What is the essence of the volatility process

The word volatility comes from the English volatility, which translates as "volatility". When applied to trading, it means a price change over a certain time interval. That is, this is the range in which the price moves from one date to another, from hour to hour, from morning to evening, and so on.

The volatility indicator is considered as a percentage. What value is recognized as low and what is high depends on the specific product. But usually high volatility is called a movement of 10% or more.

To understand what volatility is and how it affects decisions, it is enough to turn to simple examples from real life.

Example 1. You periodically buy salt at the store. One day you notice that the price of a pack has risen by 20 kopecks, which in terms of interest will be 3% of the original cost. A few months later, the price increased by another 2%. In total, you have calculated that salt has risen in price by 5% over the year. However, you will no doubt continue to buy salt. First, volatility is low. Secondly, you still cannot do without salt in the kitchen.

Example 2. You like to drink coffee in the morning. But the price for it is constantly growing. Then you start counting the changes in value. It turns out that in six months the price of coffee has risen 4 times, and its price has grown by a total of 45%. And you decide to give up your favorite drink and switch to tea. The volatility is too high and you have to save.

And best of all, the essence of the volatility process can be understood by comparing it with sea waves. They are able to climb higher and roll ashore more often, then the sea calms down. Waves become lower, appear less often. A sea storm is an analogue of a "storm" in financial markets.

Most often, volatility is spoken about in relation to the stock and currency exchanges, the derivatives and commodity markets. Many trading strategies are based on volatility.

Volatility changes.

Volatility depends on the ratio of supply and demand. The higher the demand for a particular product, the faster its price grows. This happens until buyers are satiated and the cost is too high to continue shopping. Then sellers begin to reduce the price, that is, the reverse process begins when supply exceeds demand.

Example of 2020. The relationship between the value of the US dollar and the ruble has many times clearly demonstrated how this process takes place. So, in March, in the first 3 weeks, the value of the dollar increased from 66 to more than 80 rubles. Given the situation with the spread of the coronavirus, most people believed that the dollar would continue to strengthen. Therefore, the demand for the purchase of currency was growing, and the number of those selling became less and less. Only the measures taken by the state to support the national currency made it possible to stop the process.

Is volatility a plus or a minus?

Fluctuations are the enemy of stability. It becomes difficult to calculate the return on investment and so on. Therefore, some investors are trying to leave where volatility is high and invest money where income is more predictable.

Other traders, on the other hand, view high volatility instruments as having great earning potential. Long-term price movement in one direction can give more income than with many small jumps. However, the risks of losses increase proportionally. Therefore, the appropriate strategies are best used by experienced traders.

27 August, 2020

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