Thinking About Volatility (First in a Series)

Lately I have been fielding a large number of questions about historical volatility, implied volatility and a variety of related subjects. For this reason, it seems like a good time to kick off what I envision as a series of educational posts on the subject.

First I would like to start out with my own definition of volatility and then throw out some thought starters.

Definition: Volatility is a measure of the degree of change in the price of a security

There are a number of ways to think about changes in the price of a security. For instance, changes in price may be described in terms of:

• magnitude (amplitude) – how far?
• frequency – how often?
• duration – how long?
• trend – unidirectional or choppy?
• direction – up or down?

In terms of measurement, common ways to measure price changes include:

• close to close
• open to close (intra-bar; excludes gaps)
• bar to bar maximum (e.g. Average True Range)

Of course each investor has their preferred unit of time, with each bar representing a minute, five minutes, one day or whatever.

By convention, most investors think of volatility in terms of changes in price, but I submit that volatility be measured in the following units:

• points
• percentage (of price)
• standard deviations

Looking back at the definition, I sometimes like to think of volatility more broadly than I have formally defined it. Consider that volatility can be defined in terms of:

• price
• volume
• trend (degree of trending vs. choppiness)

Finally, consider that once measured, volatility can be compared to a number of possible benchmarks. These include:

• external aggregate (broad index)
• relative to peers (sector index, sector ETF, other representative ETF)
• relative to self (including historical volatility and prior implied volatility levels)

I will touch upon all these subjects and more in the coming days and weeks.