Your One-Minute Guide to Stock Volatility
If you've seen the jagged lines on charts tracking stock prices lately, you know that prices fluctuate throughout the day and week, sometimes significantly. In fact, they fluctuate over longer periods too, as demand goes up and down in the markets. You'll see short-term fluctuations as the stock's price moves within a certain price range, and longer-term trends over months and years, in which that short-term price range itself moves up or down. The size and frequency of these short-term fluctuations are known as the stock's volatility.
Volatility can be an
important measure of
market-wide and for
an individual stock.
Volatility can be an important measure of investment risk—both market-wide and for an individual stock. If a stock has a relatively large price range over a short time period, it is considered highly volatile and may expose you to increased risk of loss, especially if you sell for any reason when the price is down. Though there are exceptions, growth stocks (companies whose earnings have increased at a faster rate than competitors, often in expanding industries) tend to be more volatile than value stocks (companies in well-established industries whose stock has been trading for many years and might be considered under-valued). In contrast, if the range of prices is relatively narrow over a short time period, a stock is considered less volatile and normally exposes you to less investment risk.
But reduced risk also means reduced potential for substantial short-term return since the stock price is unlikely to increase very much in that time frame.
Stocks may become more or less volatile over time. One example might be a newer stock that had formerly seen big price swings, but becomes less volatile as the company grows and establishes a track record. Another example might be a stock with a traditionally stable price that becomes extremely volatile following unfavorable or favorable news reports, which trigger a rash of buying and selling.
A common measure of a stock’s volatility relative to the broader market is known as the stock’s beta. This number compares the movements of an individual security against those of a benchmark index, which is assigned a beta of 1. For example, a stock with a beta value of 1.2 has historically moved 120 percent for every 100 percent move in a benchmark index such as the S&P 500. In other words, it is more volatile than the broader market index. On the other hand, a stock with a beta of .85 has historically been less volatile than the underlying index.
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