Asset Classes

Free investment financial education

Language

Multilingual content from IBKR

Close Navigation
Learn more about IBKR accounts

Volatility

Lesson 6 of 6
Duration 12:51
Level Beginner
Close Navigation
Contributed By: MarketLife

Why Volatility Is Different

We can “see” most aspects of the markets’ movements easily.

  • Movements between price levels
  • Volume
  • Patterns or cycles

Volatility is different.

It must be calculated.

The volatility we see is a reflection of both

  • “Actual” volatility
  • The way we measure it

What Is Volatility?

An academic definition:

  • A measure of risk
  • Calculated as the standard deviation of returns

A more practical definition:

  • How much something moves around

How about this?

  • How much something is likely to move around in the future

Measuring Volatility in TWS

Ways to Measure Volatility

Historical Volatility

  • Standard deviation of returns, usually annualized

Average True Range

  • Range is high – low of each bar.
  • Could be averaged over a time window
  • True Range adds any gap from the previous close

Daily/weekly volatility-adjusted measures

  • SigmaSpikes

Implied Volatility

Must be “backed out” from observed options prices

There are many academic models and measures

  • GARCH-family models

Volatility Clustering

Volatility Compression

When the ratio of short-term volatility to longer-term volatility is low, the market can be said to be in volatility compression.

When in volatility compression:

  • Big moves out of compression are likely to continuation. In other words, momentum is likely to “win”.

Implied Volatility

Options are priced according to five factors:

  • Price of the underlying
  • Strike price of the option
  • Time to expiration
  • Interest rates (and dividends, if applicable)
  • Volatility

Volatility is the only one of these that is not concrete.

We can look at existing options prices and calculate the volatility needed to “justify” those prices. This is implied volatility.

Options prices are often inflated ahead of anticipated events.

  • Earnings for a company
  • Crop report
  • Etc.

Elevated implied volatility can be a warning that the market expects something to happen.

Lessons from Academic Models

Volatility is often modeled with complex mathematical models.

Volatility in most markets has a long-term average level to which it will tend to return.

In the short-term, recent volatility is the best measure of future volatility.

Volatility shocks fade away. (Think of the example of a large rock thrown in a quiet pond.)

The timing and arrival of volatility shocks is unpredictable.

Summary

Volatility must be calculated from prices and cannot be directly observed.

There are different ways to measure and calculate volatility. Understand which is best for you.

Join The Conversation

If you have a general question, it may already be covered in our FAQs. If you have an account-specific question or concern, please reach out to Client Services.

Leave a Reply

Disclosure: Interactive Brokers

Information posted on IBKR Campus that is provided by third-parties does NOT constitute a recommendation that you should contract for the services of that third party. Third-party participants who contribute to IBKR Campus are independent of Interactive Brokers and Interactive Brokers does not make any representations or warranties concerning the services offered, their past or future performance, or the accuracy of the information provided by the third party. Past performance is no guarantee of future results.

This material is from MarketLife and is being posted with its permission. The views expressed in this material are solely those of the author and/or MarketLife and Interactive Brokers is not endorsing or recommending any investment or trading discussed in the material. This material is not and should not be construed as an offer to buy or sell any security. It should not be construed as research or investment advice or a recommendation to buy, sell or hold any security or commodity. This material does not and is not intended to take into account the particular financial conditions, investment objectives or requirements of individual customers. Before acting on this material, you should consider whether it is suitable for your particular circumstances and, as necessary, seek professional advice.

IBKR Campus Newsletters

This website uses cookies to collect usage information in order to offer a better browsing experience. By browsing this site or by clicking on the "ACCEPT COOKIES" button you accept our Cookie Policy.