Knowing how to determine stock volatility is a useful skill in long term investing as well as trading. Investors look for a margin of safety and significant intrinsic stock value as guides to buying stock. When the intrinsic value and/or margin of safety disappear it is often time to sell the stock before its price plummets. No matter how good a stock a person picks for buy and hold investing that stock will provide a better return on investment if it purchased at a lower price. Learning how to determine stock volatility is one of the skills that can help investors buy stocks at the bottom of the price curve or get out at the top before a major correction. Learning how invest successfully includes using every tool at the investor’s disposal to gain and maintain profits. Borrowing a tool from short term traders such as learning how to determine stock volatility will commonly lead to more substantial gains in long term investing.
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How to determine stock volatility, in its simplest form, is to look at the stock price chart. If the progress of the stock’s price over time looks like a saw blade with constant ups and downs measuring a substantial percentage of the stock’s price that is a volatile stock. To calculate stock volatility and come up with number takes a little arithmetic. If we are wondering what is a good investment we will want to distinguish between long term, historic, volatility and short term, usually market driven, volatility. For example, stocks that are subject to large price changes as there are changes in the economy may see their price change in multiples during a recession or a recovery. Investing in this sort of volatility typically requires the ability to read business cycles. Stocks that are very volatile in the short term are often involved in a great deal of speculation. In buying and selling these stocks the investor will commonly need to use trading tools like technical analysis to help anticipate market movement.
To calculate volatility do the following:
- Pick a time frame and write down the price of a stock for each of a number of days. Use highs, lows, opening price, closing price, or average but use the same one for each day.
- Add up the total number of prices and divide by the number of days. This gives you the average or median price.
- Then add or subtract the day’s price to or from the average price for each day and write it down.
- Square this number for each day. When you multiply the number by itself (squaring) the result will always be a positive number. This number is called the variance.
- Add up all of the squared numbers.
- Take the square root of this sum. (Hint: use a calculator)
- The square root is the volatility of the stock for the time frame involved. It is expressed as a percentage.
When asking what are safe investments, volatility comes into the picture and learning how to determine stock volatility can help an investor avoid a dangerous stock investment. It can also help an investor get into a good stock at a very favorable price and sell a stock for a substantial profit.
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