Volatility is the variation of price over time for a particular instrument and, in equity investments, the instrument can be Sensex, or Nifty, or individual stocks. However, volatility is not risk and vice versa. Understanding the difference between the two is important
Investing is akin to a marathon as one needs to pace the run to achieve the target. In the investment journey, too, there are many a high and low. It is important to understand the difference between risk and volatility, especially when one is investing in the equity market.
Simply put, risk is “not understanding what you are doing or undertaking”. Once you understand this, the other ‘risks’, which could arise in a business, can be factored in. These could be capital risk, sovereign risk, interest rate risk, default risk, systematic risk, and so on.
Volatility is the variation of price over time for a particular instrument and, in equity investments, the instrument can be Sensex, or Nifty, or individual stocks. However, volatility is not risk and vice versa. Understanding the difference between the two is important as it will impact your investment journey.
Risk is a key factor to be considered before any investment journey. You consider the choices, along with the risks involved, before making an investment.
Volatility in equity investment
Since November 20, 2014, over the last 80-plus trading sessions, the Sensex has been at similar levels. But on a closer look, you will find that the benchmark has moved by over 6% both ways (up and down) during the period. This is bound to cause apprehension in the minds of investors.
From 28,067 in November 2014, the Sensex briefly touched 30,000 and, for the week ended March 20, 2015, it was at 28,261. This is volatility. Since March 2014, we have had three instances of Sensex declining by a little over 5%.
What does history say about the gyrations during the 2005-2008 rally — when Sensex climbed from 6,000 to 21,000? There were four instances of declines of 10-15% and even 30% once. If we look at the data for 2003-2005, in the early stages of the bull run, the instances of Sensex declining in the 10-15% range are in two digits. So, one needs to be prepared for sharp declines.
Typically, “you take the stairs up and the elevators down” in the equity market. That is, the rise happens gradually whereas declines are swift. In 2006, between May and June, within a span of 25 trading sessions, the Sensex dropped nearly 30%. It recovered subsequently by 15% only in the next 25 trading sessions, though it continued its upward journey.
The ride is not always smooth. At such instances, it is your emotional quotient (EQ) that enables you to weather the storm. So, trust yourself and your investment strategy.
During the current rally, sharp declines like those seen in 2003-07 have not taken place. However, one needs to be prepared for them. Having said that, it’s possible that such a decline may not happen at all. The idea is not to predict or forecast, but to learn from history.
For medium- and long-term investing, one could invest in a staggered manner, with at least 10-20% of the corpus in liquid funds to take advantage of opportunities in the market. Again, as investing is unique to each individual, the strategy will need to be customised, based on the investment horizon and milestones set.
By Brijesh Damodaran
The writer is founder & managing partner of BellWether Advisors LLP