Investing
requires you to learn many things. You have to know how things work inside the
trading world if you plan to get ahead of other investors. And because of the
myriad things you got to stack inside your head, it’s easy to get confused even
with the most basic concepts. Many investors hate to admit it but they often
confuse terms and concepts. Let’s take a look at two of most oft-confused words
in the investing maze. Let’s learn the difference between risk and volatility.
What’s
Risk?
One of
the key terms that investors should learn early on is the term “risk.”
Risk
is the amount of probability that you will suffer losses. Simply, it’s the amount
of danger that your investments have. That’s very basic. But still, people
confuse it with another word. We’ll get into that later on.
Read further: SpreadingOut Investments For Reducing Risks
Read further: SpreadingOut Investments For Reducing Risks
When we
say that we are worried about the risk level of an investment, it means that we
are worried about the possibility that we’ll permanently lose our money.
Risk
is based on the actual fundamentals of a company or country. For instance, if
the US Treasuries have to be riskier than Southern European countries’ bonds,
there must be the big chance of the US defaulting on its debt payments over
those European countries.
However,
if you’re going to think it out loud and check the actual monetary system of
the US and Europe, you’d find that US Treasuries are much less risky than
Southern European bonds.
The US
can control its own currency, the dollar. This is not the same for individual southern
European countries, which have a common currency, the euro. The US economy is
not restrained on the amount of money it can pay out, though inflation and
faith in the US dollar may affect this (and this gives risk another feature not found in volatility: there are several types of investment risks). The US can print up money for an
interest payment for a Treasury bond, but Italy and her peers cannot do that.
There are high-risk investments and there are low-risk investments. This is one similarity between volatility and risk. There are highly volatile stocks, and there are stocks that are not so volatile.
What’s
Volatility?
The word
volatility refers to the fluctuation of stock’s value, whether sharply or
regularly. Stock market volatility and volatility in general do not necessarily equate with risk.
A “volatile”
stock chart shows more swings over a period, while “less volatile” stock chart
shows less price actions, often only a little more than a 10 percent swing.
The more
volatile stock moves up and down, up and down, up and down more drastically and
more often. In spite of this, it makes billions every year, and it stores more
billions in its cash arsenal to survive bearish economic times.
Based on
this, we can say that not all volatile stocks are risky. In fact, because of
their stronger balance sheet, they may even be less risky.
Moreover,
there’s a reason why investors are worried about a stock’s volatility.
Asset
managers, for instance, do not recommend short term investments in the stock
market. Generally, the stock market sees a 10 percent decline every other years
or so. Suppose you invest $1000 today in the stock market. There’s a big chance
that you money will not be $1000 anymore if you withdraw it two years from now.
It will be lower. Although the stock market performs very well in the long
term, it doesn’t really perform excellently in the short term.
Conclusion
Although
the two are correlated, there’s still a huge difference between risk and
volatility. Understanding that these two words are not the same is very
important if you wish to succeed in your trades, because they can affect the
way you decide about your investments,
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