Volatility Is Opportunity

How The Best Investors Turn Stock Market Fluctuations Into Wins

Volatility. It’s a word that makes even seasoned investors a little uneasy.

When the stock market starts bouncing around like a kangaroo on a caffeine buzz, it’s easy to feel anxious. Headlines scream about billions being wiped off the market, and your portfolio balance seems to have a mind of its own — going up and down more times in a day than a toddler on a trampoline.

But is Volatility an Opportunity?

Early in my investing journey, I used to hate volatility. If a stock I owned dropped 10% in a week, I’d panic. I’d think something must be terribly wrong.

Now? I see those wild swings as my chance to make some of my best investments.

The secret is this: volatility isn’t always danger — it can be an opportunity.
And if you can learn to use it, volatility can be one of your greatest allies in building long-term wealth.

Not all volatility is good. Sometimes the volatility is an indicator of a risk or a red flag in the stock you’ve invested in. Hence it’s important to dissect the reason for volatility, understand why the volatility is occuring, what it means for the stock (and the business), and conclude whether the volatility is creating an opportunity or a flashing red sign.

In this post we will explore what volatility means, the difference between volatility and risk, situations where volatility is not your friend, and how superinvestors use volatility to their advantage.

What Exactly Does “Volatility” Mean?

Let’s break it down – volatility simply refers to the degree to which the price of a stock or the overall market fluctuates over time. High volatility means prices are swinging wildly, while low volatility means prices are relatively stable.

When the market or a specific stock experiences a period of high volatility, it often leads to price dislocations. This fancy term just means that the price of a stock can temporarily move significantly away from its underlying intrinsic value – what it’s actually worth. These dislocations can happen for a variety of reasons:

Market Overreactions: Sometimes, news (good or bad) can cause investors to overreact, leading to sharp price swings that aren’t necessarily justified by the fundamental health of the company.
Fear and Panic Selling: During uncertain times, fear can grip the market, causing investors to sell off their holdings indiscriminately, even if the underlying businesses are still strong.
Economic Uncertainty: Broader economic concerns, like inflation, interest rate hikes, or geopolitical events, can create market jitters and lead to volatility across the board.
Sector-Specific Issues: Sometimes, a problem in a particular industry can drag down the prices of even healthy companies within that sector.

But is volatility the same as risk?

Howard Marks: Distinguishing Volatility from Risk

To really understand why volatility can be an opportunity, it’s helpful to consider the perspective of legendary investor Howard Marks. In his insightful memos, Marks often draws a critical distinction between volatility and risk.

Many people mistakenly equate volatility with risk. They see the price of a stock dropping sharply and automatically assume it’s become riskier. However, Marks argues that risk, in the context of investing, is the probability of a permanent loss of capital.

Volatility, on the other hand, is simply the up and down movement of prices. It doesn’t necessarily mean you’ll lose money in the long run, especially if you’ve invested in strong companies with solid fundamentals.

Marks believes that volatility can actually be beneficial for long-term investors. He explains that:

Volatility creates opportunities to buy low: When prices decline due to market volatility (but there’s no change in the underlying business), disciplined investors have the chance to acquire shares of excellent companies at attractive valuations.
Volatility punishes short-term thinkers: Those who are focused on short-term gains and panic during downturns are more likely to sell low, locking in losses. Volatility rewards those with a long-term perspective and the ability to stay calm during market storms.

Marks himself actively uses volatility to his advantage. When markets are turbulent and prices are depressed, his firm, Oaktree Capital Management, often steps in to buy distressed assets and securities at bargain prices. This contrarian approach, capitalizing on market fear and volatility, has been a key to their long-term success. (Explore: Howard Marks Investing Philosophy)

Mohnish Pabrai: Embracing the Swings

Another investor who views volatility as a friend is Mohnish Pabrai. He often talks about how Mr. Market, a metaphor coined by Benjamin Graham, behaves like a manic-depressive business partner. Sometimes Mr. Market is overly optimistic and offers you a very high price for your shares, and other times he’s deeply pessimistic and offers you a rock-bottom price.

Pabrai emphasizes that as investors, we shouldn’t let Mr. Market’s emotional swings dictate our actions. Instead, we should use his volatility to our advantage. When Mr. Market is feeling down and offering great companies at cheap prices, that’s our opportunity to buy.

Pabrai’s investment strategy often involves waiting patiently for these periods of volatility to pounce on high-quality businesses trading at a significant discount to their intrinsic value. He sees market downturns not as a reason to panic, but as a “fat pitch” – a golden opportunity to generate outsized returns. (Explore: Mohnish Pabrai’s Investing Principles)

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When Volatility is NOT Your Friend

It’s crucial to understand that not all volatility presents an opportunity. There are circumstances where sharp price declines are justified and buying into them can be a dangerous trap. Here are a few scenarios where volatility should be approached with extreme caution:

Deteriorating Company Fundamentals: If a company’s stock price is plummeting due to a genuine decline in its business – for example, falling sales, increasing debt, loss of market share, or a flawed business model – then the volatility is likely a reflection of these underlying problems. Buying into such a situation, hoping for a quick rebound, can be a gamble. It’s important to differentiate between market-driven volatility and company-specific fundamental deterioration.
Industry in Secular Decline: Sometimes, an entire industry can face a long-term decline due to technological disruption or changing consumer preferences. Think of industries like traditional print media or video rental stores in the age of the internet. If a stock in such an industry experiences high volatility and price drops, it might not be an opportunity but rather a reflection of the industry’s bleak future.
Overleveraged Balance Sheets: Companies with excessive debt are particularly vulnerable during economic downturns. If their earnings decline or interest rates rise, they may struggle to meet their debt obligations, potentially leading to bankruptcy. Sharp price drops in highly leveraged companies during volatile periods could be a sign of serious trouble, not a buying opportunity.
Lack of Competitive Advantage: Companies without a strong moat – a sustainable competitive advantage that protects them from rivals – are more susceptible to losing market share and profitability, especially during challenging economic times. Volatility in such stocks might reflect their inherent vulnerability.

