What is Volatility?

There’s an invisible force that moves your stock up or down on a daily basis, ignoring the underlying fundamentals of the company. That force is called volatility.

Volatility is the same mathematical concept as the one that says today’s temperature might vary a few degrees one way or the other from yesterday’s or that today it might take you a few minutes more or less than yesterday to get to work. It is essentially random movement governed by the mathematical laws of chance.

That may not be comforting, but it is an everyday reality in investing just as it is pretty much everywhere else. Volatility is very complex to predict, but it is a relatively simple concept mathematically, and it’s measurable.

In stock market terms, volatility is the measure of how greatly stock prices vary over a period of time. And the VIX, properly known as the Chicago Board Options Exchange (CBOE) Volatility Index, measures market expectations of near-term volatility based on option prices among S&P 500 stocks.

The VIX is commonly known as the investor “fear gauge.” High VIX reflects high uncertainty. And because markets are usually more volatile when prices are falling, a high VIX can also suggest high expectations for falling prices.

A low VIX means low expected volatility, which is more associated with expectations of rising prices. Here’s one example of high volatility and falling stock prices: In August 2015, the VIX gapped from 12 to 28 in just a couple trading days. Stocks tumbled 8% in the ensuing six weeks, and after a quick recovery, fell to new lows in early February.

Here’s the good news about volatility: every time in the last decade that the investor fear gauge has made a quantum leap, and stocks have plummeted for weeks and sometimes months, it look less than a year for them to fully recover.

If you’re curious about volatility, you might find our FREE report, Technical Analysis of Stocks, to be a robust addition to your knowledge base.