12 - Volatility, liquidity, leverage, and their impact on investments

Abstract

This chapter presents a discussion on volatility, liquidity, leverage, and their impact on investments. Economic and market conditions that cause volatility in the value of commodities cause the worth of an investor's portfolio to fluctuate. There is no assurance that one's equities, bonds, or other investments are appreciated. In regard to equities, not only might dividends not be paid because of adverse conditions but also the investor's net worth might shrink as stock market prices fall. Therefore, three principles characterizing a sound investment strategy are (1) the investor with financial staying power finally wins, (2) time in the market is more important than timing the market, and (3) the good stocks to buy are the ones that everybody is selling. Volatility is a measure of the variability of the price of an asset. It is usually defined as the annualized standard deviation of the natural logarithm of asset prices but other metrics are used also. The distribution of prices of a given commodity over a longer period of time is usually taken as being normal, even if it is known that the normal distribution is an approximation of real-life events—whether of market prices or of any other variable.