What Is Stock Volatility?
Stock volatility refers to how much a stock’s price or value increases and decreases within a specific period of time. Generally, the more volatile a stock is, the more risk an investor incurs when they purchase or hold it.
Stock volatility occurs when there are big swings in share prices in the stock market. Share prices can change quickly for a multitude of reasons. And while stock volatility usually describes significant declines in share prices, volatility can also happen on the upside.
But when thinking about what stock volatility is, it’s important to remember that stock volatility is often synonymous with risk for investors. That’s because investors generally prefer a steady source of returns rather than an erratic one. But volatility can present opportunities to generate returns, too.
Stocks are considered an important part of an investment portfolio and can be a tremendous source of wealth-building for investors. And while there are some lower-volatility equities versus higher-volatility ones, it’s undeniable that they are a turbulent asset class. That’s why understanding volatility, and how to measure stock volatility, is key to being a good stock investor. In fact, there are some stocks that are more attractive when they’re volatile.
However, volatility in the equity market can also represent significant opportunities for investors. For instance, investors might take advantage of volatility to buy the dip, purchasing shares when prices are momentarily lower.
How to Measure Stock Volatility
There are a handful of ways of how to measure stock volatility:
Standard deviation is a common stock volatility measure. Investors often measure an investment’s volatility by its standard deviation of returns compared to a broader market index or past returns. Standard deviation is a calculation determining the extent to which a data point deviates from an expected value, also known as the mean. In other words, it calculates how far off from “normal” a particular value is.
You can think of it this way: You might assume a stock has a value of $5, give or take $1.
A low standard deviation indicates that the data points tend to be close to this expected value. Therefore, an investment with a low standard deviation is considered to have low volatility. A high standard deviation indicates that the data points are spread out over a larger range. For investments, a high standard deviation generally translates to higher volatility.
This isn’t meant to be a math lesson, and calculating standard deviation can be a fairly involved process. You’re probably best off using an online calculator, but here’s what the formula looks like, if you’re curious:
σ = √∑(xi−μ)2 / N
Maximum drawdown, or MDD, is another stock volatility measure, and can give investors a sense of how much downside risk exists for a given stock. It basically measures the maximum fall in value that a stock has seen in the past, and is reflected in the difference between that maximum trough, and the highest peak in value before its value fell.
You may recognize the terms peak and trough when discussing the business cycle and bull markets, too. Accordingly, MDD is a peak-to-trough calculation, in other words. It’s a simpler calculation than standard deviation, too:
MDD= Trough Value−Peak Value / Peak Value
Another popular measure of tracking volatility is the Cboe Volatility Index, otherwise known as the VIX. The VIX measures the short-term volatility of the U.S. stock market via a formula that uses options trading or the price of call and put contracts based on the S&P 500 Index.
Finally, investors can also monitor the risk in their stock holdings by finding their portfolio beta — or, a stock’s sensitivity to price swings in the broader market. Beta is the financial risk that stems from the entire market and can’t be diversified away.
What Causes Market Volatility?
The stock market is known for having boom-and-bust cycles, which is another way of describing volatility. Long periods of booming share prices tend to drive investors to take on more risk. They enter into more speculative positions and buy assets like high-risk stocks.
They may often adjust their own risk tolerance, and make themselves more vulnerable to shocks in the financial system, leading to market busts when investors need to sell their holdings en masse when the market is shaky.
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Regarding individual stocks, events tied to the company’s performance, such as earnings or a product announcement, can drive volatility in its shares. But when it comes to broader market volatility, various factors can trigger more significant swings in share prices, like changes in economic policy or uncertainty over geopolitical events.
For instance, the early stages of the coronavirus pandemic in February and March 2020 created shockwaves in the markets. As economies across the globe shut down, investors began to sell off risky assets, bringing about high levels of volatility in the financial markets.
Governments enacted extraordinary fiscal and monetary stimulus programs to calm this volatility and bring stability to the markets.
Similarly, federal reserve interest rate increases during 2022 — instituted at the fastest rate in history in an effort to tamper inflation — likewise roiled the markets, causing stock volatility.
