What is market volatility?

It is a condition in which economic, political or geopolitical events cause uncertainty in the market, affecting the behaviour of investors, businesses, and consumers.

Typical signs of instability include:

• A sharp rise or fall in stock indices (e.g. the S&P 500).
• Significant fluctuations in currency exchange rates.
• Rising inflation or deflation.
• An increase in interest rates by central banks.
• Geopolitical conflicts, wars, and sanctions.

What causes instability?

• Macroeconomic factors such as inflation, unemployment, and GDP.
• Political events such as elections, revolutions and unstable governments.
• World crises such as pandemics, wars, and climate disasters.
• Financial 'bubbles', where popular assets turn out to be overvalued.

Key risks in volatile markets

Asset volatility

Volatility refers to an asset's tendency to fluctuate in price rapidly. In the investment world, it is an indicator of risk. The higher the volatility, the less predictable the commodity or product. Cryptocurrencies are a case in point.

Their fluctuations can be dramatic, ranging from 30 to 50% or more in a week. Among less volatile assets, government bonds of developed countries and stable 'blue chips' (such as Coca-Cola) are notable.

This raises the question of how to utilise volatility. Firstly, consider it not only as a risk, but also as an opportunity. Buy quality assets during a downturn and vice versa. Secondly, consider your risk tolerance level. If you are kept awake at night by every fluctuation, you should reduce the proportion of such assets in your portfolio. Thirdly, hedge your risk. Combine volatile and stable assets to balance your portfolio and reduce stress levels.

Systemic and non-systemic risks

Systemic risks affect the entire market or sector simultaneously. As they are independent of a specific company or industry, they cannot be eliminated through diversification in most cases. Examples:

• Financial crisis (as in 2008).
• The 2020 pandemic.
• Geopolitical tensions.

Non-systemic risks, on the other hand, are associated with a specific company or asset. For example, a change in company management, legal cases against the brand, technical failures or internal scandals.

These risks can be reduced or even eliminated by diversifying the portfolio.

What should investors keep in mind when dealing with systemic and non-systemic risks?

Systemic risks influence everyone who invests in the market. The impact of these risks can be minimised by holding international assets, cash, or shares in 'defensive' sectors.

Non-systemic risks can be mitigated by holding shares in different industries and companies. This way, if one investment performs badly, the whole portfolio will not be destroyed.

Inflation and currency risks

Inflation risk

This refers to a general rise in prices that reduces the purchasing power of money. Over time, money depreciates by a certain percentage. Some currencies are more susceptible to inflation than others.

Inflation is the silent but inexorable enemy of anyone who keeps money under the pillow. To protect yourself from inflation, you need to invest in assets that can outpace it. In other words, the value of the assets must grow faster than the rise in prices.

Choose instruments with growth potential, or at least stability. Examples include shares in profitable companies, precious metals, and real economy assets such as property or infrastructure.

Currency risk

If you invest in a foreign currency but spend in a local one, any fluctuation in the exchange rate will affect your returns.

For example, if you invest in dollars and the hryvnia devalues, your returns will increase, as your hryvnia-equivalent investment has grown. Conversely, when the hryvnia strengthens, you 'lose' out at conversion.

How can you protect yourself from such fluctuations?

• Keep part of your assets in the currency in which you plan to spend.
• Use multi-currency portfolios.
• Choose instruments that are hedged against currency fluctuations.

Investment Portfolio Management Strategies

Diversification

This involves spreading investments across different asset types, industries, countries, and instruments. Such a step reduces unsystematic risk, as even if the value of one asset falls, the value of others may remain stable or rise.

Portfolio balancing

Regular adjustments to the portfolio structure help to maintain the original proportions of assets while taking market changes into account. If a certain asset class has grown markedly, it may take up an excessive proportion of the portfolio, thereby increasing risk in the event of market changes.

Investing in protective assets

Protective assets retain or increase in value during times of economic instability. They help to reduce losses during times of crisis. These assets usually include government bonds, gold, and low-volatility funds (e.g. ETFs).

