A higher volatility means that a security’s value can potentially be spread out over a larger range of values. This means that the price of the security can change dramatically over a short time period in either direction. A lower volatility means that a security’s value does not fluctuate dramatically, and tends to be more steady.

## Understanding the Basics: What is Volatility?

This helps investors by making the volatility comparable over different time periods. To assess the level of risk and uncertainty in the market, investors commonly use a market-wide volatility gauge called the VIX. It indicates expectations of volatility over the next month – based on the prices of options on the S&P 500 Index. A fund with a beta very close to one means the fund’s performance closely matches the index or benchmark. A beta greater than one indicates greater volatility than the overall market, and a beta less than one indicates less volatility than the benchmark. It is derived from the standard deviation or variance of the past price fluctuations of an asset.

## What Does a High Volatility Mean?

Volatility is a key variable in options pricing models, estimating the extent to which the return of the underlying asset will fluctuate between now and the option’s expiration. Volatility, as expressed as a percentage coefficient within option-pricing formulas, arises from daily trading activities. How volatility is measured will affect the value of the coefficient used. If prices are randomly sampled from a normal distribution, then about 68% of all data values will fall within one standard deviation.

- For example, if a fund has an alpha of one, it means that the fund outperformed the benchmark by 1%.
- And volatility is a useful factor when considering how to mitigate risk.
- These figures can be difficult to understand, so if you use them, it is important to know what they mean.

## Volatility terminology

Bullish traders bid up prices on a good news day, while bearish traders and short-sellers drive prices down on bad news. Implied volatility describes how much volatility that options traders think the stock will have in the future. You can tell what the implied volatility of a stock is by looking at how much the futures https://forexbroker-listing.com/trade99/ options prices vary. If the options prices start to rise, that means implied volatility is increasing, all other things being equal. In finance, volatility (usually denoted by “σ”) is the degree of variation of a trading price series over time, usually measured by the standard deviation of logarithmic returns.

## What Is Volatility?

First, investment performance is typically skewed, which means that return distributions are typically asymmetrical. As a result, investors tend to experience abnormally high and low periods of performance. Second, investment performance typically exhibits a property known as kurtosis, which means that investment performance exhibits https://broker-review.org/ an abnormally large number of positive and/or negative periods of performance. Taken together, these problems warp the look of the bell-shaped curve and distort the accuracy of standard deviation as a measure of risk. Just like interest rates, volatility is quoted on an annualized basis, which means it’s converted into a yearly rate.

That way, an investor can identify a price they are willing to pay and avoid the need to watch the stock trade until such a price is available. In general, the more volatile a stock is, the more likely it’s price will vary from day-to-day and the more likely a specified limit price can be achieved during those daily fluctuations. Because volatility tends to increase with fear and uncertainty in the markets, the VIX has come to be known as velocity trade the “fear index”. These figures can be difficult to understand, so if you use them, it is important to know what they mean. To determine how well a fund is maximizing the return received for its volatility, you can compare the fund to another with a similar investment strategy and similar returns. The fund with the lower standard deviation would be more optimal because it is maximizing the return received for the amount of risk acquired.

Adam Hayes, Ph.D., CFA, is a financial writer with 15+ years Wall Street experience as a derivatives trader. Besides his extensive derivative trading expertise, Adam is an expert in economics and behavioral finance. Adam received his master’s in economics from The New School for Social Research and his Ph.D. from the University of Wisconsin-Madison in sociology.