Quick definition Volatility measures how much a security's price changes, typically expressed as a percentage. A stock with high volatility experiences large price swings; a stock with low volatility is relatively stable. What it is Volatility is typically measured as the standard deviation of returns over a given period (e.g., 30 days). A stock with 20 percent annualised volatility experiences larger daily swings than a stock with 10 percent volatility. Volatility is both a risk (you might lose money) and an opportunity (prices move, creating trading opportunities). Why it matters Volatility affects trading decisions. High volatility creates wider spreads because market makers face larger inventory risks. High volatility also creates opportunities for traders who can profit from price moves. Volatility affects option prices. High volatility increases option prices because the underlying asset is more likely to move far from its current price. Historical versus implied volatility Historical volatility measures how much a stock has actually moved in the past. Implied volatility is the volatility that options markets are pricing in for the future. Implied volatility can differ from historical volatility if traders expect future conditions to differ from past conditions. Practical example Stock A has annualised volatility of 30 percent; Stock B has volatility of 10 percent. Stock A is riskier; its daily price moves average 1-2 percent, while Stock B's daily moves average 0.3-0.5 percent. If you buy Stock A and hold it, you face larger daily losses and gains. If you are a market maker quoting Stock A, you face larger inventory risk and must quote wider spreads. Volatility clustering Volatility is not constant. Periods of high volatility tend to be followed by more high volatility (clustering). When markets become turbulent, they stay turbulent for a while. This is important for risk management. See also - Standard Deviation - Historical Volatility - Implied Volatility - VIX (Volatility Index)
