Volatility
Family VII · Market & styles
Not to be confused with implied volatility.
Volatility quantifies how much an asset's price fluctuates around its average return. It is a measure of dispersion, not of direction: a highly volatile asset can trend up, trend down, or move sideways. Because it is derived from returns, volatility is scale-free and can be compared across instruments with very different price levels.
How volatility is calculated
The most common form is realised or historical volatility, computed from a series of past returns. Returns are usually taken as logarithmic changes, the standard deviation of those returns is calculated, and the result is annualised by multiplying by the square root of the number of periods per year.
For daily data the annualisation factor is typically the square root of 252, the approximate number of trading days in a year. Other sampling frequencies use different factors, so figures quoted by different sources are not always directly comparable.
Worked example
The same daily figure would annualise differently if a 365-day factor were used, which is one reason quoted volatility values vary between data providers.
Uses and limitations
Volatility is used in position sizing, risk limits, option pricing and performance measurement. It is backward-looking when based on historical returns and forward-looking when based on option prices.
- It treats upside and downside moves symmetrically.
- It says nothing about the direction of a move.
- It can change abruptly, so past readings are not guarantees of future ones.
Often confused with
- implied volatility
- Implied volatility is derived from current option prices and represents the market's forward-looking expectation, whereas volatility in general is usually computed from past returns; the visible sign is whether the figure is calculated from a historical price series or backed out of an option premium.