Toronto Mike

Market Volatility is... Good?

Market volatility, depending on how you look at it, can be either a positive or a negative thing. Strictly speaking, any variation in the price of a share is classed as volatility; so it must be a good thing, right? After all, how would anybody make any money if the prices didn’t go up or down? Well, normal levels of volatility are good, yes, but what we really mean when we talk about volatility is movement outside the normal expected range; sudden and vast fluctuations that can make or totally break an investor overnight.

The interesting thing about volatility is that it breeds more volatility. The worldwide stock market is essentially one big domino chain, and when one index fluctuates in the US, the effects can be felt in the value of stocks in Japan, Australia and the UK. Nothing in the stock market happens in a vacuum. For short-term investors, this can be their worst nightmare, but if you have a longer-term trading strategy, then often most market volatility can be ridden out. Benjamin Graham, widely regarded as the ‘father of value investing’ once spoke of the market as a short-term voting machine and a long-term weighing machine. In other words, the market is swayed by opinions and sentiment in the short term, but over time, the true value will always win out.

Manufactured Volatility

Recently, the Russia-OPEC oil price war has been a prime example of short-term thinking dominating the market. As we know, oil is a finite asset, and its value is driven by keeping supply just low enough that the demand drives up the price. The supply is controlled by extracting and processing just the right amount of oil at any one time. But when the two biggest producers of oil, Russia, and the joint production of 14 nations under the OPEC banner began to disagree, they drove up their production amounts and subsequently devalued the competition’s value.

Source: Pexels

In early March 2020, the price per barrel plummeted by 25% and caused a massive sell-off of oil stocks, the likes of which hadn’t been seen since the 2008 financial crisis. In this case, short term opinions on the value of oil had won out, because of investors panic-selling their shares in an effort to hold on to some of the gains that they had made in previous months and years. The increase in production and the subsequent panic had a compounding effect and worked to further devalue oil stocks.

Opportunity in Chaos

It was estimated that it could take up to three years for the prices to fully recover from these actions, but that’s the thing; it was never said that prices would never recover! Over time, the true value of oil would re-emerge because oil has a fundamental value to those who purchase it to convert into petrol, diesel and jet fuel. So for those investors playing the long game, whilst being extremely disheartening, the price war didn’t signify game over for them. Instead, it was just another (albeit, quite large) bump in the road.

Source: Pixabay

Meanwhile, short-term investors that bought just before the drop had made huge losses. However, some investors now had a major opportunity. Another trading strategy referred to as ‘buying the dip’ follows the basic principle of all stock investment: buy low, sell high. But it specifically focuses on buying at a time when stocks have dropped significantly in value.

Days after the drop in value, the US Government announced that it would increase its purchasing of crude oil, partly taking advantage of the cheap price, and partly to balance out some of the worst effects of the price war. Almost immediately, oil stocks rebounded in value. Whilst not rising to the prices of a month earlier, the uptick was more than enough for savvy short-term investors to turn a quick profit as Brent Crude, the international benchmark for oil prices, rose by 5.1% overnight.

It’s All Relative

Ultimately, market turmoil is simply part of the cycle of trading. How it affects an investor really depends on what type of strategy they are employing. Long-term investors simply see volatility as part of the slow ride to the top, whilst short-term investors sit at opposite ends of the spectrum; they never have a boring day, but they have an almost equal chance of making or losing a small fortune.

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