Market volatility refers to how much the prices of financial things like stocks, bonds, or commodities go up and down. When the prices change a lot and quickly, it means there is high volatility. This usually happens when there is a lot of uncertainty and risk in the market.
To calculate volatility, we use a method called standard deviation. It helps us measure how much the prices of things change over a specific time. Here's how it works:
Choose a time period: Decide on a timeframe, like a day, week, or month, to look at the price changes.
Get the price data: Collect the historical prices of the thing you're interested in. For example, if you want to study stock volatility, gather the closing prices of the stock for each day within the chosen time period.
Calculate returns: Find the percentage change in prices for each period. To do this, you take the natural logarithm of the ratio between the current price and the previous price. This step makes the data easier to work with.
Find the average return: Calculate the average return over the selected time period.
Calculate deviations: Subtract the average return from each individual return. This tells you how much each return deviates from the average.
Square the deviations: Multiply each deviation by itself (square it).
Add up the squared deviations: Add together all the squared deviations.
Divide by the number of periods: Divide the sum of squared deviations by the number of periods. This gives you the variance.
Calculate standard deviation: Take the square root of the variance. This is the measure of volatility for the chosen time period.
Remember, there are other ways to measure volatility, like the Average True Range (ATR) and the Volatility Index (VIX), but standard deviation is a common method used in finance.