What is volatility?
Volatility means how unsettled a price is: how big its jumps are, and how often they come. A share whose price usually moves around half a percent a day has low volatility; one that often rises or falls 4–5% in a day has high volatility.
In general, shares are more volatile than bonds or deposits, and a single company’s share is more volatile than the market index as a whole. The investor guide from the US regulator, the SEC, notes that large-company US shares as a group have historically lost money in about one year out of every three.
Say Nadia and Tanvir each buy Tk 1,00,000 of shares. Nadia’s share usually moves about 0.5% a day, a swing of around Tk 500. Tanvir’s often moves 4% a day, so Tk 4,000 up or down in a single day. By the end of the year their gains might be similar, but Tanvir will have far more fear and excitement to handle along the way. The numbers are only an example.
Why it matters to an investor
- To understand the pressure on your nerves: selling in fear at the bottom of a big fall is a very common mistake. It helps to know in advance how much swinging you can stand.
- To match it with time: for money you will need soon, volatility is a big problem, because you may be forced to sell at a bad moment.
- To understand your real gain: with the same average return, bigger swings mean less money at the end. See the calculation below.
- To compare fairly: comparing two investments on return alone is incomplete; how much shaking it took to get that return matters too.
How it is measured
The most common measure is the standard deviation: how far each year’s (or month’s, or day’s) return typically sits from the average. A share with a 10% average return and a 30% standard deviation would be expected to return roughly between −20% and +40% in most years, and sometimes outside that range. It is calculated from past data and is no guarantee about the future.
There are also indices that measure fear across a whole market. For the US S&P 500, the VIX index is known as the “fear gauge”. In the Covid shock it closed at a record 82.69 on 16 March 2020, beating the previous record of 80.74 from November 2008. The S&P 500 fell about 12% that day.
Volatility is not the same as risk
- Swings are not the same as permanent loss: of a share that jumps around but grows over time and one that declines slowly and calmly, the second may do more harm.
- Low swings are not the same as safe: problems can hide behind a price that does not move. In Bangladesh, during the floor-price period many shares had steady prices on paper but could not be sold at those prices.
- Daily limits delay swings rather than stop them: on the DSE, circuit breakers cap how far a price can move in one day. If the news is big, the price can keep hitting that limit for several days.
- Calm does not last forever: assuming a few quiet years mean quiet years ahead is dangerous; in early 2020 storms hit many markets suddenly.
Worked example
- Share A: returns of +8%, +12%, +9% and +11% over four years. Average: 10%. Tk 1,00,000 becomes 1.08 × 1.12 × 1.09 × 1.11 ≈ 1.463, about Tk 1,46,300.
- Share B: returns of +40%, −20%, +35% and −15%. The average is also 10%. But Tk 1,00,000 becomes 1.40 × 0.80 × 1.35 × 0.85 ≈ 1.285, about Tk 1,28,500.
- Why: after a 20% fall you need a 25% rise just to get back. Big falls take even bigger rises to repair. The numbers are only an example.
Result: both have the same average return, yet the more volatile share ends up about Tk 18,000 behind. Looking only at the average return hides this difference.
Years
See the numbers as a table
| Share A (steady) | Share B (volatile) | |
|---|---|---|
| 0 | Tk 100,000 | Tk 100,000 |
| 1 | Tk 108,000 | Tk 140,000 |
| 2 | Tk 120,960 | Tk 112,000 |
| 3 | Tk 131,846 | Tk 151,200 |
| 4 | Tk 146,349 | Tk 128,520 |
Common mistakes
- Looking only at the average return, not at how much it swung along the way.
- Assuming a share whose price hasn’t moved for a long time is safe.
- Selling in fear on a day of heavy falls, without a plan, and turning a paper loss into a permanent one.
- Keeping money you need soon in something whose price swings a lot.
Two investments with the same average return can take very different paths; volatility is how bumpy the ride is, and big bumps also shrink the end result.