Impact of Market Volatility on ETFs: Managing Risk During Market Volatility

To understand the impact of volatility on ETFs, let’s first understand the meaning of market volatility itself. Market volatility is the fluctuations of prices of different market-linked assets such as stocks, commodities, and bonds. The ups (bull market) and downs (bear market) in the prices of these assets have often been compared to an unpredictable roller coaster ride.

ETFs in Bull and Bear Markets

However, the impact of market volatility on ETFs depends largely on the assets within the ETF and how they respond to market conditions.

• ETFs in Bull Markets

A bull market is a market condition when the economy is expanding, leading to steadily rising prices of market-linked assets. During such times, ETFs that track stock market indices, such as the Nifty 50 or the Sensex, tend to perform better than other ETFs, including company stocks, bonds, or commodities. On the other hand, ETFs that track specific sectors can also become profitable during such a bull market. Hence, during a bull market, the impact of volatility on ETFs is mostly positive.

• ETFs in Bear Markets

A bear market occurs when the economy shrinks, and the prices of market-linked assets steadily decline. Unfortunately, most investors begin liquidating their assets during a bear market. However, since ETFs are considered a platter of several asset classes, the risks are distributed across this diversity of assets.

ETF Performance in Choppy Markets

Regarding market conditions that are neither bullish nor bearish but more erratic, ETFs can be one of the best investment forms. Such markets are often choppy and can be an anxious time for investors.

In such cases, the impact of market volatility on ETFs becomes clearer because you can witness in real-time how they help you mitigate risks in a choppy market. For example, ETFs offer the facility to trade intraday, unlike traditional mutual funds, which can only be bought and sold at the end of the trading day. So, whenever you see a significant shift in the market, you can quickly adjust your portfolio by buying and/or selling the necessary ETFs.

To better understand this impact of volatility on ETFs, here are some real-life examples. 

1. ETFs in 2024: Bond ETFs and gold ETFs have become very popular in the current year because of their immense growth potential. The price of gold has steadily risen since the beginning of this year, making gold ETFs a good hedging device against market inflation.
2. ETFs During Demonetization: Another example is the 2016 demonetisation. The market was quite choppy during that year, and there was an uptick in the demand for gold ETFs. Investors who realised the minimal impact of market volatility on ETFs began investing in gold and bond ETFs to help them through demonetisation.
3. ETFs During Pharma Sector Boom: Moreover, sector-specific ETFs have enabled investors to indulge in sector rotation during volatile markets. During the COVID-19 pandemic, the pharma sector experienced a massive boom, which was quite the opposite of the trend in the travel and hospitality sector. So, investors who held ETFs specific to the latter sector pivoted to ETFs in the former. Therefore, learning about the impact of market volatility on ETFs specific to certain sectors can also help investors plan better.

Managing Risk During Market Volatility

To manage risk during a volatile market, you need to learn how to navigate the impact of market volatility on ETFs. Several strategies can help you do this. There are some useful tips for managing risks during market volatility.

• Diversification With ETFs: By purchasing ETFs that contain assets from different sectors, you can spread your risk across different asset classes and industries. When your investment portfolio includes a variety of ETFs, such as stock ETFs, bond ETFs, commodity ETFs, etc., you reduce your risk exposure to market volatility.
• Liquidity in ETFs: While ETFs offer better liquidity than conventional mutual funds, inventors should ensure that the ETFs in their portfolio can be liquidated easily during market fluctuations.
• Limiting Orders in ETFs: Another way to leverage the strategic impact of market volatility on ETFs is to incorporate limit orders in your ETF trades. In such orders, you decide at what price a specific ETF from your portfolio would be automatically bought or sold. This can help you passively avoid losses during market volatility.
• Panic Selling ETFs: Last, you should avoid panic selling your ETFs during market fluctuations. Volatility is quite natural for market-linked financial investment instruments, you do not need to sell them in a panic.

Conclusion

Therefore, the impact of market volatility on ETFs can bring some challenges. You should regularly track your ETFs, which can be done through trusted platforms like HDFC Sky.