What Is a Volatility Measure?

A volatility measure is any attempt to gauge the amount of price movement over a period of time for a particular security or group of securities. This measurement is important to investors, since a security with excessive volatility is much riskier over a long period of time than a more stable security. One volatility measure involves taking the average of prices over a given period and then measuring the deviation from that average the price took each day. Another way of measuring volatility is to study the beta of a given security, which is the amount that the price of a security moves when compared to some benchmark.

Understanding volatility is important for anyone willing to risk money in the stock market. Investors would certainly love a stock with the potential to soar high in price, but stocks like that often have just as much potential to plummet. Volatility measure helps to determine how much a price is likely to change and just how often that change might occur, all of which is crucial information for investors.

One familiar method of volatility measure is the standard deviation method. This method requires taking an average of a security's prices over some significant period of time. Once that is accomplished, each day's price during that period is measured for the amount of deviation from that average price. For example, if the average price of a stock over a 10-day period was $100 US Dollars (USD) per share, and the price on Day 1 of that period was $120 USD per share, that day's deviation would be $20 USD. Taking the average deviation of all of the days yields a good approximation of volatility.

Beta is another excellent volatility measure available to investors. The beta represents the amount of price movement that one security makes when a predetermined benchmark moves. In the case of stocks, the benchmark is usually some stock index which measures the prices of a large group of stocks. For example, if the beta of a stock is 120 percent, that means that the price moves an average of 120 percent for every 100 percent move of the chosen benchmark.

There are many other methods of volatility measure which investors may attempt, many of which can get extremely intricate and complicated. Whatever method is used, an investor needs to decide how much volatility he can endure when it comes to his investment choices. As volatility rises, so too does risk. Since this is the case, the tolerance for risk is tied directly into an investor's willingness to accept high volatility levels.