Historical volatility (HV), sometimes referred to as realized volatility, can be defined as the past price fluctuations of a stock over a certain period of time. Investors use historical volatility to measure how volatile a stock has been in the past and to analyze how volatile it may become in the future.
When an investor refers to a stock's historical volatility, they are referring to the past price fluctuations of the stock. The following examples represent one stock with low historical volatility and another stock with high historical volatility:
Low HV: The chart below shows the 30-day historical volatility levels of Wal-Mart. The current HV level is around 13%. This means that over the past 30 days Wal-Mart's stock price changed in a way that investors expected the stock to fluctuate 13% over a year's time (252 trading days). Therefore, if Wal-Mart's stock price was $50 per share and HV was 13%, investors expected the stock price to fluctuate between $44.50 and $56.50 over the next year based on that HV level.
HIgh HV: The chart below shows the 30-day historical volatility levels of First Solar. The current HV level is around 60%. This means that over the past 30 days First Solar's stock price changed in a way that investors expected the stock to fluctuate 60% over a year's time (252 trading days). Therefore, if First Solar's stock price was $150 per share and HV was 60%, investors expected the stock price to fluctuate between $90 and $210 over the next year based on that HV level.
Clearly, First Solar is a much more volatile stock. This is represented with higher 30-day HV level. Investors need to take this into account when assessing what type of position to open. Opening a position in First Solar would be much riskier than Wal-Mart- however the defined risk also represents the chance for a higher return, based on the previous HV levels.
Historical
volatility is important to investors because it shows how
volatile a
stock has been in the past and gives clues to how it
volatile it may
be in the future.
The next few lessons will further introduce volatility and how to analyze it.
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