Hedging

Hedging is a strategy that protects an investment from potential losses by using other instruments to offset them. There are three common hedging options.

Using currency hedging, such as forwards or currency options, allows you to reduce the risk of exchange rate fluctuations. This is particularly important if you invest in one currency but spend in another.

Hedging through derivatives (such as options and futures) enables you to protect yourself against fluctuations in the price of an asset. One example is buying an option that gives you the right to sell shares at a fixed price.

Another option is to use inverse funds, which rise in value when the market falls. These funds are suitable for short-term hedging of anticipated downturns, but should be used with caution as their effect can be distorted if held long-term.

Investor Behavioural Aspects

Emotional mistakes

Sometimes, the biggest threat to your investments is your emotions when making decisions. What are some common emotional mistakes investors make?

Panicking and selling when the market is falling. The first urge is, “That's it! I'm selling before it gets worse!' However, it is during a fall that you should consider reallocating your assets. Therefore, it is better to stay calm and consider how to use the situation to your advantage.

Buying on emotion: Cryptocurrency has soared by 100%! People rush to buy, fearing they will ‘fall out of the trend’. However, this often ends up being a trap.

Changing your strategy on the fly: One day you're a 'long-term investor', the next you're a 'downside trader'. Investing requires consistency.

The importance of discipline and planning

Planning provides a clear course of action by defining the investment amount, asset types, objectives, timing, and risk tolerance. This enables investors to act consistently, regardless of market fluctuations.

Key factors for long-term success include adhering to a set strategy, investing regularly, rebalancing the portfolio periodically, and avoiding spontaneous actions.

What should your investment plan include?

• Financial goals. Decide why you are investing: building up capital for retirement, buying a flat in five years, funding your children's education, and so on.

• Investment horizon: How long can you hold the invested funds for? Short-term goals (1–3 years) require more conservative instruments, whereas long-term goals (10+ years) allow you to take more risks in pursuit of higher returns.

• Risk tolerance. This will determine the proportion of equities (risk assets) in the portfolio — the lower your willingness to accept losses, the fewer stocks and the more bonds and deposits you should hold.

• Target asset allocation. Specify which asset classes you will include and their respective proportions.

• Decide on the order in which you will deal with changes. Set out how often you will rebalance the portfolio or under what conditions. Some investors rebalance once a year on a fixed date; others rebalance when the proportions of assets have deviated by more than 5% from the plan.

Practical recommendations from experts

Case studies

Case 1: 'Balancing through the crisis'

Situation: An investor with a portfolio of 70% stocks and 30% bonds invested in the US stock market. In 2020, the market crashed due to the pandemic. What did the investor do?

• He did not succumb to panic.
• He performed asset rebalancing instead of selling, namely buying up falling stocks with free cash or a portion of the proceeds.
• A year later, the profit had exceeded the pre-crisis level.

Conclusion: A disciplined and planned response is key to survival and growth.

Case 2: 'Diversification through ETFs'

Situation: After losing his job in the tourism industry, an investor decided to invest his savings more safely. What path did he choose?

• He invested in three global ETFs: US stocks, bonds, and gold.
• He set up automatic monthly replenishment.
• After two years, he achieved stable growth with minimal risk.

Conclusion: Even with limited experience, you can achieve good results with the right tools.

Portfolio management tools

Successful investment portfolio management requires real-time observation, analysis, and decision-making. Professional tools can help with this.

Financial advisors

Financial advisors are experts in making informed decisions about money, investments, savings, loans, taxes, pensions, and insurance. When does it make sense to engage such a professional?

• When you have significant capital ($20,000 or more).
• Your finances have become more complex, for example, if you have multiple sources of income, a business or foreign assets.
• You are preparing for a life event such as a wedding, retirement, inheritance, or asset sale.
• You need structure and discipline. Third-party oversight can help you stay on track.

So, how do you choose an advisor?

• Look for experience and certification. Look for someone with a CFP (Certified Financial Planner) certification or similar qualifications.
• Transparent fees are important, too. Avoid free consultations – there's usually a catch.
• Ask to see a portfolio of cases. Ask about previous projects and testimonials.
• Specialisation. Some work with entrepreneurs, while others work with pension plans.

