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Reviewed by May 18, 2022| Updated on
Volatility measures the rate of change in the price of a security being traded on the stock market. This change is the major component of the risk talked about in investing that may define how much money that could be gained in parallel to how much will be lost.
Price fluctuations of securities on the stock market are natural and given. This rate of change is what makes up most of the market risk. This measurement of change is what volatility is, which calculates the level of change, and thus the risk associated with it. The calculations enable investors and traders to assess the movement of the security with its price and thereby predict possible future trends. Volatility measures the quickness with which the indices or the market moves, thereby giving a broad assumption on the amount of risk. Volatility is measured using standard deviation, variance, beta coefficients, option pricing models etc. By measuring the standard deviation, technical analysts try to study the possible prices to which the security will climb or fall or continue with respect to its current position. It is the square root of variance, which also measures the dispersion of the security’s price. Volatility is not a singular concept; it can be calculated over various periods of time like weekly, daily, quarterly or annually. Historical volatility measures the past performance of the assets and pushes analysts to check if price patterns may repeat. It is a common type of validity calculated for most securities, and is expressed as a percentage. Implied volatility is used in options trading to find the volatility of the underlying asset. The interpretation of the volatility is what matters. If an asset is highly volatile, it means that the asset may climb to higher prices and therefore hold greater risk. Although there are exceptions; it greatly depends on the time taken into reference.
A popular kind of volatility measurement is done by beta (β). Beta finds out the overall volatility and relates it against a relevant benchmark on an index to see how stocks perform individually or collectively. Factors affecting volatility are the present market conditions like the supply and demand of securities, geopolitical factors, socioeconomic factors etc. and expiration date of an options contract in options trading.