Volatility is the change in the performance of an investment over time. Volatility is calculated by measuring the standard deviation in the return of an investment, and it is often used to calculate an investment's risk. Volatility is one of the most important factors an investor takes into consideration when managing their portfolio and evaluating new investments. For this reason, many metrics compare a unit of return against a unit of volatility, such as the Sharpe ratio, information ratio, and tracking error. Investors expect to be compensated extra for additional risk they incur. While volatility is the change or swing in an investment's returns, risk is the probability of permanent loss. Volatility becomes more closely related to risk when investors are planning to sell in the shorter term. For example, investors closer to retirement may be forced to sell stock in order to pay for their expenses and are therefore more averse to volatility. Long-term investors, however, do not associate volatility with risk as closely, and are, in general, more resilient. Warren Buffet, a famous long-term investor, stated the following about volatility: "Charlie and I would much rather earn a lumpy 15% over time than a smooth 12%." Larger market cap stocks are generally less volatile than smaller companies because the amount of market activity needed to move that stock's price is typically greater. This is why larger companies often have less perceived risk than smaller companies. Investors use a variety of methods to calculate volatility, including the standard deviation of returns, beta coefficients, and option pricing models such as the Black Scholes method. In each case, an investor seeks to understand the degree that a security's price fluctuates, either to minimize risk or maximize return.Volatility Definition
Defining Volatility in Simple Terms
Probability of Permanent Loss
Warren Buffet on Volatility
Large Cap or Small Cap?
Calculating Volatility
Volatility FAQs
Volatility is the change in the performance of an investment over time.
Investors use a variety of methods to calculate volatility, including the standard deviation of returns, beta coefficients, and option pricing models such as the Black Scholes method.
Investors calculate volatility to seek to understand the degree that a security’s price fluctuates, either to minimize risk or maximize return.
Long term investors do not associate volatility with risk very closely, and are, in general, more resilient.
Larger market cap stocks are generally less volatile than smaller companies because the amount of market activity needed to move that stock’s price is typically greater.
True Tamplin is a published author, public speaker, CEO of UpDigital, and founder of Finance Strategists.
True is a Certified Educator in Personal Finance (CEPF®), author of The Handy Financial Ratios Guide, a member of the Society for Advancing Business Editing and Writing, contributes to his financial education site, Finance Strategists, and has spoken to various financial communities such as the CFA Institute, as well as university students like his Alma mater, Biola University, where he received a bachelor of science in business and data analytics.
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