Understanding Volatility

The Key to Stress-Free Investing

The Importance of Volatility

Marcus Padley | 19 September 2024 | Education Corner

What’s the most important number for investors? Many of you might think it’s the price-to-earnings ratio, yield, or maybe some other figure. But you’d be wrong. The most important number for investors—and one I believe every stock should have listed beside it—is volatility. Now, I might lose some of you here because, sure, that’s a nice statement, Marcus. But what exactly is volatility?

What is Volatility?

Let me explain. You could have two stocks that perform exactly the same, both moving from the bottom left to the top right on a chart, steadily growing. But one does it in a smooth, straight line, while the other bounces around all over the place.

Volatility Scale

So which stock do you want to own?

Obviously, you want the one that’s going to cause you the least stress. The one that will help you sleep at night—the one that’s not volatile (the green one).

Volatility measures how far a stock’s price deviates from the average. So, if a stock is swinging wildly, it’s going to give you headaches. You’ll be awake at night, worried about what’s happening. But with a low-volatility stock, you can sleep easy because it’s not jumping around.

Measuring Volatility

So, what you can do is measure how volatile a stock is (we do this in the newsletter).

This is called the “average true range“—it measures how much a stock moves between its high and low points over a set period. Let’s take 14 days as an example: Telstra moves about 1.3% a day. Is 1.3% going to stress you out? Probably not. But BHP currently moves 4.1% a day. Is that going to stress you out? Well, it should—about four times as much as Telstra. And Fortescue Limited? It moves 8.4% a day at the moment. So, is that going to stress you out compared to Telstra? Of course, it is! It’s eight times more volatile, and yet, most people barely take notice of volatility at all.

Why Volatility Matters

For most investors, especially long-term ones, you want a portfolio that doesn’t keep you up at night. You’re looking for stability, and that’s why stocks like Coles, Westpac, CBA, and Telstra attract so much attention. These are low-volatility stocks, the ones you know are going to do their job without any nasty surprises.

On the other end, you’ve got high-volatility stocks, like lithium plays. People love them when they’re winning, but that wild volatility can lead to mistakes, especially if you’re not paying attention. You could be holding BHP and Telstra, then throw in a lithium stock, not realizing it’s ten times as volatile. No wonder some people wonder what went wrong.

Volatility and Long-Term Investors

Understanding volatility is key, especially for long-term investors. I’ve seen too many people get caught out by stocks they don’t fully understand. The more volatile a stock is, the more risk you’re taking on. That’s why, in our Marcus Today newsletter, we rank every stock on volatility—so you know exactly what you’re signing up for.

For conservative investors, it’s obvious why everyone sticks to the bigger, more stable names. They won’t surprise you, and you can rest easy knowing your portfolio is built on a solid foundation.

Volatility Ratings in the Marcus Today Newsletter

At Marcus Today, we’ve done the work for you. We rank every stock from the most volatile to the least. You’ll find the usual suspects among the safest—Coles, Westpac, CBA, Telstra—but also some surprises among the more volatile stocks, particularly in sectors like lithium. Volatility is often the most important factor when picking stocks for long-term, stress-free investing. If you want peace of mind, you need to know what you’re dealing with.

Prefer to watch? Check out Marcus’ YouTube Video

 

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