Volatility

Volatility, defined as the price fluctuation of a stock or ETF, is a crucial indicator for understanding the risk of an investment. Simply put, it measures how much a financial security's value fluctuates over time. Put in even simpler terms: how much its price fluctuates over time.

High volatility → Large price swings in a short time (e.g., Tesla, cryptocurrency).

Low volatility → Greater price stability and small changes (e.g., ETFs on broad indices such as S&P 500).

How is volatility measured?

One of the most common methods is the standard deviation of a financial security's return. That is, how much the stock's returns deviate on average from the average (or expected) return over a given time period.

High standard deviation → the security has highly variable returns, so it is riskier.

Low standard deviation → the security has more stable and predictable returns, so it is less risky.

Another popular measure is Beta, which indicates how much a stock moves relative to the reference market (e.g., a Beta of 1.5 means the stock tends to vary 50 percent more than the market).

It is crucial to take into account the various factors that influence volatility, such as significant economic events, corporate news, or changes in monetary policies. During periods of economic crisis or market uncertainty, volatility tends to increase, often reflecting panic or euphoria among investors.

Why is it important?

Understanding volatility is essential in the context of wealth planning, as it allows investors to balance portfolio according to their risk tolerance. Finally, it is interesting to note that volatility can be interpreted differently in emerging markets than in developed markets, with the former often showing larger swings.

Higher volatility: potential for high gains but also higher risks.

Lower volatility: more stable and safer investments in the long run.

In general, ETFs have lower volatility than individual stocks because they diversify risk across multiple stocks making them more stable and safer options for investors in the long run.