What Is Volatility: Calculation, VIX, Key Figure, Beta, & Trading


What is volatility?

Volatility, or “volla” in everyday speech, is a risk measure that indicates how large the movements have been in a share, expressed as a percentage. The measure is based on the share’s development over the past 30 days and measures the difference between the share’s highest and lowest price during the period in relation to the average value.

Volatility explanation:

When looking at the volatility of a stock, it is not the long-term return that is meant, but only how shaky the journey ahead is expected to be in the short term.

The fact that a share has high volatility means that the share price tends to fluctuate a lot, while a share with low volatility indicates that it fluctuates slightly.

You can compare volatility to turbulence when flying – the higher the volatility the higher the turbulence and then it may be a wise idea to fasten your seat belt and be prepared for a shaky journey.

What does volatility show?

When looking at the volatility of a stock, it is not the long-term return that is meant, but only how shaky the journey ahead is expected to be in the short term.

The fact that a share has high volatility means that the share price tends to fluctuate a lot, while a share with low volatility indicates that it fluctuates slightly.

As I mentioned before, volatility is like turbulence when flying – the higher the volatility the higher the turbulence.

One and the same share can have periods with both high and low volatility. Reports and important news for the company are examples of information that can affect the price and volatility. The higher the uncertainty, the higher the volatility in general.

How do you use volatility as a key figure?

Volatility is a measure that says more about a company’s share than about its operations. In general, it can be said that if you are a long-term owner, it is more important to look at fundamental key figures.

Fundamental key figures are those that show the company’s sales, profit and growth – things that drive the share price in the long term.

If you are more short-term in your savings, it is all the more important to look at the volatility measure because it shows how much the stock fluctuates in the short term.

Is high or low volatility best?

Whether to look for high or low volatility depends entirely on what you prefer.

Risk and return are linked, and the risk measure volatility gives an indication of how much a share’s price usually fluctuates in a short time.

The fact that a share has high volatility means that the share price tends to move a lot in a short time. It is both a risk and an opportunity. The possibility is that the share will rise sharply, while the risk is that the price will fall with a loss as a result.

The fact that a share has low volatility means, on the other hand, that the share has had small price movements in a short time. This too is both a risk and an opportunity.

Equities with low volatility are not usually the ones that rise the most in a short time, nor are they the ones that fall the most – they simply have a less shaky journey.

By comparison, the stock market’s (OMXS30) volatility has been just under 20 percent over the past 5 years, while the stock exchange’s total return has been 83 percent during the period *.

Companies that have had a volatility above that level have thus had a higher risk than the stock exchange and vice versa.

(OMXS30 is like the Swedish version of the American Nasdaq)

VIX index

The VIX Index, or fear index as it is also commonly called, is a volatility index that measures market expectations of volatility over the next 30 days.

It is thus a forward-looking measure that gives an indication of the market’s expectations. There are three different VIX measures that measure the volatility of different indices; VIXS & P500, VXN Nasdaq 100 and VXD Dow Jones.

A high number indicates that the market expects a turbulent market in the next 30 trading days. On the contrary, a low figure indicates that the market expects a pleasant journey over the next 30 trading days.

It is important to remember that no one knows how the stock market will develop, it can go both up and down. The measure thus only shows the market’s expectations.

Where can I find the volatility of a stock?

On my stock broker it’s on the share’s overview page, they show how high volatility has been in the share over the past 30 days.

What is the difference between volatility and beta?

Short answer: Volatility shows how much a stock fluctuates, while the key ratio beta measures how much the stock has fluctuated in relation to the stock market.

Volatility looks at how a price fluctuates in relation to its average value. It thus says nothing about the market in which it operates.

This may mean that volatility must be analyzed in the light of market events. If, for example, we have a large and broad downturn across the entire market, in connection with a financial crisis, well then our individual share is guaranteed to be dragged down in the downward swing and get a higher volatility.

Therefore, it may also be of interest to compare the fluctuations of a share against the stock market, instead of against its own average value.

This is where the BETA number comes into the picture. The BETA figure looks at the fluctuations in the price of a share and compares these against the stock exchange or a specific index.

If we look at OMXS30, for example, we can see a volatility of around 20% in the last 5-year period. It may therefore be interesting to compare the volatility of a share against this figure, either by comparing the volatilities or by looking at the BETA number.

How to calculate volatility?

