Watching the market react to economic data is really about watching the human beings that constitute the market react with fear and optimism to normally mixed messages. George Soros terms this reflexivity - good news drives markets up, which worries the central bankers, and the anticipation of this keeps a handbrake on the degree to which the market drives up in the first place. This circularity is especially evident as we move towards 2006, which is shaping up to be the year of volatility.

Volatility has three key impacts on investor behaviour.

First, of course, volatility increases the risk to investors, as prices gyrate more frequently, a...