Volatility definition

What is volatility?

Volatility is a statistical measure of the amount an asset’s price changes during a given period of time. It has become a popular way of assessing how risky an asset is – the higher the level of volatility, the more risk is associated with the asset.

Volatile markets are characterised by extremely fast-paced price changes and high trading volume, which is seen as increasing the likelihood that the market will make major, unforeseen price movements. On the other hand, markets that exhibit lower volatility tend to remain stable, and have less-dramatic price fluctuations.

Volatility is often measured using standard deviation, or by looking at the variation between the asset’s price movements and the movements of its underlying index.

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Pros and cons of volatility

Pros of volatility

Volatility can provide a range of opportunities for traders, especially because derivative products – such as CFDs and spread bets – enable them to profit from markets that are falling in price, as well as rising.

It is an especially important area of consideration for day traders, who work with price changes that occur by second and by minute rather than over a longer period of time. If there is no volatility, day traders would be unlikely to make a profit.

Cons of volatility

As a general rule, high volatility comes with greater risk. This is due to its association with periods of market uncertainty.

However, volatility and risk should not be confused for the same concept. Although volatility does come with an increased chance of loss, traders can prepare for this eventuality by matching the volatility of a particular asset to their own risk profile before they open a position. By creating an outline of their risk appetite in their trading plan, traders can navigate these periods of market volatility.

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