Calculating Volatility: A Simplified Approach

Volatility is a statistical measure of the dispersion of returns for a given security or market index. In most cases, the higher the volatility, the riskier the security. Volatility is often measured from either the standard deviation or variance between returns from that same security or market index. 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.

  1. In the event of a “loss scenario,” where the asset continues lower, he recommends having a stop-loss set up before the next retracement level — so in this case, 50%.
  2. Long-term buy-and-hold investors, however, often prefer low volatility where there are incremental, steady gains over time.
  3. During the bear market of 2020, for instance, you could have bought shares of an S&P 500 index fund for roughly a third of the price they were a month before after over a decade of consistent growth.
  4. Thus, stocks that go up will go down and everything that will go down will go up.
  5. For individual stocks, volatility is often encapsulated in a metric called beta.

But in the end, you must remember that market volatility is a typical part of investing, and the companies you invest in will respond to a crisis. Market volatility is the frequency and magnitude of price movements, up or down. The bigger and more frequent the price swings, the more volatile the market is said to be.

For example, if a fund has an alpha of one, it means that the fund outperformed the benchmark by 1%. Negative alphas are bad in that they indicate the fund underperformed for the amount of extra, fund-specific risk the fund’s investors undertook. Beta by itself is limited and can be skewed due to factors other than the market risk affecting the fund’s volatility. First, Vernier warns traders against using the 23.6% level as an entry point, because it’s typically too early to confirm a trend.

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Historical Volatility

Blue-chip corporations historically perform well and yield a positive return, while small-cap, more growth-oriented corporations might have large returns with periods of high volatility. Typically, volatility will have more impact on investment strategy in a bearish market as investors see their returns plummeting which adds to their stress during a downturn. Shares of a blue-chip company may not make very big price swings, while shares of a high-flying tech stock may do so often.

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For simplicity, let’s assume we have monthly stock closing prices of $1 through $10. 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.

One examination of the relationship between portfolio returns and risk is the efficient frontier, a curve that is a part of modern portfolio theory. The curve forms from a graph plotting return and risk indicated by volatility, which is represented by the standard deviation. According to the modern portfolio theory, funds lying on the curve are yielding the maximum return possible, given the amount of volatility. When considering a fund’s volatility, an investor may find it difficult to decide which fund will provide the optimal risk-reward combination. Many websites provide various volatility measures for mutual funds free of charge; however, it can be hard to know not only what the figures mean but also how to analyze them. Next in line are corporate stocks and bonds, which are always desirable but with the caveat that some corporations do better than others.

Market volatility is defined as a statistical measure of a stock’s (or other asset’s) deviations from a set benchmark or its own average performance. Loosely translated, that means how likely there is to be a sudden swing or big change in the price of a stock or other financial asset. Because market volatility can cause sharp changes in investment values, it’s possible your asset allocation may drift from your desired divisions after periods of intense changes in either direction. That said, let’s revisit standard deviations as they apply to market volatility.

Second, he says every Fibonacci level should be traded in isolation from other potential entry points. The value of shares and ETFs bought through a share dealing account can fall as well as rise, which could mean getting back less than you originally put in. In financial markets, an index is an indicator of the overall change in the values of some or…

The Volatility Index or VIX measures the implied volatility of the S&P 500. For example, in February 2012, the United States and Europe threatened sanctions against Iran for developing weapons-grade uranium. In retaliation, Iran threatened to close the Straits of Hormuz, potentially how to trade s&p 500 restricting oil supply. Even though the supply of oil did not change, traders bid up the price of oil to almost $110 in March. Price volatility is caused by three of the factors that change prices. It measures how wildly they swing and how often they move higher or lower.


Investors can find periods of high volatility to be distressing as prices can swing wildly or fall suddenly. Long-term investors are best advised to ignore periods of short-term volatility and stay the course. Meanwhile, emotions like fear and greed, which can become amplified in volatility markets, can undermine your long-term strategy. Some investors can also use volatility as an opportunity to add to their portfolios by buying the dips, when prices are relatively cheap.

Maximum Drawdown Quote

Once the upside range is established, traders maneuver around those levels. The chart below shows an asset price that’s near the top of its range that’s fallen enough to approach the 38.2% level in the sequence. As part of the strategy, someone might buy once the price reaches that support, with the general idea being that the asset will rebound and continue higher. This refers to the volatility of the underlying asset, which will return the theoretical value of an option equal to the option’s current market price. It provides a forward-looking aspect on possible future price fluctuations.

However, it does not provide insights regarding the future trend or direction of the security’s price. Stock market volatility can pick up when external events create uncertainty. For example, while the major stock indexes typically don’t move by more than 1% in a single day, those indices routinely rose and fell by more than 5% each day during the beginning of the COVID-19 pandemic. No one knew what was going to happen, and that uncertainty led to frantic buying and selling.

Volatility is also a key component in options pricing and trading. For the entire stock market, the Chicago Board Options Exchange (CBOE) Volatility Index, known as the VIX, is a measure of the expected volatility over the next 30 days. The number itself isn’t terribly important, and the actual calculation of the VIX is quite complex.

Crucially, there are ways to pursue large gains while trying to minimize drawdowns. The outer bands mirror those changes to reflect the corresponding adjustment to the standard deviation. The standard deviation is shown by the width of the Bollinger Bands. The wider the Bollinger Bands, the more volatile a stock’s price is within the given period. A stock with low volatility has very narrow Bollinger Bands that sit close to the SMA.

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