How Does Stock Volatility Affect Your Portfolio?

What is stock volatility? The most basic definition for the volatility of a stock is the fluctuation of trading prices for the stock. In the stock market, the price of all stocks will usually vary through the day and week, sometimes by small amounts and sometimes by large amounts. Each trade on the market may make the price go up, down, or remain the same. Changing prices during trading constitute the volatility of the stock. This refers to the fluctuation only of the stock trading price, regardless of whether the price change is up or down. The volatility of the stock will reflect the level of risks involved because a stock with high volatility will incur a higher risk than one with low volatility. The volatility of a stock is measured by how wide the range of value is for the stock over a given time period. The change in value of the stock may make wide swings, which means more risk because the price can change substantially in a small amount of time.

The net change of the closing price for a stock over a length of time is called the return of the stock. Beta is a term that describes one way that stock volatility can be measured. Beta will give an approximate volatility of the returns for the stock compared to a relevant benchmark return. Normally, for the S&P, or Standard & Poor, 500 is used for the benchmark to compare against beta. The beta value reflects how much the stock has moved historically in comparison to the benchmark. If the beta value of the stock is 0.8, this means that historically the stock has moved 80 percent for every move that is 100 percent in the benchmark index. If the beta value is 1.5, then historically the stock has moved 150 percent for every move that is 100 percent in the benchmark index.

One indicator of volatility is the standard deviation, but the Bollinger Band width indicator can be used instead because the standard deviation indicator is used to help traders figure the spread that occurs in the width of the Bollinger Bands. This is the spread size in the difference between the upper and the lower Bollinger Bands. The direction and shape of the Standard Deviation will generally match the shape and direction of the Bollinger Band width indicator no matter what parameters are used, so either method can be used to help determine the volatility of a stock.

Determining the standard deviation of a stock so the volatility can be determined is not too difficult. Most traders use a 20 period standard deviation method, which is what this equation is based on, but any number of periods can be used to show short or long-term volatility. First you want to figure the mean or simple average of the closing price for the stock. To do this, simply add together the closing prices for the stock over the last 20 closing periods and divide the total by 20 (total closing periods) to arrive at the simple mean of the stock. Next, subtract the simple mean closing price for the stock from the actual closing price for that period. This will show the deviation for that period’s closing price. Now square the deviation for each period and add together all of the squared deviations. Divide this number by 20. Now square the results. This will give you the standard deviation. This is important in finding the volatility of a stock so traders can determine how much risk is involved in trading that stock.

The information supplied in this article is not to be considered as medical advice and is for educational purposes only.