Volatility tells you about the stability of a stock or market. High volatility means the price is very changeable. If it’s low, the stock or market price is more stable.
Imagine a stock’s price bouncing up and down rapidly over a short period—that’s a sign of high volatility. When prices stay more or less the same, that’s low volatility. Investors look at this to understand the potential risk and opportunity.
How to Measure Volatility
You can use standard deviation to measure how much a stock’s price swings from its average. Another way is variance, which shows you the spread of a stock’s returns around its average value.
Here’s a basic idea of how to work it out:
- Find the average price of the stock over time.
- Calculate how much the price moves away from the average.
- Take those differences, square them, and average them out.
- A higher result means more erratic price movements.
Types of Volatility
- Implied: This type is about the future. It’s used in options trading to predict price changes.
- Historical: This kind looks at past prices to see how much they’ve moved.
Other Views on Volatility
- Beta: Compares a stock to the overall market. Above 1 is more erratic than the market.
- VIX: This index predicts expected stock market fluctuations. Higher values mean more expected movement.
Long-term investors might not focus on short-term fluctuations. Active traders might use these changes to buy low. You can also use strategies like options to manage potential risks.
Example with Beta
In building a retirement portfolio, you might consider:
- A company with a beta below 1, suggesting less price fluctuation.
- A company with a beta above 1, indicating more fluctuation.
Understanding price stability is key for gauging risk and planning trades or long-term investments. It plays a crucial role in options pricing and can offer insights into market sentiment.