In Finance, What Is Volatility?

Volatility, in financial jargon, is the amount of fluctuation in price that a specific security is likely to endure over time. Securities that are exceptionally volatile have the potential for great investment returns but are also extremely risky if held for a significant amount of time. Measuring volatility requires measuring both the range between a security's highs and lows and the frequency of significant price movements. Investors may also refer to a particular section of the market or even the entire economy as being volatile depending on the context.

Everyone who decides to invest their money in any type of security must understand that there is risk involved, although the levels of risk vary from one security to the next. Some investments are safe, representing a steady return on capital with little risk of any significant losses. There are other investments which can bounce back and forth between highs and lows from day to day, taking the investor on a roller coaster ride. Such investments are said to have significant volatility, a term which broadly refers to the price movement over time of a particular financial security or market.

Knowing about the volatility levels of a security allows an investor to understand if those levels fit with specific investment goals. For example, day traders, who trade stocks on a regular basis and try to predict the timing of price movement, might not mind volatile stocks, since the wild price swings actually can make them more profitable in the sort term. Long-term investors probably want to avoid especially volatile securities, since the constant ups and downs do not bode well for financial security.

Measuring volatility is a task that is especially important to the owners of stock options, which are contracts that derive their value from the value of an underlying security. Many factors come into play in these measurements, including the stock's price movements when compared with some sort of market benchmark. Other factors that affect how volatile a stock may be include interest rates and overarching economic conditions.

It is important to realize that individual stocks are not the only things measured for volatility. Sections of the market may also be more or less volatile than the market as a whole. In certain cases, the overall economic picture can affect how volatile certain industries might be. For example, if the economy as a whole is in a particularly volatile stage, subsections, like the real estate market or the stock market, will also likely fluctuate in response.