Introduction:

Volatility is a critical factor to consider when investing in stocks, as it represents the degree of the price fluctuations a stock experiences over time. Understanding how to calculate volatility can help investors make informed decisions and manage their investment portfolios more effectively. In this article, we will discuss the steps on how to calculate the volatility of a stock.

1. Collect historical data:

The first step in calculating volatility is gathering historical price data for the stock. Generally, daily closing prices are used for this calculation, which you can find on financial news websites or through your brokerage platform. To get a useful estimate of volatility, collect data for at least one year, preferably more.

2. Calculate daily returns:

For each consecutive trading day, compute the percentage change in closing price to find the daily returns. Use the following formula:

Daily Return = [(Current Day’s Closing Price – Previous Day’s Closing Price) / Previous Day’s Closing Price] * 100

3. Determine the average daily return:

Calculate the average of all daily returns by adding them together and dividing by the total number of trading days.

4. Calculate deviation from average:

For each daily return value, subtract the average daily return from it to find its deviation from the average. This shows how much each day’s return deviates from the mean.

5. Square deviations:

Square each of these deviation values by multiplying them with themselves. These squared figures are known as variance values.

6. Calculate average of squared deviations (variance):

Add up all variance values and divide by the total number of trading days (minus one). This gives you the average variance value, also known as variance.

Variance = Sum of squared deviations / (Number of trading days – 1)

7. Find standard deviation (volatility):

Take the square root of the variance value obtained in step 6; this is equal to the standard deviation, which represents the stock’s volatility.

Standard Deviation (Volatility) = √Variance

8. Convert to annualized volatility:

To represent volatility on an annual basis, multiply the standard deviation by the square root of the number of trading days per year. In most markets, there are approximately 252 trading days in a year.

Annualized Volatility = Standard Deviation * √252

Conclusion:

Calculating a stock’s volatility enables investors to better comprehend its risk profile and make more informed decisions about their investment strategies. Understanding the impact of volatility can help you develop a diversified portfolio that aligns with your risk tolerance levels. Keep in mind that it is just one of many indicators you should evaluate when assessing potential investments.