DEFINITION of volatility
The volatility is a rate at which the price of a security increases or decreases for a given set of returns.
WHAT IT IS IN ESSENCE
Volatility is measured by calculating the standard deviation of the annualized returns over a given period of time. It shows the range to which the price of a security may increase or decrease.
Volatility measures the risk of a security. It is used in option pricing formula to gauge the fluctuations in the returns of the underlying assets. So, it indicates the pricing behavior of the security and helps estimate the fluctuations that may happen in a short period of time.
If the prices of a security fluctuate rapidly in a short time span, it is termed to have a high level. But, if the prices of a security fluctuate slowly in a longer time span, it is termed to have low.
HOW TO USE
Volatility refers to the frequency and severity with which the market price of an investment fluctuates. Some psychological studies show that investors are happiest when prices are the lowest, even if that means making less money over time.
The irrational obsession with market price only manifests itself in items such as stocks, bonds, mutual funds, and stock options.
It is possible to make money from volatility. Value investors seek to buy assets when no one else wants them. Certain types of options traders make much higher profits when fear is rampant. This is because people are willing to pay them more to write derivatives such as put options.
In fact, the more professional and intelligent an investors, the more beneficial are to him or her. Because investor can use it to buy more of what is cheap and sell more of what is expensive.
For long-term investors regularly putting away money through a dollar cost averaging plan, volatility is not particularly meaningful.