The Wisdom of Buffett and Munger

Warren Buffett and Charlie Munger, the legendary duo behind Berkshire Hathaway, are also strong proponents of using volatility to their advantage. Buffett famously said, “Be fearful when others are greedy and greedy when others are fearful.” This perfectly encapsulates the contrarian mindset needed to capitalize on market volatility.

Munger has often emphasised the importance of having a “psychological immune system” that allows you to remain rational and avoid being swept up by market emotions. During periods of panic and selling, it’s crucial to stay calm, assess the underlying fundamentals of the businesses you own or are considering buying, and act rationally rather than emotionally.

Buffett and Munger have built their immense wealth by patiently waiting for periods of market turmoil to buy high-quality businesses at attractive prices. They understand that volatility is an inherent part of the stock market and that it presents recurring opportunities for disciplined investors.

Examples of Superinvestors Taking Advantage of Volatility

It’s one thing to talk about volatility as opportunity in theory, but it becomes far more convincing when we look at how the greatest investors of all time have actually used it to their advantage.

Warren Buffett and American Express

Perhaps the most famous example is Warren Buffett’s American Express investment in the 1960s. During the “Salad Oil Scandal,” American Express was hit with massive losses and its stock price crashed more than 50%. Most investors panicked and sold. Buffett, however, recognized that while the scandal created short-term damage, the company’s charge card and travelers check business remained strong. Instead of fleeing, Buffett bought aggressively and kept adding more shares. That contrarian move paid off spectacularly as American Express went on to recover and become one of his best long-term holdings.

John Templeton During World War II

Another classic case is Sir John Templeton. At the outbreak of World War II in 1939, fear dominated the markets. Templeton borrowed money and bought shares in every U.S. company trading under $1, many of them distressed simply because of war panic. His belief was that pessimism had created extreme undervaluation. That bet returned many multiples over the next few years.

Seth Klarman and the Financial Crisis

In more recent times, Seth Klarman of Baupost Group showed how volatility can create rare bargains during the 2008–2009 Global Financial Crisis. While others dumped stocks in fear, Klarman accumulated distressed debt and undervalued equities. He saw that many businesses with solid fundamentals were trading at absurdly cheap valuations due to panic-driven selling. By leaning into volatility, he generated outstanding returns for his investors once stability returned.

How to Turn Volatility into Opportunity: Practical Tips

So, how can you, as an everyday investor, take advantage of market volatility? Here are a few practical tips:

Focus on the Long Term: Investing in the stock market is a marathon, not a sprint. A long-term perspective allows you to ride out the volatility and benefit from the eventual recovery and growth of strong companies.
Do Your Homework: Before investing in any stock, especially during volatile periods, thoroughly research the company’s fundamentals, its business model, its competitive advantages, and its financial health. Understanding what you own will give you the conviction to hold on during downturns and potentially buy more.
Have a Watchlist: Create a list of high-quality companies that you’d love to own at the right price. When the market experiences a dip, revisit your watchlist and see if any of your target companies are now trading at attractive valuations.
Don’t Panic Sell: One of the biggest mistakes investors make during volatile periods is selling their holdings out of fear. This locks in losses and prevents you from participating in the eventual recovery. Remember that temporary price declines don’t necessarily mean permanent losses if the business you own remains fundamentally sound.
Stay Informed, Not Emotional: Keep up with news and events that could impact your investments, but avoid letting short-term market noise and emotional headlines drive your decisions. Focus on the long-term fundamentals.
Learn from History: Market downturns and periods of volatility are a recurring feature of the stock market. Studying past market cycles can provide valuable perspective and help you understand that even sharp declines are often followed by recoveries.
Develop a Stomach for Volatility: As Peter Lynch once said, the “stomach is the most important organ” for a successful investor, not the brain. This sentiment is echoed by Charlie Munger, who argued that if you’re not prepared for your holdings to temporarily fall by 50% multiple times in your career, you’re not fit to be a shareholder.

My Final Thoughts

Volatility can be unsettling, but it’s also an inherent part of the stock market. By understanding what it is, learning from the perspectives of successful investors, and developing a disciplined and long-term approach, you can shift your mindset from viewing volatility as a threat to recognizing it as a significant source of opportunity.

Most superinvestors embrace volatility. Howard Marks taught me volatility isn’t risk; permanent loss is risk. Mohnish Pabrai showed me how to wait for the no-brainers. Buffett and Munger reminded me that fear creates the best deals.

Remember, the goal isn’t to avoid volatility altogether (that’s impossible in the stock market), but to learn how to navigate it intelligently and use it to your advantage. So, the next time you see the market taking a rollercoaster ride, take a deep breath, remember that volatility can be your friend, and look for those potential “discounted sale” on great businesses. It might just be the key to unlocking significant long-term wealth.