Calculating the volatility, or standard deviation, of your stocks can provide you with information about the overall level of risk in your portfolio. Volatility measures risk as the average range of price fluctuations for each stock over a fixed period of time. Generally, a stock that is less volatile, meaning that the range in which the price fluctuates is relatively small, is an indication that the stock is not a risky investment.
1. Choose the period of time for which you want to calculate volatility. It is advisable to choose a period of time that is long enough to provide a sufficient amount of data but short enough to yield a result that is representative of recent economic conditions. Generally, choosing a period between one month and one year is sufficient.
2. Obtain the daily price for each stock during the period you choose. You can use the price the stock opens or closes at. However, once you make the choice, it’s vital that you remain consistent with the daily price you choose to extract.
3. Compute the average market price for each stock during the period. The formula for computing the average is equal to the sum of the stock price on each day the market is open divided by the number of trading days in the period you are evaluating.
4. Calculate the deviation for each day of the period. The deviation formula is equal to the difference between the daily market price and the average price for each stock during the period.
5. Square the deviation for each trading day. Squaring indicates that you must multiply a number by the same number. For example, if a deviation is equal to 0.5, you multiply 0.5 by 0.5, which yields 0.25.
6. Calculate the average of the squared deviations of each trading day. You can compute the average by summing the squared deviations and dividing the result by the number of trading days within the period.
7. Compute the standard deviation. The standard deviation is equal to the square root of the average of the squared deviations.
- To eliminate the potential for mistakes in each of the calculations, it’s advisable to use an Excel spreadsheet rather than computing all calculations manually. The Excel program allows you to input a formula for each calculation, thereby minimizing the time it will take you to assess the volatility of your stock portfolio.
- You should use volatility as just one of many tools for assessing the risk of your stock investments. For example, if the volatility of your stock portfolio is low for the period, future fluctuations of the stock price outside of the standard deviation can be the result of other economic factors that affect the price of all stock rather than the inherent risk of one particular stock.
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