Understanding the Four Measures of Volatility
Updated from 3/8/2007 at 2:15 p.m. EST
"Volatility" is a term that is increasingly interjected into financial market commentary by the press and professionals. In fact, Bloomberg Radio has a daily "Volatility Report." While the term is being thrown around with a seemingly high degree of expertise, I find that the concept is not well understood by most commentators and the average investor. This module of TheStreet University will cover the four main types of volatility measures:
- historical volatility;
- implied volatility;
- the volatility index; and
- intraday volatility.
Type 1: Historical VolatilityVolatility in its most basic form represents daily changes in stock prices. We call this historical volatility (or historic volatility) and it is the starting point for understanding volatility in the greater sense. Historic volatility is the standard deviation of the change in price of a stock or other financial instrument relative to its historic price over a period of time. That sounds quite eloquent but for the average investor who does not command an intimate knowledge of statistics, the definition is most overwhelming. Think of a Pendulum To help you visualize the concept of volatility, think of a pendulum like in the picture below. The pendulum is constructed from a steel ball, attached to a rope and then suspended from a ceiling.
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