Trade in Groups

Phrases most commonly associated with volatility are: degree of unpredictability; extent of uncertainty; range of values within a specific time period.

Volatility refers to the change in value of a financial instrument within a time horizon. It is considered by investors as an important measure of risk when assessing a financial instrument. A stock can have a stock price that grows very steadily at 15% per year. A very similar stock can also have a growth rate that averages 15% per year, but the trend in price may be volatile. That is, growth in year 1 may be 25%, while growth in year 2 is 5%. This variance of 20% between year 1 and year 2 is considered as risk by investors. Thus, all things equal, most investors would consider the first stock because of its predictability, especially long-term investors with a buy-and-hold investing strategy.

On the other hand, volatility can present opportunities to quickly make (and lose) money for short-term traders. Day traders can follow volatile stocks, making purchases at the bottom price point, and shorting stocks when at its peak. Investors with large amounts of capital, such as institutions, often mandate internal controls in place to prevent massive losses. That is, losses (and gains) beyond a certain threshold are capped, and trigger a sale of the financial instrument. Derivative securities such as options and variance swaps allow investors to trade volatility directly.