What is volatility ?
For a common man, volatility of a stock is the measure of its price fluctuation or price swing. Higher the volatility means daily stock price are trading in wider range and lower the volatility means stock prices are trading in narrower price range.
If above statement make sense then get ready for a small quiz, which of the charts looks most volatile and which one least.
Chart -A
Chart -B
Check your answers
Chart B - least volatile (Volatility = 0.60%)
Chart A - most volatile (Volatility = 3.23%)
Thumb rule to compare the volatility of stocks, higher the heights of candlesticks more volatile is the stock.
Statistically standard deviation of everyday price change indicates the stock volatility. Commonly, the higher the volatility, the risker the security. Also higher volatility means that the price of security can change dramatically over a short time period in either direction.
Why should an investor worry about volatility?
More volatile means more the changes in the price or more the risk. More volatile stocks might make sharper up or down turn in the price. This might be good for people who keep a close watch on the market but not good for passive investors. Also some stocks see small burst in volatility but later their volatility comes down, which means stock is consolidating its position and there is potential for uptrend. Traders looks for high volatility stocks because daily gain potential is high, while long term investors look for low volatility stocks.
What causes the volatility?
In efficient market theory every public or private information is factored in the price of stock.
- More news/rumors about the company.
- Manipulations by traders (specially in small stocks). For a stock with market float of 100 Crore one can create volatility by 10 crore itself.
- Expectation from the company based on other companies in the same industry like all IT companies stock go up based on Infosys results.
- News about the promoter or related companies.
