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Portfolio & RiskGlossary

Volatility

Volatility is how widely an investment's returns swing around their average, often measured by standard deviation. Definition, example and where to see it.

Also called: price volatility, market volatility, standard deviation of returns

By The Token Thesis Desk2 min read4 cited sources

A wooden roller coaster with steep rises and drops
“Lagoon Roller Coaster (cropped)” by Jeremy Thompson — CC BY 2.0 (edited: cropped, recolored)

Quick answer

Volatility is how much an investment's returns move up and down around their average. A common measure is the standard deviation of returns: the bigger it is, the wider the typical swings, in both directions.

What does volatility mean?#

An economic letter from the Federal Reserve Bank of San Francisco explains that one commonly used measure of volatility is the standard deviation of returns, which measures the dispersion of returns from an average[1]. Dispersion simply means how spread out the numbers are. Low volatility means returns cluster near their average; high volatility means they often land far from it.

Volatility is not the same as loss. Prices can swing up as well as down. It matters most when you might need to sell during a downswing, which is why it is tied to your time horizon.

What does volatility look like with numbers?#

Worked example

Two paths with the same 5% average return

Both made-up paths average +5% a year over four years. The bumpy one has a standard deviation of 20.00% and ends at $11,289.06 from $10,000, versus $12,155.06 for the steady one.

PathYearly returnsStandard deviationValue after 4 years
Steady+5%, +5%, +5%, +5%0.00%$12,155.06
Bumpy+25%, −15%, +25%, −15%20.00%$11,289.06

Figures computed in code from the stated inputs; rounded to the nearest cent or tenth.

Where can you see an investment's volatility?#

For U.S. mutual funds and ETFs, SEC Form N-1A requires the prospectus to show a bar chart of annual total returns for up to the last 10 calendar years and the fund's highest and lowest quarterly return in that period, which the form says provides some indication of the risks of investing in the fund[2]. Rules differ by country.

For the stock market as a whole, FINRA explains that the VIX index reflects an expectation of stock market volatility over the next 30 days implied by S&P 500 index option prices[3]. In mid-March 2020 that kind of option-implied measure reached a record daily reading, according to the Federal Reserve[4].

How does volatility relate to other terms?#

Volatility measures typical swings; a drawdown measures the depth of a fall from a peak. Diversification can reduce the swings that come from any single holding. For the longer explanation, with a real market fall and recovery math, read volatility and drawdowns explained.

Sources

Numbers in brackets in the text point here. Grade A = primary source (regulator, statistics agency, law or official document).

  1. 1
    Stock Market Volatility (Economic Letter 2002-32)Federal Reserve Bank of San Francisco (2002) · Grade A
  2. 2
    Form N-1A (registration form for mutual funds and ETFs), Item 4(b)(2)U.S. Securities and Exchange Commission (current) · Grade A
  3. 3
    Volatility InvestingFINRA (2023) · Grade A
  4. 4
    Financial Stability Report, May 2020 — 1. Asset valuationBoard of Governors of the Federal Reserve System (2020) · Grade A

How we checked this note

Every number, date and rule above links to its source. This note cites 4 sources, 4 of them primary (Grade A). Worked examples were calculated in code, and a second editor compared each figure with its source before publishing. Spotted an error? Tell us — corrections are listed on the note. Read our editorial policy.