What Causes Volatility in the Stock Market?

Key Takeaways

The stock market moves up and down all the time, and you may see a lot of movement during the day. Like supply and demand for a product, if there are more buyers than sellers, prices will generally move higher; if there are more sellers than buyers, prices will generally move lower.

However, sometimes, drops and gains are much more significant. For example, the stock market took a sharp downturn when three banks failed in five days in March 2023.¹

A turbulent—or volatile—market can be concerning as an investor, especially if your investments lose value. You may wonder what to do. Should you cash out? Move your money? Do nothing?

Here's what to know about a volatile stock market, the causes and the potential ways to combat it.

What Are the Primary Causes of Stock Market Volatility?

Different events and factors can cause the markets to move up and down. Surprising events, economic uncertainty and changes in investor sentiment can all cause market fluctuations. Larger drops occur occasionally, but historically, markets have bounced back from declines.

Understanding the potential causes of stock market volatility can help you make decisions about risk in your investment plan. It may also help you stick with it through the ups and downs. Here are some causes beyond the "normal" ebbs and flows of the market.

Global Events and Geopolitical Risks

Wars, terrorism and tensions between countries are geopolitical risks that can significantly affect global economies and businesses. They also bring uncertainty. And where there's uncertainty, there is usually stock market volatility.

Global events can spur volatility because their effects are more widespread, and the uncertainty is more significant. Examples include an economic crisis in a leading world financial center with the potential to ripple into other countries. Or, as we saw in 2020, a pandemic that impacts health and disrupts economic activity.

Political Risks

Politics can cause uncertainty and spur market volatility, especially before an election. As the rhetoric heats up, it can add to increased nervousness. In the U.S., that can be true in both presidential and mid-term election years. However, stock market volatility has historically tended to smooth out following elections—regardless of which party is in power.

A significant leadership change in any country could cause uncertainty because government policy can shape the business environment. Major policy changes can impact a business's financial standing, creating both winners and losers. The larger the country’s economy, the greater the potential ripple effect around the world.

Natural Disasters

Earthquakes, hurricanes and wildfires are examples of natural disasters that can impact global markets. How widespread the event is and how quickly governments and companies can respond to a catastrophe (or not) affects how investors view these events.

In recent years, the costs of natural disasters to governments, companies and individuals have grown significantly. In August 2023, 15 weather and climate disasters in the U.S. caused losses of more than $1 billion each.⁴ The high cost of recovery can contribute to negative investor sentiment impacting financial markets.

Economic Developments

Investors can become jittery as government agencies release reports about the economy's health. Job numbers, Gross Domestic Product (GDP), consumer prices, and manufacturing activity can indicate if an economy is growing. The stock market often reacts when economic indicators are higher or lower than expected.

For example, markets may react if GDP numbers decline. GDP measures the goods and services a country produces, and people consider it a comprehensive measure of economic growth. GDP affects the market because stock prices typically reflect expectations about the future. And when an economy slows or does not grow, businesses may not perform as well.

Rising prices on goods and services can affect market activity, too, especially when it involves a resource that impacts all economic segments—like oil. Investor sentiment about the economy and the stock market can rise and fall with changing fuel costs. These costs can fluctuate for several reasons, including supply, demand and geopolitical events. A recent example is the change in oil prices following the 2022 Russian invasion of Ukraine.

Central Bank Policies

You don't have to look too far back in time to see that when a country's central bank announces a monetary policy change it can prompt volatility. The U.S. Federal Reserve’s (Fed) interest rate hike campaign to fight inflation is one example. We may also experience volatility when investors react to economic data they believe will cause a change in Fed policy.

Stock market volatility may depend on the purpose of the monetary change—to expand the economy or to restrict it. Expansionary measures, such as lowering interest rates, tend to positively impact the stock market while tightening has had the opposite effect.

Bad Headlines for Large Companies

Scandal is never good for a company, but does it impact all of us? Maybe. Corporate scandals can undermine the financial standing of the affected company, causing its stock price to drop significantly. The company's reputation can also be at stake for years to come. It may even cause investors to lose confidence in an entire industry or the broader stock market.

A single company's bad news may make investors wary. In addition, scandals can lead to new regulations that could impact companies within and outside the industry. While scandals are bad news, they may not have as much impact on the overall stock market in the long run.

Investing in a Volatile Stock Market

Understanding that volatility is a normal part of investing is an important point. When making investment decisions, you also want to consider risk versus return. Taking on risk can mean more potential for gains but also more potential for bigger losses.

If you're uncomfortable with wide swings in value that may come with riskier investments, you can choose investments that have historically been less volatile. That decision may reduce return potential in favor of more stability. A lower-risk portfolio might have fewer equities and more bonds or cash equivalents, such as money markets.

How Do You Handle Volatility?

During volatile times, many investors feel tempted to take action, such as selling declining investments. A better response may be to review your strategy and make decisions based on your plan rather than market whims. Such times are true tests of your risk tolerance and may be an indicator that your investment strategy is not aligned with your willingness to accept risk.

Here are some tips for turbulent times.

Remember Investing Is a Long-Term Strategy

Because volatility is normal, your long-term investing plan should consider market ups and downs. Review your plan and make sure it matches your risk appetite.

Are you comfortable with big swings in your portfolio value? How big? Ask yourself if you're prepared to handle the stress of higher volatility and watch your investments lose (and hopefully regain) value.

Also, be prepared to set aside your emotions and use a framework to make better decisions, such as recognizing you own investing biases and setting guidelines for yourself. If you have a good plan, don't let fear or anxiety make you make bad decisions that ruin your investment plans.

Adjust Your Portfolio To Prepare for Volatility

All investments have ups and downs. If you are nearing retirement or saving for college, it's wise to be more careful and take extra measures. If your goals are decades away, you likely can withstand more volatility and hopefully take advantage of market rebounds.

Regardless of your investing timeline, a surprisingly simple way to manage volatility is with a diversified portfolio. A healthy mix of different kinds of investments can help smooth out volatility in your portfolio.

View Market Volatility as an Opportunity

After you’ve aligned your portfolio with your tolerance for market swings, try changing your focus from fears about volatility to the inherent opportunities it can offer. You can add to your portfolio at deep discounts when stock prices are down. Keep in mind that short-term declines may offer long-term opportunities.