Volatility

Volatility captures the size of price swings, whatever their direction. Historical volatility is calculated from past returns, usually as their standard deviation, and then scaled to an annual figure so that different assets can be compared. Implied volatility is worked out from option prices and reflects how much movement the market expects in future; volatility indices built from option prices are sometimes called fear gauges because they tend to jump when markets fall. Shares of small or young companies are usually more volatile than those of large, established ones, and shares are typically more volatile than high-quality bonds.

Volatility is the most common way of measuring investment risk, but it is not the same as the risk of permanently losing money. A volatile investment held for many years may end well ahead, while a steady-looking one can fall suddenly. What volatility does capture is the chance of needing to sell at a bad moment and the emotional strain of watching large swings. It also drags on compounded returns: a 50% fall followed by a 50% rise leaves you 25% down. Investors with short time horizons generally need less of it.