A Quick Overview of Volatility
Volatility is often viewed as a negative in that it
represents uncertainty and risk . However, volatility can be
good in that if one shorts on the peaks, and buys on the lows
one can make money, with greater money coming with greater
volatility. The possibility for money to be made via volatile
markets is how short term market players like day traders hope
to make money, and is in contrast to the long term investment
view of buy and hold.
In today's markets, it is also possible to trade volatility
directly, through the use of derivative securities such as
options and variance swaps.
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Volatility does not imply direction. (This is due to the
fact that all changes are squared.) An instrument that is
more volatile is likely to increase or decrease in value
more than one that is less volatile.For example, a savings
account has low volatility. While it won't lose 50% in a
year, it also won't gain 50%.
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It's common knowledge that types of
assets experience periods of high and low volatility. That
is, during some periods prices go up and down quickly, while
during other times they might not seem to move at all.
Periods when prices fall quickly are often followed by
prices going down even more, or going up by an unusual
amount. Also, a time when prices rise quickly
may often be followed by prices going up even more, or going
down by an unusual amount.
- Over time volatility always
increases.
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