InvestorQ : What exactly is understood by historical volatility and how is it measured for the purpose of charting?
Riya Dwivedi made post

What exactly is understood by historical volatility and how is it measured for the purpose of charting?

Answer
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rhea Babu answered.
1 year ago


As the name suggests, the historical volatility of a stock is the extent to which the stock price fluctuates from the average or the mean. Volatility is always measured with reference to the mean. Greater the volatility or the divergence from the mean, higher the standard deviation and hence higher the risk on a historical basis! But what exactly do we mean by Historical Volatility in this context?

Historical volatility is nothing but the annualized one standard deviation of stock prices that measures how many past stock prices deviated from their average over a period of time. To cover the full series you also consider the 2 SD and the 3 SD. Let us now see the importance of this historical volatility as an indicator and how it works in practice. Historical Volatility does not measure direction; it measures how much the securities price is deviating from its average. In fact, historical volatility is indifferent to whether the volatility is on the upside or the downside. It is more about the extent of deviation and not the direction.

When a security’s Historical Volatility is rising, or higher than normal, it means prices are moving up and down farther/more quickly than usual and is an indication that something is expected to change, or has already changed, regarding the underlying security (i.e. uncertainty). Higher volatility is a measure of higher risk and such risk gets priced into the asset in terms of lower valuation. That is why volatility becomes important. That is why you will see that stock with high volatility get a lower P/E valuation in the market. You may want to research/monitor the security more closely. When a security’s Historical Volatility is falling, things are returning back to normal (i.e. uncertainty has been removed). This is normally positive for the stock prices.