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Measure volatility of a stock by using “Beta”

How you can gauge volatility of a stock and evaluate stock value

The stock market movements over the past few weeks can be best described as unpredictable. It goes a few impressive points up, only to slide back after a few days. The upward and downward fluctuations can create panic among investors. Returns on stocks become increasingly difficult to predict over the short term. It may be a reaction to global market conditions, high oil prices, world economy and soaring inflation. Volatile markets torment investors.

How do you measure market stability?

A measure of volatility gives ample information for an investor to base his decisions. The time to enter, buy or sell, are critical decisions that depend on market moods. Shrewd investors find volatile markets or crashes an ideal time for picking value stocks at bargain prices. Since these are purchased at discounted rates, it gives a sufficient cushion for the long-term investor. Though scouting for bargain stocks may appear a lucrative proposition, one must not grab a poorly performing stock that is heading downwards.

Investors can use the Beta value of a stock to understand its volatility. In simple terms, it's a measure of individual stock risk relative to the overall stock market risk. Hence, if the stock fluctuates more than the general market, its beta remains greater than one. On the contrary, if the Beta is less than one, it means that the stock's price swings are less than the market's.

Consider a stock with a Beta of two. This implies that this stock is twice as volatile as the market. A Beta value of one indicates that the stock is moving in sync or proportion with the market in general.

A highly volatile stock means its value can potentially be spread out over a larger range of values. So its price can be expected to change dramatically over a short time period in either direction. A less volatile stock means that its value does not fluctuate dramatically. Any associated price movement is at a consistently steady pace spread over a time frame.

Volatility is a measure of dispersion around the mean return of a security. The statistical unit of standard deviation is a measure of volatility. This parameter gives an idea of how a stock is tightly grouped around an average. A small standard deviation means the price is tightly bunched together. A large standard deviation means the price is spread apart.

With globalisation, the domestic markets are no longer immune to global trends and happenings. Further, foreign institutional investor (FII) inflows and moods impact the market as a whole. The domestic economy is no longer independent of the world economy. Hence, it becomes important to understand the cause of volatility and devise a long-term strategy. Invest in stock markets with a long-term perspective.

If the market movement exhibits high volatility, investors need to review the value of their portfolios more frequently. It is usually observed that when the stock markets are bound upwards, the volatility tends to decline. Volatility tends to rise in falling markets. The higher the volatility, the riskier is the security.

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