Volatility is the measure of the dispersion of returns around the average return of a security as measured by standard deviation. A low standard deviation means that returns are grouped close to the mean, while a large standard deviation means that returns are more spread out. When the returns are more spread out, it means that you are taking on more uncertainty as to what the return may be.
If we look at an example, a stock with an expected return of 5% and a volatility of 5% would imply a range of returns from -5% to 15% assuming a normal distribution of returns and a 95% probability that returns will fall within 2 standard deviations. On the other hand, if we had a stock with an expected return of 5% but the volatility doubled to 10%. then we would be looking at a returns range of -15% to 25%. Quite the difference in the size of the range of returns.
When volatility increases it’s not always a bad sign as it provides opportunities for investors. An increase in volatility typically leads to an increase in emotions on the market. This is why we always encourage people to have an investing plan and to stick to the plan as it can help take the emotion out of decisions.
