What is Historical Volatility?

Mary McMahon
Mary McMahon

Historical volatility is the fluctuation in price of a market, commodity, or debt instrument over time. It is usually expressed in the form of a percentage, with the percentage representing the amount of standard deviation from the mean. The higher the percentage, the more extreme the price fluctuations. People who work in financial markets, such as stock traders and bankers, use historical volatility to make smart financial decisions and to create forecasts which can be used to predict the direction a market will take.

Knowing how corn prices move in drought years can be important to someone who trades corn.
Knowing how corn prices move in drought years can be important to someone who trades corn.

A number of mathematical calculations can be used to arrive at historic volatility. Many people use computer software which makes such collections for them, with the software also interfacing with a regularly updated database which includes the most recent information. The software can also be used to generate charts and graphs which may be useful for people who want a visual representation of historic volatility.

Farmers use historical volatility to determine the best times to sell a crop, such as in advance of a predicted drought.
Farmers use historical volatility to determine the best times to sell a crop, such as in advance of a predicted drought.

People can look at historical volatility over a range of time frames, sometimes comparing time frames for more information. For example, someone might be interested in fluctuations in the price of corn over the last year, in the last hundred years, and during specific periods in history, such as years in which droughts impacted the corn crop. Looking at historic volatility over extended time frames can give people a general idea of how volatile a price is, while studying specific time frames allows people to make useful comparisons and forecasts.

In the corn example above, knowing how prices move in drought years can be important to someone who trades corn or corn futures. He or she will be able to buy or sell at the best price during a drought or in advance of a predicted drought by examining the patterns which prices tend to follow. Historical volatility does not necessarily predict what will happen in the future, but it can provide some useful clues, and someone who makes an unwise financial decision in defiance of historical volatility will probably be criticized for it as a result.

Being able to examine historical volatility can also provide some perspective. For example, a particular financial commodity may appear extremely volatile during a relatively short period in time, but when it is examined in the context of a larger historical context, people may see that the volatility is not actually very unusual. Conversely, people can also compare short and long term volatility to identify troubling market patterns, such as extreme swings in price which are actually quite notable.

Droughts can influence the cost of produce such as corn which may increase in price.
Droughts can influence the cost of produce such as corn which may increase in price.
Mary McMahon
Mary McMahon

Ever since she began contributing to the site several years ago, Mary has embraced the exciting challenge of being a wiseGEEK researcher and writer. Mary has a liberal arts degree from Goddard College and spends her free time reading, cooking, and exploring the great outdoors.

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