.
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What goes up eventually comes back down.
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After a volatility spike,
at some point, levels do find stability,
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situations resolve,
market shocks subside,
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and people gain a better understanding
of the economic environment.
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