Concept
Volatility: What It Measures and What It Does Not
Volatility measures how much price moves, not which way. Historical volatility is computed from past price variability; implied volatility is derived from option prices and reflects the movement the market is currently pricing in.
How to read it
- Higher volatility means larger typical moves in both directions. It is a statement about magnitude only.
- Historical volatility looks backward; implied volatility is extracted from what options currently cost and is therefore forward-looking in construction.
- Volatility tends to cluster: quiet periods are usually followed by quiet periods and violent ones by violent ones, until the pattern breaks.
What it does not tell you
- Volatility carries no directional information whatsoever.
- Implied volatility reflects what the market is pricing, which is regularly different from what subsequently happens.
- Position sizes calculated during quiet conditions can become far too large when volatility expands, which is why sizing rules that ignore volatility fail exactly when it matters.
Frequently asked questions
Does high volatility mean the market will fall?
No. Volatility measures the size of moves, not their direction. Sharp advances raise volatility just as declines do, though declines historically tend to be more abrupt.
What is the difference between historical and implied volatility?
Historical volatility is calculated from past price movement. Implied volatility is backed out of current option prices and represents the movement the market is currently pricing in.
Why does volatility matter for position sizing?
Because a fixed stop distance represents a different probability of being hit depending on how much the instrument typically moves. Sizing without reference to volatility means the actual risk taken varies with conditions.
Related
- Average True Range (ATR) — Indicator
- Bollinger Bands — Indicator
- Position Sizing Basics — Strategy
Educational use only
This page is educational material about how a technical tool is calculated and read. It is not investment advice, not a recommendation to buy or sell anything, and not a signal service. No indicator predicts future prices. CernoQuant is a trading journal and analytics platform, not a SEBI-registered investment adviser. Trading decisions and their outcomes are yours alone.
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