What Is Volatility?

Volatility is a measure of how much an investment’s price moves up and down over a period, usually expressed as the annualized standard deviation of its returns. A stock with 40% annual volatility swings far more than one with 15%, in both directions.

How it’s measured

The usual measure is standard deviation: how far returns typically land from their average. Analysts calculate it from daily returns and then scale it to a yearly figure. Because volatility grows with the square root of time, the daily figure is multiplied by the square root of the number of trading days in a year, about 252.

Worked example. A stock’s daily returns have a standard deviation of 1%.

1% x square root of 252 = 1% x 15.9 = about 15.9% annual volatility

As a rough guide, in about two years out of three a stock with 15.9% volatility would land within 15.9 percentage points of its average annual return. That rule assumes returns follow a bell curve, and stock returns have fatter tails than that: extreme days happen more often than the model expects.

Historical vs implied volatility

• Historical (realized) volatility looks backward at actual price changes.
• Implied volatility is worked out from option prices and reflects what traders are paying for protection over the coming weeks or months.

The best-known gauge of implied volatility is Cboe’s VIX Index, which uses S&P 500 index option prices to estimate the market’s expected volatility over the next 30 days. It tends to jump when stocks fall sharply, which is why it gets called the “fear gauge.”

Volatility vs risk

Volatility is a convenient stand-in for risk, but they are not the same thing.

• Volatility is about the path, how bumpy the ride is.
• The risk most people care about is permanent loss, or not having the money when they need it.

A diversified stock index fund can be very volatile in a given year, falling sharply in a bear market, yet historically it has recovered over long periods. A single stock with low recent volatility can still collapse on one piece of bad news. Volatility matters most when you might have to sell during a drop, which is why time horizon is central to stocks vs bonds decisions.

For how a stock’s swings relate to the market’s, see beta. For the other kinds of risk volatility misses, see stock market risks explained honestly.

Related: Stock Market Risks Explained Honestly · Bull and Bear Markets · What Is Beta?