Investing in stocks? Learn volatility first

If you have to make money in equities, you need to understand volatility and try to make it your friend, says P V Subramanyam

How will the markets be?

He thought for a little while and said "It will be volatile." This answer is at least 100-year-old. It was given by J P Morgan. And this answer is true even today, and will always be true.

After all prices are a function of exchange rate, demand, supply, cost of money across the world, etc. etc. Since none of this is static, markets will always be volatile.

If you do not want volatility, you need to invest in PPF.

There is an old Indian saying 'You cannot bathe in the ocean if you wait for the waves to stop'.

So if you have to make money in equities, you need to understand volatility and try to make it your friend.

And that is possible, and it is the only way to learning equity investments -- especially if you do not want to do a continuous SIP permanently in your life. Sadly, when people think of volatility, they think of permanent losses in their portfolio.

Like Reliance Power.

People bought it at Rs 450, and are now staring at a price of Rs 45. This is erosion of your portfolio. Volatility is in the index -- it will NEVER ever come to zero. If you invested in the index, you will see fluctuation in the index -- and by a huge amount. This is volatility, and you need to learn to understand this. Or be indifferent and lose money!

Best is to learn, right?

What exactly does it say?

Simply put volatility is the standard deviation. Deviation from the means that is. To take an example, if over the past 36 years Sensex has given an AVERAGE return of 16 per cent with a standard deviation of 20, it means you could expect to get a return of -4 per cent to +36 per cent.

HOWEVER please remember that there could be some outliers like 265 per cent return and -49 per cent kind of return. All that is volatility.

Sadly volatility is only a part of the explanation in the equity market. When there are very large variations, it can test your gut. Imagine you invest and the market goes down by 49 per cent -- it could take you a decade to just get back your capital!

Illustration: Uttam Ghosh/Rediff.com