What Else Drives Volatility?
Other factors that can drive volatility include liquidity and the derivatives market. Stock liquidity is the ease with which an asset can be bought and sold without affecting prices. If an asset is tough to unload and gets sold at a significantly lower price, that could inject fear into the market and cause other investors to sell, ramping up volatility.
Separately, there’s sometimes a debate as to whether equity derivatives — contracts that are based on an underlying asset (e.g. futures and options) — can cause volatility. For instance, in 2020, investors debated whether large volumes of stock options trading caused sellers of the options, typically banks, to hedge themselves by buying stocks, exposing the market to sudden ups and downs when the banks had to purchase or sell shares quickly.
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What Causes Stock Prices to Go Up?
As noted, any number of things can cause a stock’s price to go up — be it good or bad news. For instance, geopolitical events can cause certain stocks to appreciate in price. When there’s political instability, some investors seek safer investments and may pile into consumer staple stocks, or investments that track the price of precious metals.
When the economy is faring well, earnings season can be another time during which stock prices go up as companies report positive news to investors, who may, in turn, feel better about the economy overall, which can affect their investing decisions.
What Causes Stock Prices to Go Down?
What goes up may come down — right? Just as nearly anything and everything can drive stock prices up, there are numerous things that can likewise drive values down. That can include bad earnings reports from companies, or earnings data that doesn’t live up to expectations. Political or regulatory changes can also spook investors, who may sell certain stocks and drive prices down.
Again: Stock prices can go down for any and every reason, or no reason at all. This is as good a time as any to remind you that there really is no such thing as a completely safe investment.
How to Manage Volatility When Investing
Let’s pretend that it’s 2007, and an investor has money invested in the U.S. stock market. Unfortunately, this investor is facing one of the largest stock market crashes in history: The S&P 500 fell by 57% during the crash of 2007-2008.
This sort of dramatic drop in the stock market isn’t typical, and it can be traumatic even for the savviest and most experienced investor. So, the first step to handling stock market volatility is understanding that there will always be some price fluctuation.
The second step is to know one’s risk tolerance and financial goals, then invest, readjust, and rebalance your portfolio accordingly.
Balancing Risk and Reward
Generally speaking, higher rewards sometimes come with higher risks. For example, younger investors in their 20s might want to target high growth and be open to more volatile stocks. They may have enough time to weather the gains and losses and, possibly, come out ahead over time.
The reverse is true for someone approaching retirement who wants stable portfolio returns. With a shorter time horizon there’s less time to recover from volatility, so investing in lower risk securities may make more sense.
Some strategies offer ways that more cautious investors might take to mitigate volatility in their portfolios. One way is diversification.
Here is why portfolio diversification matters: Lower volatility stocks, such as utility or consumer staple companies, can add stability to a stock portfolio. Meanwhile, energy, technology, and consumer discretionary shares tend to be more turbulent because their businesses are more cyclical, or tied to the broader economy.
Another way to diversify one’s portfolio is to add bonds, alternative investments, or even cash. When deciding to add bonds or stocks to a portfolio, it’s helpful to know that the former is generally a less volatile asset class.
This is all very useful to know if you decide to start investing online, and managing your own portfolio.
There are a few other things to take into consideration when managing volatility in your portfolio.
Risk Tolerance Assessment
A big part of effectively managing stock volatility as it relates to your portfolio is knowing your limits, or, as discussed, your risk tolerance. How much risk can you actually handle when it comes down to it?
Every investor will need to give that question some thought when deciding how to deploy their money.
While bigger risks often come with bigger rewards, when the market does experience a downturn, there’s the outstanding question of whether you’ll stick to your investing strategy or cut and run. Each investor’s risk tolerance will be different, but it’s important to think about how you can actually handle the risk you take on when investing.
One way to parry market volatility is to stick to a long-term investing strategy, such as a buy-and-hold strategy. If you stick to long-term investments rather than derivatives or other short-term assets or tools, you may be able to better weather market volatility — you don’t plan on making any moves with your portfolio, so you can somewhat ignore the day-to-day ups and downs of stock prices.
