When we think about stock market, we think about its volatile nature. Unpredictability is the essential part of the market. Volatility in stock market is the relative rate at which the price of a security moves up and down. There are many definations of volatility but in simple words volatility is "the rate and magnitude of changes in price", it is about how fast prices move. Volatility is low when the market is quite but moving in range of trade.
Today's market deals directly with volatility through options and variance swaps. Accounting the annualized standard deviation of daily change in price leads to evaluation of volatility. In simple terms, if the price of a stock moves up and down rapidly over short time periods, it has high volatility. If the price almost never changes, it has low volatility.
Many Investors feel that when volatility is high, it's time to buy but when it is low you should not step into market. On the contrary, a number of studies have also shown that when volatility rises, there is a greater chance that the stock market is experiencing losses. Basically, when the stock market is climbing, volatility tends to decline. On the other hand when the stock market falls, volatility tends to rise. So if you go by above said theory you should be more conscious of the volatility in the market as you make buy and sell decisions.
Volatility is calculated by a simple mathematical term called beta that shows how volatile the security is compared to the market. Beta measures U.S-listed stocks and funds. A beta greater than 1 means the stock or fund you're looking at is more volatile than the broader market. Beta measures this volatility risk for securities trading in the market, where information about securities is integrated into prices.
The Volatility Index (VIX) is the most popular measure of stock market volatility. A high reading on the VIX marks periods of higher stock market volatility. Low readings on the VIX mark periods of lower volatility. This index is important as it works easily with other market indicators. This indicator helps to ascertain when there is too much optimism or fear in the market. By analyzing its message, traders get better understanding of investor's sentiments, and thus likely flip-flops in the market.
Volatility is often viewed as a negative term in the market that represents uncertainty and risk. Higher volatility brings worry to the investors as they watch the value of their portfolios move wildly and decrease in value. Volatility can also cause investors to respond irrationally, selling when the price of the shares have fallen to a low. You may earn a lot by knowing how to use volatility to your advantage. The key is not to fear and you should make rational decision on when to buy and when to sell the stocks.
However, volatility can be good in that if you buy on the lows, you can make money. Short term market players like day traders hope to make money through volatility. The most successful investor in the history, Warren Buffet says volatility is not a measure of risk. Volatility provides investment opportunities. So you can make good purchases and make money even when market is dropping.