MARKET PERFORMANCE AND VOLATILITY

2.1.4   MARKET PERFORMANCE AND VOLATILITY

There  is  a  strong  relationship  between  volatility  and  market  performance. Volatility tends to decline as the stock market rises and increase as the stock market falls. When volatility increase, risk increase and returns decrease. Risk is represented by the dispersion of returns around the means the greater the dispersion of returns around the means, the larger the drop in the compound return.

In a 2011 report, Crestmont Research examined the historical relationship between stock market performance and the volatility of the market. For  this analysis Crestmont used the average range for each day to measure the volatility of the standard and poor (S&P 500) index. Their research tells us that higher volatility corresponds to a higher probability of a declining market. Lower volatility corresponds to a higher probability of a rising market.

For example, as shown in the average daily range in the S&P 500 index is low (the first quartile 0 to 1%) the odds are high (about 70% monthly and 91% annually) that investor will enjoy gain of 1.5% monthly and 14.5% annually.

When the average daily range moves up to the fourth quartile (1.9 to 5%), there is a probability of a 0.8% loss for the month and a 5.1% loss for the year. The effects of volatility and risk are consistent across the spectrum.

This research shows that we need to be aware of the volatility in the market if we hope to adjust our portfolio as it changes.

2.1.5   FACTORS THAT AFFECT VOLATILITY

Region and country economic factor such as factor and interest rate policy, contribute  to  the  directional  changes  of  the  market  and  thus  volatility.  For example in many countries, the central bank sets the short-term interest rates for overnight borrowing by banks. When they change the overnight rate can cause stock markets to react, sometimes violently.

Changes in inflation trends influence the long term stock market trends and volatility. Expanding price-earning ration (PIE ratio) tend to correspond to economic periods when inflation is either falling or is low and stable. This is when markets experience low volatility as they trend higher, on the other hands, period of falling PIE ratios tend to relate to rising or higher inflation periods when prices are more unstable. This tends to cause the stock markets to decline and decline and experience higher volatility.

Industry and sector factor can also caused increased stock market volatility. For example, in the oil sector, a major weather storm in an important producing area can cause price of oil to jump up. As a result, the price of oil-related stocks will suit some benefit from the higher price of oil, other will be hent. This increase volatility affects overall markets as well as individual stock.

Assessing current volatility in the market.

Using crestmont’s research, investors can use their understanding of the longer term  volatility of  the stock market to  align  their portfolios with  the  expected returns. But, how do we know if the market is experiencing higher volatility?

One way is to use the (BCE volatility index (vix). The vix measures the implied volatility (iv) in the prices of a basket of pin and can opinion on the S&P 500 index. The vix is used as a tool to measure investor risk. A higher reading on the vix makes periods of higher stock market bottoms. Low readings on the vix market periods of lower volatility. The periods of low volatility may last several years and are not a good, for identifying market tops. The vix is intended to be forward looking, measuring the market is expected volatility over the next 30 days.

As a general trend, when the vix rises the S&P 500 drops. When the vix is at a high, the S&P 500 is at a low which may be a good time to buy. However, if the vix is high, there is a concern that the market is going continue to go down. This fear makes it difficult method of econometric analysis. The study revealed that the  relationship. The fear  makes  it difficult to  buy during  high  stock  market volatility. But, investor who used the high on the vix to time their buy entered the market at or new the low volatility works well to help identify market bottoms based on high volatility. For long-term investors, it also does a pretty good job of helping to identify that the stock market is at or near a top, when volatility is very low, keep in mind that this indicator is not intended to time the exact top. But rather that the volatility of the market does not stay substantially below the mean for a long period of time. As the volatility increase, then the market performance will tend to decrease.........

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