Investors are often told that the stock market is volatile. This is one of its defining characteristics. It is however important to understand exactly what this means.
The volatility of the stock market comes out in two distinct ways. The first is that, in the short term, the market is almost entirely unpredictable. The second manifestation of volatility is that the market can experience very large, very rapid changes.
Over the past 10 years, the JSE has made daily gains 53% of the time. As the graphic below illustrates, the dispersion of negative and positive days is almost equal.
Even over a month, the JSE was down 38% of the time. Over the past 12 months, this has been 50%.
|JSE monthly movements
For six of these months the JSE was higher, and for six months it was lower. What makes this even more noteworthy is that over the full period, the market was effectively flat. It has vacillated significantly, but ended up at the same level.
This is why it is so important to see the stock market as a long term vehicle for building wealth. Day to day, week to week and even month to month it is unpredictable, but over many years, it is far less so.
Long Term Perspectives shows that since 1960, there has not been a single five- or 10-year period over which the JSE has delivered a negative return. Despite being up for only 52% of the days in the past 10 years, the JSE has still gained 11.5% per annum over this period.
As pointed out earlier, the market’s volatility inevitably means that there will be days of losses even in a strong upward market, and days of gains even when the market is strongly trending downwards.
Following the daily market movements is therefore meaningless. Not only are the significant majority of day-to-day changes too small to be consequential, they are also not indicative of what will happen next.
The important lesson for investors to appreciate when it comes to volatility is that the stock market often gives the impression that a lot is happening, when little actually is. Most of the time, movements in share prices only really become meaningful over long periods of time.
In that respect, equities are predictably unpredictable in the short term. Any investor looking at their portfolio every day should expect to be disappointed almost as often as they are pleased. Over the long term, however, the latter emotion is far more likely to win out.
Extract from article by Patrick Cairns who is one of South Africa’s most respected commentators on the investment industry. He also covers economics issues and business news.
Patrick writes for Moneyweb!