Stock Volatility

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Volatility is one of the many essential indicators in analyzing individual financial instruments or portfolios of assets. Volatility does not measure the direction of price or price changes; rather, it measures their dispersion over a given investment horizon. When calculating variance, all differences are squared to combine negative and positive differences into one quantity. Two instruments with different volatilities may have the same expected return, but the asset with higher volatility will have larger swings in values over a given period.
Stock volatility is calculated from the historical prices of equity instruments and shows the degree of variability in the returns. In the context of Modern Portfolio Theory, the risk-return relationship is the theoretical association between the performance expected from investment and the amount of risk assumed in that investment. The more returns investors expect from the market, the more risk they should undertake to achieve that return. In the context of efficient markets, volatility usually associated with swings in either direction of the market. As the stock market goes up or down, most securities will react, and volatility will change, causing a shift in investor risk-return utility function. Stock volatility is a key factor when analyzing investments or derivatives.


How to measure stock volatility?

Before comparing or considering investments, it is better to perform a stock volatility calculation that will adjust the returns according to how risky the stakes are. The riskier they are, the more the returns are lowered before any comparison. Technically risk refers to mean stock volatility, which measures how returns vary over a given period. An investment or a portfolio that grows steadily has low risk, and another investment with a value that jumps up and down unpredictably has high risk.

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How to Determine the Volatility of a Company's Stock

Volatility refers to the frequency at which a company's stock price increases or decreases within a specified period. These fluctuations usually indicate the level of risk that's associated with the security's price changes. Investors will then calculate the volatility of the company's stock to predict their future moves. A stock that has erratic price changes quickly hits new highs, and lows are considered highly volatile. A stock with relatively stable price changes has low volatility. A highly volatile stock is riskier, but the risk cuts both ways. Investing in highly volatile security can either be highly successful, or you may experience significant failure. There are two main types of volatility:

Historical Volatility

This type of stock volatility measures the stock's fluctuations based on previous trends. It's commonly used to predict a stock's future behavior based on its past. However, it cannot conclusively determine the future direction of the stock.

Implied Volatility

This type of volatility provides a positive outlook on future price fluctuations for the stock's current market price. This means that the stock will return to its initially predicted market price.

How to Calculate Volatility

A stock's volatility analysis is derived either by using standard deviation or beta. Standard deviation will reflect the average amount of how the stock's price will differ from the mean after some time. To get its calculation, you should first determine the mean price during the specified period then subtract that from each price point.

What Drives a Company's Stock Price Volatility?

Several factors can influence a company's stock volatility:

Industry

Specific events can influence volatility within a particular industry. For instance, a significant weather upheaval in a crucial oil-production site may cause oil prices to increase in the oil sector. The direct result will be the rise in the stock price of oil distribution companies. Similarly, any government regulation in a specific industry could negatively influence stock prices due to increased regulations on compliance that may impact the company's future earnings and growth.

Political and Economic environment

When governments make significant decisions regarding trade agreements, policies, and legislation regarding specific industries, they will influence stock prices. Everything from speeches to elections may influence investors, who can directly influence the stock prices in any particular industry. The prevailing economic situation also plays a significant role in stock prices. When the economy is doing well, investors will have a positive reaction and hence, better stock prices and vice versa.

The Company's Performance

Sometimes volatility will only affect an individual company. A revolutionary product launch or strong earnings report may attract many investors who want to purchase the company. This positive attention will raise the company's stock price. In contrast, product recalls, and data breaches may negatively influence a company's stock prices.

How to Leverage Volatility for Opportunity

Since volatility provides investors with entry points to take advantage of stock prices, companies may benefit. Downward market volatility can be a perfect environment for investors who play the long game. Here, they may decide to buy additional stocks from companies they prefer at lower prices. For example, an investor can purchase a stock that has halved in price over a short period. This will lower your average cost per share, thereby improving your portfolio's performance when the markets normalize. Similarly, when the prices of stocks rise, investors can sell out and invest the proceeds in other areas with better opportunities. Investing when markets are volatile with better valuations will accord both investors and companies the opportunity to generate better long-term returns. This reduces the stock risk. Please note, the New York Stock Exchange (NYSE) and American Stock Exchange (AMEX) have recently merged. Although Macroaxis has implemented solutions to handle this transition gracefully, you may still find some securities that may not be fully transferred from one exchange to another.