You may also want to reframe your thinking around volatility, and remember that price movements also offer an opportunity to make money, rather than just see your share prices erode. This would involve some experience and luck, as timing the market isn’t generally considered a good or wise investing strategy for most investors. But if you know what you’re doing, it’s possible to use volatility to your advantage.
How Much Stock Volatility Is Normal?
The average stock market return in the U.S. is roughly 10% annualized over time. But 10% is an average — returns can be much higher or lower. For example, as measured by the S&P 500, equity prices closed out 2008 down 38%. Then, in 2009, they rallied by 23%. So, the average doesn’t really tell the entire story.
It’s also important to remember that past market performance is not indicative of future returns. But looking at history can help an investor gauge how much volatility and market fluctuation is normal. Since World War II, the S&P 500 has posted 13 drops of more than 20%. These prolonged downturns of 20% or more are considered bear markets.
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The table below shows the S&P 500’s returns from the highest point to the lowest point in a downturn. According to this data, bear markets average a decline of 34%, lasting a little more than a year. Bear markets have occurred as close together as two years and as far apart as nearly 12 years.
|Peak (Start)||Trough (End)||Return||Length (in days)|
|May 29, 1946||May 17, 1947||-29%||353|
|June 15, 1948||June 13, 1949||-21%||363|
|August 2, 1956||October 22, 1957||-22%||446|
|December 12, 1961||June 26, 1962||-28%||196|
|February 9, 1966||October 7, 1966||-22%||240|
|November 29, 1968||May 26, 1970||-36%||543|
|January 11, 1973||October 3, 1974||-48%||630|
|November 28, 1980||August 12, 1982||-27%||622|
|August 25, 1987||December 4, 1987||-34%||101|
|March 27, 2000||October 9, 2002||-49%||926|
|October 9, 2007||March 9, 2009||-57%||517|
|February 19, 2020||March 23, 2020||-34%||33|
|January 3, 2022||October 12, 2022||-25%||282|
Investing in Stocks With SoFi
Stock volatility is the pace at which the market moves up or down during a certain period of time. It’s a complex topic that often sparks debate among investors, traders, and academics about what causes it.
While equities are considered an important part of any investment portfolio, they are also known for being volatile, and some degree of turbulence is something most stock investors have to live with.
However, for long-time investors, periods such as when the dot-com bubble burst in the early 2000s and the financial crisis of 2008 are defining moments when market volatility seemed to get out of hand. While such events are rare, investors may want to diversify their portfolios, monitor the share prices of their stock holdings, and seek downside protection when possible.
If an investor wants to pick stocks and exchange-traded funds (ETFs) for their portfolio, a SoFi online brokerage account might be a good option. The markets may be volatile, but SoFi’s user-friendly interface and helpful supporting materials may help smooth out the ride.
What is the best stock volatility indicator?
There may not be a “best” stock market volatility indicator, but perhaps the most common or popular one is the VIX. An internet search will lead you to many more, however, that may be useful as well.
What is good volatility for a stock?
Every stock is going to have some level of volatility, so investors should expect it. But the higher the volatility, the riskier (and potentially worse) it is for investors. As such, a “good” level of volatility for a given stock is probably around 15% during a given year.
Is it good if a stock is volatile?
It can be good if a stock is volatile, as price movements open up opportunities for investors to generate returns — assuming they play their cards right. That said, volatility can also be a bad thing, as values can go down, too.
What causes volatility in a stock?
Just about anything and everything can cause stock volatility. Some of the more common causes of volatility, though, are earnings reports, geopolitical news and developments, or broader economic changes, such as recessions — or news of economic changes.
What is the meaning of volatility in the stock market?
Volatility, as it relates to the stock market, refers to the up-and-down nature of stock values. Stock prices go up and down all the time, but usually within a given range. That’s what volatility generally refers to, and investors should anticipate some level of volatility for each investment they buy.
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