Almost all types of investments experience volatility at some point, so it’s good to discover that volatility can give rise to profit opportunities not found in calmer markets.
Volatility Isn’t All Bad News: Some Investors Positively Revel In It!
What Is Volatility?
Volatility represents the ‘ups’ and ‘downs’ of the price a particular asset.
It’s a measure of the frequency and severity of the price movement in a given stock, or a market.
Two Definitions Of Volatility
According to Investopedia, volatility can be defined in two ways:
- Volatility is a statistical measure of the dispersion of returns for a given security or market index. Volatility can either be measured by using the standard deviation, or variance between returns from that same security or market index. Commonly, the higher the volatility, the riskier the security.
- A variable in option pricing formulas showing 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.
For the record, I didn’t understand it either!
But if you watch the video below, you’ll see a really simple explanation of volatility, and how you can measure it.
The Key Driver Of Volatility
In the short term, volatility is affected by a number of factors, some of which include the following:
- Earnings reports
- New economic data
- Company leadership changes
- New innovations
- Herd mentality
- Political changes
- Interest rate changes
- Market sentiment swings
- Economic and political events
Whilst volatility is driven by many underlying factors, what ultimately matters for volatility is demand.
In short, if a stock moves up or down on a given day, it’s definitively the case that demand for that stock was more (or less) than the available supply of that stock.
Volatility Of An Equity Market
Quite simply, the volatility of a stockmarket is pretty much the overall volatility from all of the stocks that make up the market.
The world’s most followed stockmarket index is the S&P 500. It’s a collection of 500 of the largest companies listed in the United States.
One measure of the volatility of the S&P 500 is the CBOE Volatility Index, or as it’s known by its ticker symbol, the VIX.
Volatility and equity market sentiment are important. It’s because generally, investors feel the pain of losing money far more acutely than they enjoy the upside of making gains. And this affects decision making.
Volatility In Picture Format
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