Stock Volatility
Stock Volatility
Stock Investing
Volatility
Officially, volatility of an investment is the characteristic to rise or fall sharply in value within a short period of time. This means that for a number of reasons, the price of the investment changes more frequently than can be accounted for by normal market fluctuations. How volatile it is depends on how often and to what extremes the price changes in a given period.
It turns out that, like many computed factors of an investment, particularly stocks, there can be a lot of useful information in examining the volatility of a stock. The most obvious is that it is often taken as the direct corollary to RISK. If a stock can rise fast and fall fast, you are at risk for catching the falls and not the rises. If it falls a lot and you have bought on margin, you can owe a lot of money in a short time that you did not expect to.
A direct measure of the volatility of a stock is a computed value called the “beta coefficient”. It is the covariance of the stock in relation to the rest of the market. By definition, the S&P 500 has a beta of one (1). Any stock with a higher beta is more volatile than the market as represented by the S&P 500 index. A stock that is expected to rise and fall more slowly than the market will have a beta lower than one.
A Beta does not necessarily mean that it will not rise or fall as much as he S&P 500, it just means that it may not move as fast as the index. Beta is based on past performance.
Another related factor is called “alpha”. It indicates the volatility of the investment itself rather than the rest of the market. If a stock is not expected to change in price in the coming year as a result of its inherent values such as growth of earnings per share, then it has an alpha of one (1). If it is expected to grow by 25% in the next year, regardless of the performance of the market as a whole, then it has an alpha of 1.25. Alpha is based on expected or projected future performance.
Putting them together, you can get some interesting insights into the expectations of the investment. (A high is a factor larger than 1, a low is a factor lower than 1).
A low beta and a high alpha would be an ideal investment. It would mean that there is low risk and a projected high return over the next year. This situation is rare in typical investments.
A high beta and a low alpha may be a poor investment since it indicates that the stock is a potentially high risk with lower growth than the rest of the market.
Today’s technology stocks are typically a high beta and a high alpha. They are very volatile but typically are expected to grow faster than the S&P 500.