Volatility is measured as the standard deviation in a security’s return. You can calculate the standard deviation by taking the mean divided by the square of the deviations from the mean, followed by the root from it.

Why it is important to understand volatility?

You have started investing in shares and bought 10 Tesla stock. One day the price drops 5% and you sell quickly because you assume that something specific has happened that affected the price so negatively.

If, on the other hand, you had known the volatility of the share, you might not have reacted as much to the price change.

By knowing how big changes are “normal”, it becomes easier to understand which price changes are just everyday trading and what can reflect news on the market.

Why are some stocks more volatile?

1. Speculative

A speculative stock generally has very high volatility. Rapid and large changes can arise from mere rumors or minor news. Here you will find, for example, so-called hope companies but also those in med-tech.

2. Rewritten and debated

Shares that are much rewritten and debated attract more interest, which in turn creates greater trading volume. It is thus a factor that can partly increase volatility.

3. In smaller markets / smaller market capitalization

In smaller markets (lists), significantly smaller trading volumes are needed for the price to change relatively much. Thus, individual trading items can create a large volatility, something that is extremely unusual for the company with a greater market capitalization.

4. Uncertainty in the market

Uncertainty is the mother of volatility… The more uncertainty there is in the market, the greater price changes can be expected.

Trading with a focus on volatility

Volatility shows nothing about a stock’s expected rise or fall. However, the key value is used together with the moving average to create, for example, Bollinger Band.

These can be used to create a basis for buying and selling positions. It is also possible to speculate in the coming increase / decrease in volatility.

1. Bollinger Bands

Bollinger Bands are used in technical analysis and show price volatility in a share and its standard deviations. Basically, a 20-day moving average and 2 in standard deviation are used (unsure of what is meant here), after which the expected volatility of the share is presented based on this with a lower and an upper band.

When the course reaches the upper, or lower, band, it has reached a breakdown. Here, the probability of a recoil is considered to increase.

The market is simply oversold or overbought.

Bollinger bands are generally used as one of many indications, not least for those with a short-term investment horizon.

2. Trading on VIX

The VIX index is an index that shows the market’s expectations of volatility over the next 30 days. During turbulent trading times, VIX generally increases and then stabilizes over time.

In IG-market, it is possible to invest in the VIX operations and thereby “invest” in increased or decreased VIX.

VIX is compiled by the Chicago Board Options Exchange and indicates expected volatility on the S&P 500 index. This is based on weighted prices for call and put options on the S&P 500.

3. “Volatility funds”

Another alternative is to invest in so-called volatility funds. Funds that, for example, take positions in VIX and where investors focus on macroeconomic events instead of individual shares.

S&P 500 VIX Short-Term Futures ETN (VXX)
S&P 500 VIX Mid-Term Futures ETN (VXZ))
VIX Short-Term Futures (VIXY)
VIX Short-Term ETN (VIIX)

Conclusion

Summary – volatility

Like all key figures, volatility should be used as one of several tools in the overall risk analysis of an asset. It is often companies that are often described in the media that have a high turnover.

By looking at short-term movements, individual news events affect volatility. Take a company like Apple for example. The course moves a lot up and down and their reports get an enormous amount of exposure in the media.

Even in large equity forums, these shares are discussed extensively, which of course also has an impact on price movements.

More anonymous companies that are not so often seen in the media tend to have a low volatility.

This may be why stocks that are often called “boring stocks” have low volatility while the stocks that everyone is talking about have high volatility.

Sources

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https://academic.oup.com/qje/article-abstract/122/1/243/1924732

https://books.google.se/books?hl=en&lr=&id=iuJdTL31TeQC&oi=fnd&pg=PA26&dq=Volatility&ots=6X5wzqaeAr&sig=neZ7Ij-mJz5duJ_-4UjXxgwaNa8&redir_esc=y#v=onepage&q=Volatility&f=false

https://www.tandfonline.com/doi/abs/10.1080/07474930701853616

https://www.sciencedirect.com/science/article/pii/B9780750669429500042

https://onlinelibrary.wiley.com/doi/abs/10.1111/1468-0416.00009

https://www.sciencedirect.com/science/article/abs/pii/S030439320600208X

https://www.sciencedirect.com/science/article/abs/pii/0304405X87900262

Kevin

This article has been reviewed by our editorial board and has been approved for publication in accordance with our editorial policies.

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