Stock market volatility can be an important factor to consider for both long-term investors and day traders. Volatility provides the opportunity to make above-average profits, but it also presents the risk of losing a lot of money in a short period of time. Diversification and using hedging strategies can help reduce the impact of volatility on your investment portfolio.
This article discusses the different ways that volatility is measured, including beta, maximum drawdown, and the Chicago Board Options Exchange Volatility Index (VIX). The CBOE VIX is a market-based measure of the expected volatility of the S&P 500 over the next 30 days based on prices of call and put options. This volatility is a key input to the pricing of stock options and exchange-traded products.
The most common way to measure stock market volatility is by calculating standard deviation, which measures the dispersion of returns around the mean. This is commonly reported daily, weekly, monthly, or annualized to create a volatility statistic. This statistic can be misleading, however, as it only captures the average magnitude of differences between price changes and does not account for the direction of those changes. It is therefore a good idea to take the time to learn about the many different methods of measuring volatility and which one best suits your trading style.
Regardless of the method you choose, it is important to understand that volatility does not occur out of nowhere and that there is often an underlying cause. Large movements in the market are typically presaged by an increase in volatility or by uncertainty in specific future events, a phenomenon known as autoregressive conditional heteroskedasticity.
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