Chapter II: Risks associated with short and long period price changes can be understood through Volatility Analysis. Here the impact of the Volatility Curve on the potential profitability positions across different time spans is shown. |
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Volatility is defined as the price range for a period, divided by the average price for the period: For instance, on 2/8/2010 the average price was 9971.04 with a range of 176.39, indicating a Daily Volatility of 1.7%. The Daily Volatility is obtained by dividing the daily range by the daily average. A longer Volatility period such as Weekly Volatility is obtained by dividing the weekly price range by the weekly mean price. It is important to avoid confusing this with the weekly average of the daily volatility, which is a completely different concept. The red plot shows the actual price. The remaining marks on the plot correspond to the Volatility measured across several time intervals. According to academic theory, Volatility is exactly equal to Risk. But investors often make a distinction between these two concepts. The different character of Volatility as seen in different time frames, lends some support to the investor's view. Average Daily Volatility over the history of DJIA has been 2% in contrast to the Average Quarterly Volatility of 13%. |
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You may be familiar with the "yield curve" which shows how interest bearing yields vary according to term. These Volatility Curves each apply to a discrete time interval. As the timespan across which Volatility is measured increases, the Volatility is expected to increase. However, as seen in this plot of the DJIA Volatility Curve, the increase is not constant. |
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This histogram is a frequency distribution of Daily Volatility, corresponding to the green points on the first chart on this page. |
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Similarly, the purple points on the top chart, the Quarterly Volatility Values, are subjected to frequency distribution here. |
Refined Volatility Risk Analysis for DJIA : |
| Monday, February 08, 2010: We have news on Nicor Inc., ticker symbol GAS. Some signs of an over-sold condition have become evident. Also, there are breaking events concerning American International Group, Inc. and MicroSoft. From the News Archive: (2/4/2010 ) Favorable events happened at Illinois Tool Works Inc., Polo Ralph Lauren Corporation, and Briggs and Stratton. Meanwhile, bad news came from Eastman Kodak. |