Stock Volatility Information
Those who are new to stock market investing might be primarily concerned with the price of stock over a period of time. After all, it is the price that ultimately generates profits. But many factors affect how stock prices move. The concept of volatility plays an important role in market analysis. Those who are constantly aware of volatility have an advantage in predicting stock prices. It is an important component of the financial system that can lead to better investing decisions.
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Definition
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"Volatility" refers to the frequency of price turnarounds in a stock or the entire stock market, and the degree of these price reversals. It is a measure of uncertainty in the marketplace. Many industry professionals refer to volatility as a study of "fear" in the stock market. When investors become more skeptical of economic success or individual corporate growth, a stock or entire market can fluctuate with greater volatility than during times of relative normalcy. A stock that moves in a consistent direction without much deviation is said to have low volatility.
Causes
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The tight interrelationships between different areas of the financial system is often displayed in the behavior of the stock market. The Great Bear Market of 2008 was a textbook example of how problems in the real estate and loan industries can have dramatic consequences on stocks in entirely unrelated sectors. Whenever a general crisis threatens an entire economy, volatility in the stock market is sure to increase. Even in stable times, threats against a particular sector, such as pharmaceutical stocks, can become more volatile because of changes in regulatory practices, such as policies by the Food and Drug Administration.
Additionally, every three months the stock market enters an "earnings season" in which the overall economic climate is quantified by corporate earnings reports. This, too, can lead to increased volatility.
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Measurements
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The volatility of the stock market is closely watched and quantified in several ways. One of the most prominent measures of volatility is the Chicago Board Options Exchange Volatility Index, commonly called VIX. Many refer to the VIX as the "fear gauge," as it is a direct measure of how investors see the stock market outlook over a short period into the future. When the VIX rises, volatility increases. This is usually accompanied by larger swings in stock prices and ultimately a decline in the stock market.
Individual stocks can be compared against market volatility by studying their "beta" values. These are calculated by comparing a stock's price action with the overall action of a major index, such as the S&P 500. Beta values as well as the VIX can be viewed in any trading platform or financial-services site, such as Yahoo! Finance or Google Finance.
Profiting from Volatility
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When the stock market becomes more volatile, it can be dangerous to buy into stocks. However, there are other ways to profit from the increased volatility. There are exchange traded funds, or ETFs, that correspond to all kinds of stock market behavior. These are traded like regular shares of stock, but they do not actually represent any corporation. Instead, they offer returns that correspond to their particular measurement. Some funds, such as TZA and SDS, increase in share price when the stock market decreases from increased volatility.
Those who trade stock options often benefit from increased volatility as well. Most stock options increase in price even if their underlying stock remains unchanged, so long as volatility in the market rises.
Considerations
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Always study the VIX whenever you participate in active stock trading. A VIX measurement greater than 30 often coincides with high volatility and a potential decline in the overall stock market. The VIX reached its highest point in history (as of March 2010) during the stock market crash of 2008, when it soared to more than 80. Additionally, monitor the beta value of an overall sector by studying that sector's ETF. If the beta rises unexpectedly, consider staying on the sidelines with any stocks in that sector, unless you employ a strategy that profits from a stock's decline.
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References
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