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Deciphering volatility

Deciphering volatility
Highlights

Volatility is the lifeline of stock markets and without it, price determination is not possible. On the other hand, any huge volatility would lead to distress among small investors; thus they need to be protected. Herein lies the role of regulator.

Volatility is the lifeline of stock markets and without it, price determination is not possible. On the other hand, any huge volatility would lead to distress among small investors; thus they need to be protected. Herein lies the role of regulator. In order to measure volatility in the near-term, Chicago Board Options Exchange introduced Volatility Index (VIX) in 1993 and since then it is being considered by many to be the world’s premier barometer of investor sentiment and market volatility. In India, VIX is created, based on Nifty Index Option prices. It indicates the expected market volatility over the next 30 calendar days, which is now hovering at 15. In a layman’s version, the volatility is being caused due to demand and supply of the stocks coupled with the investor sentiment, which will derive from the economic happenings around the globe. For instance, last couple of days Indian stock markets are witnessing a slump as US Federal Reserve is expected to hike interest rates in view of positive job numbers and firming up of oil prices. Markets continuously update on economic activities around the world and form an opinion or sentiment, which pushes markets either up or down.

Take for instance, as corporate profit forecasts are slowly bottoming out, the RBI announced rate cut for the second time, and the infrastructure spending is raised in the budget. However, the stocks tumbled on Monday. The reasons are external like Greece debt, Fed Reserve’s likely move to up rates or slowing of Chinese output. All these trigger the sentiment of markets collectively. But the real reason for the fall, analysts say, is that the market is in an overbought position, meaning share prices are too high, and hence they are retreating. But the India growth story is still not over and the falling stock prices should be the reason for clever investors to buy and hold them for medium term to reap profits. Interestingly, analysts in foreign funding agencies feel the Sensex needs to fall further, by about 5 per cent, as macroeconomic indicators are still not improving and investment decisions will take time to translate into earnings. The Indian growth numbers, as estimated, are tempting foreign funds to enter the markets afresh. The Indian economy is estimated to grow 8.5% in the next fiscal and RBI is targeting an inflation rate of 4% as against 5.11% in January 2015. If these are for real, the Indian market is undervalued. Hence, the higher degree of volatility is a kind of bliss for those having liquid cash to enter even now as global investors are upbeat about the future earnings growth. The tailpiece: Investors need to be cautious about stock investments and take expert advice. Always keep in mind that investing in stocks is risky.

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