What Is Price Volatility?

Jim B.

Price volatility refers to the tendency of an asset to rise and fall in price over a period of time. Volatility depends upon the range between the high and low prices of an asset, and on the number of price changes it undergoes. The more price volatility that an asset possesses, the riskier it is as a potential investment. On the other hand, some investors prefer to look for assets with significant volatility, since these assets represent the best opportunities for big profits in a small period of time.

Volatility is a measure of how often and to what extent prices swing for stocks and commodities.
Volatility is a measure of how often and to what extent prices swing for stocks and commodities.

Many people think of the stock market as having volatility, and the term is indeed often used in that context. But, in fact, people deal with volatility every single day. For example, gas prices rise and fall depending on the cost of oil, and food prices can swing significantly if the production of a critical ingredient is interrupted. There are many more examples of price volatility, which measures how much an asset's price changes, that affect the overall financial climate.

It is important to note that price volatility of an asset is measured independently of its price level. For example, imagine that Stock A trades at $10 US Dollars (USD) per share, and stays at that level for seven consecutive days. Meanwhile, in the same time period, Stock B starts at $20 USD per share, rises to $40 USD per share, drops to $10 USD per share, and then returns to $20 USD per share. Even though Stock A is the cheaper stock, it has far less volatility and is more stable than the more expensive Stock B.

The amount of price volatility that an investor is willing to endure may depend upon the goals he has for his capital. In general, extreme volatility is a bad thing for investors, since it is impossible to predict what the price of an asset will be from one day to the next. This means that any capital that is invested upon an especially volatile asset is at great risk.

There are times though when investors may prefer a stock or other asset with great price volatility to those with more stability. For example, day traders, who specialize in making many trades in short periods of time, often embrace volatile stocks, attempting to buy them at their low points and sell them at their high points to make a profit. The holder of an options or futures contract also might prefer volatile stocks, since the contract premium is already paid and the volatility of the asset underlying the contract might actually help make it profitable.

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