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Volatility

VOLATILITY

Internet technology changed the world in many ways. By connecting millions of people and businesses together, it increased the pace at which information travels, and therefore the pace of people's lives. No longer was it necessary to wait for news about emerging industry trends or details about the performance or conditions surrounding a particular company. As the Internet became more pervasive, such information traveled quickly via e-mail and found its way onto Web sites in seconds or minutes. In addition to information traveling at a much faster pace, as the World Wide Web caught the attention of consumers and businesses it gave rise to e-commerce. Much like a gold rush, e-commerce caused a flurry of activity. New ways of doing business were rapidly conceived, developed, and executed. With the promise of great wealth, investors poured large amounts of money into new ventures, some of which failed miserably.

Along with new social and lifestyle challenges, the aforementioned factors caused unprecedented volatility in the stock market. Volatility is characterized by sudden, often drastic changes in stock prices. This phenomenon can cause the New York Stock Exchange and other major exchanges to suddenly drop by many points and bounce back quickly as stock trades are influenced by the rapid, instant exchange of information. In many ways, volatility changed the nature of the investment game for everyone involved.

In addition to causing a flurry of mergers among investment banks, which banded together to more effectively deal with market uncertainties, volatility also required investors to become more focused. Simply investing in the technology sector was no longer specific enough. As it became necessary for important investment decisions to be made faster, a more specific focus made this already difficult task somewhat simpler. Investment funds emerged which emphasized specific kinds of technology, such as data communication, networking, Internet Security, or business-to-business technology.

Many different factors can be attributed to volatility. The faster pace of business was one factor. In the new economy, a departure from time-honored investment standards took place. Shorter periods of time (months as opposed to years) transpired before companies made initial public offerings (IPOs), and venture capitalists began quickly devoting large sums of money to new, unproven ventures. The faster pace of business translated to heightened movement on the part of the investment community. According to Venture Capital Journal, an emphasis on speed "altered and compressed the very process of screening, analyzing and making investments." In order to capitalize on changing, volatile markets, capitalists were required to focus on effectively managing risk and being strategic about investment liquidity. They also were faced with the challenge of applying existing methods and strategies in a more fast-paced environment.

Related to the issue of speed was the information that traveled quickly throughout the investment world via chat rooms and other channels. Investment news, accurate or otherwise, had the power to cause interesting ripple effects within markets and specific industries. For example, bad news from a chipmaker like Intel might cause stock prices to fall for other companies within the technology sector, such as PC and server manufacturers. Also of importance was the kind of information that traveled, and when. In October of 2000, a new Securities and Exchange Commission regulation, called Regulation FD (fair disclosure), went into effect in an effort to deal with selective disclosure. Selective disclosure is an unfair practice that decreases the confidence of investors. It happens when nonpublic information about a company is released to only certain parties, such as securities analysts, instead of to the general public as a whole.

Over the years, many theories have been developed to explain stock market volatility. These have been used in attempts to predict future market activity. According to some theorists, psychological factorssuch as the attitudes of investors and their different reactions and access to informationcause volatility. Other theories are rooted more heavily in the field of economics. In reality, no one theory will likely ever explain volatility. Rather, the numerous theories each explain different factors and conditions that contribute to this phenomenon.

According to CMA Management, capital market volatility "is directly related to a lack of proper new economy standards, standards that are needed to value both old and new economy companies and to measure their periodic performance. Until such standards are developed and adopted, the daily guessingas it relates to our stock marketswill continue and volatility will reign supreme." The publication cited the example of General Motors, a long-established old economy company, and Cisco Systems, a company with roots in the new economy. In mid-2000, General Motors' market value totaled $90 billion, while Cisco's was more than $500 billion. This was so even though General Motors listed a significantly higher number of assets on its balance sheet. This variance was due to the different way value was calculated for each company.

FURTHER READING:

Brain, Marshall. "How Stocks and the Stock Market Work." How Stuff Works, August 11, 2001. Available from www.howstuffworks.com.

Conway, Brian. "Viewpoint: Speed ThrillsThe Opportunities and Challenges of Investing at E-Speed." Venture Capital Journal, June 1, 2000.

Grimm, Dennis. "Reporting Value in the New Economy." CMA Management, July/August 2001.

SEE ALSO: Investing, Online; New Economy; Shake-out, Dot-com

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volatility

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