Sunday, July 30, 2017

The volatility.

The volatility is an important parameter in the financial markets. 
It is useful to : 
  • measure the underlying risk of an asset or portfolio (higher the volatility, higher the risk);
  • set the market orders, stop loss, take profit, limit orders and so on (higher the volatility, "wider" the market orders) ;
  • set the trading profile (higher the volatility with pure trader strategy and lower the volatility with pure investor strategy) ;  
  • measure the market mood (higher the volatility with an important event price-sensitive ; "stock market fever", see also the VIX indicator). 
As there are so many purposes, in the same way, there are so many methods of measuring and indentifying it. At first, the classical measure is the deviation standard. To calculate it, it needs to import the historical returns of an asset to an Excel spreadsheet and then applying the following formula :

=  DEV.ST.POP (historical returns).

Historical data from Investing.com
Here, we have an image that clearly explains the case. The time-period can be daily, weekly, monthly etc, in the analyst's discretion and based on the purpose of the analysis (it means also holding period and investor perspectives). The ticker is APPLE. The time-frame is daily. 

Another measure is that provided by the graph (indicators).  
In this sense, it means respectively : 
  • width of the real bodies and of the shadows (candlesticks chart ; wider the bodies and the shadows, higher the volatility) ;
  • width of the Bollingers Bands (wider the bands, higher the volatility) ;
  • magnitude of the volumes and so market interest (higher the volumes, higher the volatility). 
As shown in the following chart, there is the silmultaneous presence of more detectors (read the notes inside the graph). 

Chart from Investing.com

Indeed, BBW and HV are useful indicators to measure the volatility. There is a peak compared to the historical series (circled ellipses). The Envelopes (EV) have the same meaning of the BB : if the stock price is above or below the envelopes, there is high volatility in both directions.

Envelopes (EV) ; chart from Investing.com

To conclude, once measured and identified the volatility, every trader/investor should set his trading strategy accordingly, pursuing own profit and loss targets, of course. 

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