Stock market volatility is a commonly misunderstood concept, although when broken down in terms of function and how to calculate and access it, it is relatively simple. Learning about stock market volatility will also help a potential investor interact with the stock market as wisely as possible, providing statistical data to supplement their research on which stocks to purchase.
Stock market volatility, in short, is the tendency of the stock market to rise or fall sharply over a short period of time, measured by standard deviation of the return on an investment. This primarily denotes the risk in the value of a security. If the volatility is higher, it means that a security’s value can be spread over a breadth of values. This manifests in that the value can change drastically over a short period of time, either dramatically increasing or decreasing. It flexes and falls erratically in response to constant dynamic changes. If a volatility is lower, it means that the security does not fluctuate as drastically, and instead rises or falls in value. This relatively means that the stock is more stable, and is, at the time when recorded, less risky than a stock with a high volatility
There are numerous industries which track the trends in the United States stock markets. These industries establish their own windows and periods to evaluate the performance of stocks. The best-known index is the Dow Jones Industrial Average, also referred to as DJIA. The DJIA was created in 1896 and has been around for over 100 years. Industries like this track the volatility and offer volatility measures that are available for those looking into which stocks to purchase.
The traditional way of measuring volatility is by using the standard deviation, which is calculated by subtracting the square root of the average variance of the data from the mean. This is a relatively simple calculation, however, there are often concerns about the validity of this calculation. This only functions as an accurate marker of risk if the data follows a normal distribution, which presents on a graph as a bell-shaped curve.
Volatility and predicting volatility can be highly beneficial to investors. Many conservative traders employ a strategy called buy-and-hold. This is a long-term strategy, where the stock is purchased and held for an extended time period in order to profit from incremental growth. This strategy understands the potential for drastic fluctuation, yet holds the stock for long enough for it to generally stabilize and increase incrementally at the end of the holding period.