Historical Volatility

Understanding Historical Volatility in Trading

The world of trading often feels like a minefield of complex terms and phrases, especially for beginners. One such term that tends to throw off newbies is historical volatility. But worry not! We're here to explain it to you in simple, clear language.

What is Historical Volatility?

When we talk about historical volatility in trading, we refer to a statistical measure of the changes in prices of an asset over a specified past period. Simply put, it shows how much the price of an asset has moved in the past. It’s worth noting that historical volatility does not predict future price movements. Instead, it provides a sense of the asset's past price pattern.

The significance of Historical Volatility

Historical volatility plays a significant role in trading. Its main purpose is to help traders get a sense of how much an asset's price has varied in the past. A higher historical volatility indicates that an asset's price has changed a great deal in the past. On the other hand, a lower volatility suggests that the price has been relatively stable.

How is Historical Volatility calculated?

The calculation of historical volatility involves complex statistical formulas. However, it mainly focuses on comparing an asset's price at different points in time. These comparisons can then be used to calculate a standard deviation, which is the square root of the variance. The result shows how far the price deviated from its average over the past.

Applying Historical Volatility in trading strategy

While historical volatility doesn't predict future price movements, it's a valuable tool in forming a trading strategy. It can help traders decide on suitable trading instruments. For instance, traders who prefer risk might go for assets with high historical volatility. Conversely, those who prefer stability might opt for assets with low historical volatility.

Conclusion

In conclusion, historical volatility is a key concept in trading. It helps traders understand past price movements of an asset and aids in forming an effective trading strategy. Remember, it’s not about predicting future movements, but looking back to understand the past.