Volatility Definition and Example
Volatility Definition – The degree at which the price of a security rises or decreases for a specific set of returns.
In simple words it shows the rate at which the price of security fluctuates, that is increases or decreases. The volatility of a stock is measured by computing the standard deviation of the annual returns over a fixed period of time. It can also be calculated using the variance of the returns of a security or market index.
The higher the volatility of the stock, the higher the risk associated with the risk. In addition to this, volatility also implies the amount of risk or uncertainty with respect to the changes in the price of the security. A higher volatility means that the rate of fluctuation in the security is very high. However, lower volatility implies that the value or prices of security does not fluctuate drastically.
Example of Volatility
To get a deeper understanding of volatility definition, let’s discuss an example.
The stock price of XYZ is currently trading at Rs. 100. Within 15 days it rises to 200 and in another 20 days it again comes to 100. This is the example of high volatility.
Importance of Volatility
Volatility plays an important role at the time of investing. As it computes the risk associated with the security. The main use of volatility is in option pricing formula that is used to gauge the fluctuations in the returns of the underlying assets.
For calculating option pricing, volatility is used as percentage of coefficient. Therefore, measurement of volatility depends upon the value of the coefficient. To be precise, it shows the behavior of the price of security that is whether the prices will go up or come down. So, if fluctuations in the price is very high it represents higher volatility and vice versa.