Last updated on April 11th, 2024 at 01:15 am
I am sure you must have heard the word’ volatility.’ Even if you have little knowledge about the stock market, you must have heard about the volatility in stock market. The term ‘Volatility’ refers to the fluctuations that occur in the stock market.
A stock market is a place that is never stable. Every day, you will see a high fluctuation in prices. This regular fluctuation in the stock market shows that the market is highly volatile. Even though high volatility in stock market implies risk, this risk is unavoidable. And the most interesting part about it is that knowing about this risk can be the key to your success in the stock market.
What is Volatility in Stock Market?
Volatility is the fluctuation rate at which market securities prices increase or decrease. Mostly, a 1% change in the security price indicates that the security is volatile. The more percent in a security price change, the more volatile it is. Volatility can be said to be the potential changes that can happen to the market prices.
Standard Deviation and Variance are the two methods by which we can calculate the volatility of a security. While calculating either, we take an annual report of the security as data.
For results, the higher the answer is, the more volatile the market is. The higher the standard deviation or variance, the higher the market’s volatility. In the same way, the lower the standard deviation or variance, the lower the volatility.
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How Calculate The Volatility in Stock Market?
The method to calculate the volatility in stock market is given below. Let’s take an example to understand.
Example – The stock price for XYZ LTD. for four weeks is provided below.
| Weeks | Price in Dollars |
| Week 1 | 12 |
| Week 2 | 16 |
| Week 3 | 17 |
| Week 4 | 15 |
Step one: Calculate the mean of the total price.
Mean = Total price / Number of weeks
= 12 + 16 + 17 + 15 / 4
= 60/4
= 15
Step two: Calculate the Deviation.
12-15 = -3
16-15 = 1
17-15 = 2
15-15 = 0
Step three: Square the Deviation and add them
9 + 1 + 4 + 0 = 14
Step Four: Divide the squared deviation by the total number of elements in the table.
14/4 = 3.5
Step five: Calculate the Variance.
Variance = Square root of 3.5
= 1.87
Types Of Volatility
Historical Volatility
As the name hints, this method uses historical data to decide the volatility of the security. This method is also called as statistical volatility method. The decision is made based on the calculation of a variance.
According to this method, if the security prices fluctuated in the past, then the security is highly volatile. Meaning the price of the security is unstable and expected to fluctuate heavily.
In contrast, if the security’s price does not fluctuate much, the price of the security is expected to stay stable for a while.
Implied Volatility
Unlike the historical volatility method, the Implied volatility method uses future prediction about stock prices. Investors use this method across the globe to predict stock prices. This method is mostly useful for option contracts.
Equity researchers evaluate several factors that can potentially affect the security price. This helps them determine how volatile the prices will be in the future. Although it helps predict future volatility, we cannot determine in which way the stock price will move.
High implied volatility suggests there is a high chance for fluctuations. Low implied volatility indicates a more stable price.
There is low volatility in a bull market. The reason for low volatility is that the market is expected to increase. In comparison, there is high volatility in a bear market. The reason for the high volatility is that the market is expected to be in a decline stage.
Measures of Volatility in Stock Market
Other than standard deviation and variance, there are 2 more measures used for volatility in stock market. They are described below –
Beta
The first measure of volatility in stock market is the Beta. Beta shows the market’s volatility by comparing the stock prices against its benchmark. Beta shows a positive reaction between the stock prices and the market index. A high beta value implies high volatility.
Example – If the value of Beta is 0.70, the benchmark (S&P 500 or NIFTY 100) will be 100. Then It means the volatility is 70%.
Volatility Index
Another measure of volatility in stock market is the Volatility Index. The Volatility index was introduced by the Chicago Board Options Exchange. The Volatility Index was developed to study 30 days of market volatility. This was studied by evaluating the real-time investment of investors in the S&P 500.
The volatility index uses the investor’s stocks and investments prediction as a volatility indicator. The volatility index is dependent upon the investor’s prediction. It takes investors’ predictions into account. What do they believe? Which stock will be likely to grow? Which direction will the market go?
A high Volatility Index indicates a highly fluctuating and risky market. In contrast, a low volatility index signals a stable market.
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FAQs
Is volatility a good thing?
Volatility can be an excellent opportunity for investors. The only thing needed is knowledge about how the market is about to move.
What is Volatility in Stock market?
Volatility refers to how much fluctuation takes place in the market. High volatility means higher chances of price movement. Low volatility means a more stable price.
How is volatility calculated?
Volatility can be calculated by using Standard deviation and Variance by using the past price dataset.
Closing Statement
Volatility is an essential concept of the stock market. Every investor is aware of it. It can be said that volatility is the reason investments turn a profit.
As investors, brokers, and financial institutions, we must be aware of how it works and how it is likely to be. We can predict the volatility in stock market by using standard deviation and variance. Although we can’t predict if it will increase or decrease just by calculating the volatility, we will know how volatile the market is. And with enough knowledge about the company’s operations, we can turn a good profit.
I hope this article about the volatility in stock market is informative. If you have any doubts or suggestions, calculate the volatility of your data, and put it in the comment box.
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