What is Historical Volatility ?

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Historical volatility (HV) is a statistical measure of the dispersion of returns for a given security or market index over a given period of time. Generally, this measure is calculated by determining the average deviation from the average price of a financial instrument in the given time period. Using standard deviation is the most common, but not the only, way to calculate historical volatility. The higher the historical volatility value, the riskier the security. However, that is not necessarily a bad result as risk works both ways—bullish and bearish.

Definition

Historical Volatility (HV) is a statistical measure of the dispersion of returns for a given security or market index over a specific time period. It is typically determined by calculating the average deviation of a financial instrument's prices from its average price over the given period. The standard deviation is one of the most common methods for calculating historical volatility. A higher historical volatility indicates greater risk for the security, but this is not necessarily negative, as risk can be both bullish and bearish.

Origin

The concept of historical volatility originates from volatility measurement in statistics, with its first application in financial markets dating back to the early 20th century. As financial markets became more complex, investors and analysts began using historical volatility to assess the risk and potential returns of securities.

Categories and Features

Historical volatility can be categorized based on different time periods, such as daily, weekly, and monthly volatility. Daily volatility is suitable for short-term traders, while monthly volatility is more appropriate for long-term investors. Its main feature is that it is calculated using historical data, thus reflecting past market behavior rather than predicting future movements.

Case Studies

A typical case is Apple Inc. in 2018, where due to market expectations for new products and the impact of trade wars, Apple's stock price experienced significant fluctuations, leading to a notable increase in historical volatility. Another example is Tesla, Inc. in 2020, where the rapid growth of the electric vehicle market and internal innovations led to dramatic stock price swings, increasing its historical volatility.

Common Issues

Investors often misunderstand historical volatility as a prediction of future volatility, but it is merely a measure of past fluctuations. Additionally, over-reliance on historical volatility might lead to overlooking other important market factors, such as macroeconomic changes and company fundamentals.

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