ForecastingStocks

Volatility measures how much and how fast a price moves around. A calm, slow-trending asset has low volatility; one that lurches up and down has high volatility. It is the most basic numerical handle on risk.

How it is usually measured

The common statistical measure is the standard deviation of returns — how far, on average, returns spread out from their mean. A higher standard deviation means wider swings. You will also see traders use the Average True Range (ATR), a simpler day-to-day gauge of the typical range a price covers in one period.

A simple read

Suppose a stock returns on average 0% per day with a daily standard deviation of 2%. Roughly speaking, on most days it moves within plus or minus 2%, and on a minority of days it moves more. Compare that to a stock with a 0.5% daily standard deviation: same average, but a quarter of the typical swing — and a quarter of the risk by this measure.

Why volatility drives position size

Two assets can have the same price, but if one moves four times as much per day, an equal-dollar position in it carries four times the daily risk. This is the core reason you size positions by volatility, not by price:

Wider expected swing  ->  smaller position
Narrower expected swing  ->  larger position allowed for the same risk

A caution

Volatility treats up-moves and down-moves the same, and it assumes the recent past predicts the near future. Both break down in a crisis, when volatility itself jumps. It is an excellent everyday tool and a poor crisis tool — which is why the later lessons add drawdown and stress testing.