However, don't view counsellors as the only possible solution. Sometimes, the services of a professional may not be necessary. Here are some examples of situations in which this may be the case:

• You have simple finances with one income, no debts or investments, and everything is clear without advice.
• You're not ready to pay. If your budget is limited, you can start investing independently.
• You have a good grasp of finances yourself. Experienced investors can manage their money without help.

Online platforms and robo-advisors

Today, you can invest using smartphone apps that leverage algorithms to help you make decisions. What are the advantages of using such online platforms?

• 24/7 access to global markets.
• You can buy everything from stocks and bonds to ETFs and cryptocurrencies.
• Access analytics, charts, and news in one place.

Examples:

• Interactive Brokers, eToro and Saxo Bank for experienced users.
• Robinhood, Revolut, and Trade Republic are ideal for beginners.

Robo-advisors, on the other hand, are online platforms or applications that automatically form and manage an investment portfolio based on your responses to a series of questions.

You only need to specify your desired income level, investment goals, risk appetite and investment period. The algorithm will then create a portfolio, usually comprising ETFs or other available instruments. The system then automatically invests and rebalances, i.e. it maintains the balance between assets in the set proportions.

Advantages:

• Low entry threshold.
• Simplicity: there is no need to understand technical terms or charts.
• Low commission (typically 0.2–0.8% per year).
• Investment decisions are made by an algorithm, so there is less emotion involved.
• It is convenient for beginners.

The main disadvantages are the standardised strategy and limited personalisation, which do not take into account complex situations, taxes, etc.

Financial analytics and forecasts

Financial analytics involves collecting, processing and analysing financial data in order to understand the current situation, identify trends and forecast future financial results. This includes:

• Estimates of profitability and costs.
• Identification of risks or investment opportunities.
• Comparisons with competitors or the market.
• It also involves making strategic decisions at a personal, business, or portfolio level.

How is work involving forecasts and analytics organised in practice?

Data collection

At this stage, relevant information is sought and compiled. This may include company financial reports, sales statistics, economic indicators such as GDP, inflation and unemployment, market prices, and news.

Both publicly available sources, such as Yahoo Finance, Investing.com and official company websites, and professional platforms, such as Bloomberg, Reuters, S&P Capital IQ, Morningstar and Seeking Alpha, are used for data collection.

Data processing

Raw numbers mean little until they are structured. At this stage, analysts typically format the data correctly, remove noise and errors, and create summary tables.

Table processors such as Excel and Google Sheets can be used for this, for example, to calculate profit growth over five years or average margins.

For big data or complex calculations, business intelligence (BI) systems such as Power BI or Tableau are employed, as they enable data visualisation and the identification of patterns through graphs and dashboards.

Model building

Analysts use simple formulas, such as forecasting revenue by assuming growth at the industry average percentage, as well as more complex multifactor models and machine learning algorithms.

A popular approach is 'what if' analysis, which involves changing a parameter to see how it affects the results. Examples include 'What would happen if inflation rose to 10 per cent?' and 'How would profit change if costs were cut by 15 per cent?'.

Interpretation and decisions

In the final stage, analysts translate the results of the calculations into clear conclusions, identifying weaknesses, potential opportunities, and risks that warrant attention, as well as the impact of various actions on financial health or profits.

Managers or investors base their decisions on this interpretation: whether to invest or abstain, how to adjust the portfolio structure or the company's strategy, and so on.

The role of financial analytics has grown alongside technological development. Nowadays, even private investors have access to powerful analytical tools that were previously only available to investment bankers. Much of the data is now accessible in open sources. However, one should be aware of information overload, where an excessive amount of data can obscure the main issue.

Finally, it is worth noting that financial forecasts are not inherently flawless. Markets depend on many factors, and it is impossible to predict everything. Therefore, an analyst's task is not to provide a 100% accurate forecast, but to outline the most likely scenarios and assess the risks.

An experienced investor always considers several options in case reality does not align with their scenario.