What is volatility?
Prices in the financial markets rarely stand still – they are almost continuously fluctuating. As a spread bettor, you’ll be seeking to capitalise on these movements in the hope of making a profit.
Volatility is the degree of variation of a trading price over time
A market’s volatility refers to the likelihood of it making major short-term price movements at any given time. So, a market that is generally seen as unstable and prone to sharp movements in price in either direction would be described as highly volatile. Markets with low volatility are the opposite – less susceptible to dramatic changes in price and more stable over a given period of time.
While there is a greater chance of profiting in a volatile market, there is also increased risk should the market move against you.
Supply and demand
Whether the price of an asset moves up or down is dictated first and foremost by the laws of supply and demand.
Suppose you were looking to buy a new car – you'd naturally look for the lowest price on the model you wanted. And if there are plenty of them in circulation and other buyers are scarce, you should be able to strike a good deal. On the other hand, if you were trying to purchase a rare and sought-after vehicle, you might have to pay a higher price.
Supply and demand affect financial assets in a similar way. For example, if more people want to buy a share than sell it, its price will invariably rise, as the demand outstrips the supply. However, if the supply is greater than the demand, then the price of a share will fall.
Linked to supply and demand is market sentiment. This is essentially the general attitude of the participants in a particular market as to its future price movements.
If prices are rising, that would tend to indicate bullish market sentiment. If they are falling, that tends to signify bearish market sentiment. It’s worth noting that the overall sentiment towards a market is not always based on the fundamental information available.
For example, a specific company might have a good feeling or a buzz around it – therefore pushing its share price higher – despite not posting exceptional earnings figures (see below).
Supply and demand are affected by different issues depending on the specific market.
Why do share prices move?
Share prices can be affected by a wide variety of issues, but the main two are:
- Earnings – This is the profit a company makes. If a company is performing well and posts better earnings than anticipated, its share price should benefit. However, if the earnings disappoint, then the share price is likely to fall. Prices tend to be at their most volatile in the period immediately before and after earnings announcements – which are usually released quarterly or half-yearly, depending on which exchange the shares are listed on.
- Microeconomic factors – Share prices tend to react strongly to expectations of the company’s future performance. Any major news about the company or sector, such as upcoming industry legislation, the general health of the economy or public faith in the company’s management team, could have a big effect on its share price. However, if the outlook for the company is generally positive, then demand for its shares will increase, pushing prices higher.
Bear in mind that the value of a stock index is also determined by fluctuations in the share prices of its constituent stocks.
What drives the forex markets?
Currencies are effectively barometers for the economic health of the country or region they represent. So, in general terms, the stronger the economy of a country, the stronger its currency will be in comparison to others.
Factors that affect a country's economy therefore tend to have a significant impact on a currency's price. These include:
- Interest rates
- Inflation rates
- Government policy
- Demand for imports and exports
- Economic statistics such as a county’s growth figures, unemployment levels and manufacturing data
What influences commodity prices?
As the production and consumption of commodities rely on many different factors, their prices can be highly volatile. Some of the key factors that affect prices are:
- The weather – Soft commodities are dependent on the weather as it influences the harvest. If there’s a poor harvest, then this will result in low supply, causing prices to rise.
- Economic and political factors – Events such as war or political unrest can have a big effect on prices. For example, turbulence in the Middle East often causes the price of oil to fluctuate due to uncertainties on the supply side. Likewise investors will often tend to buy assets known as ‘safe havens’ in the face of geopolitical or financial uncertainty. Gold is one of the more well-known safe havens, as historically it has kept its value during these times.
- The value of the US dollar – Commodities are also normally priced in US dollars, meaning their prices will generally move inversely to it. This is because if the price of the dollar falls, it takes more dollars to buy the same amount of commodities – so the price of commodities rises. Should the dollar rise, it would be cheaper to buy the commodities.
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