On the exchange market, any asset has its own price, which is always in dynamics, constantly changing within certain limits. The reasons for price fluctuations can be very different and are determined by the simultaneous influence of many factors. It is the difference in prices for raw materials, currencies, stocks, precious metals that allows market participants to make a profit.
The meaning of the concept of "volatility"
If the value of exchange assets were unchanged, exchange trading would lose all meaning. Therefore, a trader who is beginning to get acquainted with the peculiarities of exchange trading, among other concepts, has to comprehend the meaning of the term "volatility". This parameter characterizes the volatility of asset prices and is included in the structure of most investment forecasts.
Volatility is a range within which the price of a particular asset changes over time. Volatility is fixed within a certain period, which can be a day, a week, a month, or even a year. The analysis of this parameter makes it possible to make forecasts and place bets taking into account the previous price fluctuations. Prices for all assets traded on the market are volatile: raw materials, stocks, bonds, precious metals, currencies. Given this indicator, traders can make informed decisions on the choice of an investment instrument and trading strategies.
When measuring volatility, averaged indicators are used for a certain period, which are expressed either in absolute (monetary) or relative value of the price, that is, in percentage. The most interesting for analysis is the volatility of the market for commodities, securities and currencies.
Volatility is within a certain range. To calculate this indicator, charts with daily price fluctuations are usually used, which determine the magnitude of the spread of values, that is, the distance between the maximum and minimum price of the traded asset for the exchange day.
If we use a weekly chart for analysis, the range of price fluctuations will be different. When conducting financial analysis, the average volatility is often used, which is calculated as the average value of a sample consisting of individual indicators. The volatility calculated in this way makes it possible to make a forecast of a fall or rise in prices, taking into account the previous values.
Volatility indicators
Volatility is assessed using indicators. There are many tools for such analysis, but the most common are the so-called Bollinger lines. This indicator reflects the level of volatility in asset prices with a limited range of fluctuations. If the estimated parameter falls into a narrow corridor, then with a high degree of probability it is possible to predict a large-scale change in the exchange rate. An addition to this method is the CCI indicator, which allows you to identify the most suitable entry and exit points to the market.
Volatility types
There are several types of volatility:
- historical volatility;
- potential volatility;
- historical expected volatility.
Volatility can be relevant when it reflects the change in the value of an asset over a specific period of time, and potential when it comes to forecasting price changes. Traders with real trading experience are able to very accurately calculate the expected volatility and trade in the most profitable positions.
Factors affecting volatility
The following factors influence the range of market price fluctuations:
- change in interest rates of the Central Bank of the country;
- the level of credit risks;
- the presence or absence of economic sanctions;
- market value of energy resources;
- reduction in reserve stocks of currency;
- capital outflow.
Volatility and market analysis
Traders are interested not only in the direction in which the market will move, but also in the dynamics of such movement. It is the rate of change that ultimately determines the likelihood that the prices of the traded asset will go over those values that the market participant considers critical. An indicator of this speed is the standard deviation of the price, that is, a measure of how widely the data points are scattered around the average price
Methods for calculating price changes:
- calculation of the percentage change in price;
- calculating the logarithm of the ratio of the subsequent price to the previous price;
- complex calculation of two parameters.
For successful exchange trading, it is necessary not only to correctly determine the direction of price movement, but also to guess how long such a change will take place. Estimating volatility does not always require the use of accurate calculation methods. Sometimes the most general, approximate measurements are enough. Let us assume that the price of an asset during the week varied within 1-2% of the price that was fixed at the close of the market on Friday. This is considered low volatility. If the price either grew or fell by 10-15%, we can talk about high volatility.
When considering volatility, the concept of a trend must be considered. The fact is that asset prices tend to move either up (bullish) or down (bearish). Sometimes the market does not make any significant fluctuations. In this case, they speak of a “sideways” trend. When it comes to volatility, analysts are referring to the degree of random market price changes that move market prices away from the current trend. Usually, such movements are caused by some one-time events that affect the behavior of most market participants.
How to use volatility in stock trading?
A market with high volatility is often referred to as the time of speculators, since a significant range of price fluctuations can bring significant profits. However, strong volatility cannot always be assessed unequivocally as a good or bad phenomenon. This indicator affects both capital invested for a long time and fast speculative transactions in different ways.
The range of price fluctuations serves as an indicator of the main trends in the market situation. If the level of activity of market participants is low, then the price is in a relatively narrow range, the trend is weak. With high volatility indicators, we can talk about the beginning of a large trend.
A volatile market can not only increase a trader's profits, it can lead to very large losses. This is especially true for those transactions where leverage is used. The use of tools to minimize possible losses is not always justified, since such stop losses can be easily knocked out due to strong price fluctuations. One of the possible recommendations is to enter the market at low volatility, and leave it when a strong trend has emerged in the market, which is characterized by a significant range of price fluctuations.
When it comes to long-term investing, it is believed that it is safer to use financial instruments with low volatility. Perhaps this will slightly reduce income, but it will save the investor from the need to be nervous in case of a sharp change in trend that can bring tangible financial losses.
Regardless of whether a trader is engaged in short-term speculation or investing for a long time, he needs to take into account volatility indicators in his work. A chart of asset price fluctuations can be built in the trader's terminal, which is provided by the brokerage company to its clients. The terminal usually includes standard instruments for assessing volatility. If desired, the user can independently supplement the toolkit with third-party programs that are suitable for assessing the range of price fluctuations.
The impact of volatility on the economy
Price volatility carries risks of negative consequences. The impact of significant volatility can affect wide areas of society and the economy - from the securities market to food stocks in the country. The consequences can be comparable to the domino effect: a sharp increase in volatility can lead to a collapse of world exchanges and financial collapse of enterprises. A significant and rapid change in prices leads to a decrease in household spending and, consequently, to a decrease in the profits of companies operating in the trade sector.
The high amplitude of price fluctuations testifies to the lack of stability and poor controllability in the market. When volatility decreases, they talk about the entry of the economy into a stable state and about the absence of crisis phenomena.
As a statistical parameter, volatility serves as a financial risk management tool. The use of time-tested statistical indicators allows the investor to assess the degree of risk in the event of an asset purchase. When investing regularly and wisely, volatility benefits capital and contributes to its growth.
