What Is Volatility?
In quantitative finance, volatility refers to the degree of variation or fluctuation in the price of a financial asset over a certain period of time. It is often measured by statistical metrics like standard deviation or historical price changes. Higher volatility indicates a greater potential for rapid price changes, while lower volatility suggests more stable pricing. Sometimes volatility is shortened as “vol” (not to be confused with volme that is similarly shortened).
Example: If a cryptocurrency experiences rapid price swings within short periods, it is said to have high volatility.
Volatility is a crucial concept in financial markets, often used by traders and investors to assess the risk and potential returns of an asset. High volatility can offer opportunities for greater returns but also poses higher risks.
Each of these terms offers a different lens through which to analyze market conditions and can be used in combination to make more informed trading or investing decisions.
Volatility can be applied to - Asset prices - Asset returns - Portfolio returns
When benchmarking different portfolios for Risk-adjusted return, volatility is the fundamental metric for various risk vs. rewards calculations. Delta neutral trading strategy is a strategy that is immune to volatility: no matter which direction the price moves, the strategy makes profit. A volatility basket trading strategy construct a basket of assets based on their volatility.
Volatility is calculated as returns / standard deviation of return. Returns can be binned daily, weekly, hourly, etc. The period of returns can be trailing months, years, or the whole duration of an asset. Volatility always expressed as a positive number because it measures the magnitude of fluctuations around an average return, regardless of whether those fluctuations are positive or negative. In other words, volatility is a measure of risk or uncertainty, not direction.
Sharpe ratio is the derivation of volatility: returns / volatility.
See also