| If there is one area that is regularly
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| | traders, and a beta of more than 1
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| ignored by CFD traders it is that of
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| | suggests greater volatility than the
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| volatility, which is often confused with
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| | benchmark, with a beta of less than 1
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| risk. Certainly in terms of grading
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| | suggesting lower volatility.
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| different types of asset classes, the two
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| | A stock with a beta of 2 for instance
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| are connected, and both the risk and
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| | would be expected to move 2 times more
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| volatility of a government stock for
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| | than the benchmark, or double the
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| instance will usually be much lower than
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| | underlying index move. Clearly if a CFD
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| say a or emerging market smaller company.
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| | trader has a balanced list of positions
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| But the bottom line is that risk is
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| | in terms of longs and shorts, the average
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| related to reward, and it simply measures
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| | beta on each side needs to be assessed in
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| the amount that it is possible to lose
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| | terms of the overall risk of big market
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| within each investment or trade.
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| | moves in one direction.
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| Volatility however measures how much
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| | Normally, but not always, the highest
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| prices rise or fall over a set time for
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| | beta stocks are those with the greatest
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| each investment issue, sector or share,
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| | volatility as measured by the standard
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| and this is very useful when constructing
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| | deviation, but also how much they are
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| portfolios, assessing margin requirements
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| | affected by the business cycle and
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| and position sizing.
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| | interest rates. Fund managers,
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| Standard Deviation - the basic measure of
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| | housebuilders and insurance companies for
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| volatility
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| | instance have much higher betas than
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| Standard Deviation is the basic
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| | supermarkets, pharmaceuticals and utility
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| statistical measure of the dispersion of
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| | stocks.
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| a population of data observations around
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| | In portfolio analysis, the beta
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| a mean (average), and is widely used in
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| | coefficient, or financial elasticity
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| stockmarket trading, forex and commodity
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| | (sensitivity of the asset returns to
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| analysis. It is simply the square root
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| | market returns and relative volatility),
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| of the variance, and is calculated as
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| | is a key parameter in the capital asset
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| follows:
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| | pricing model and is a way of separating
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| 1. Establish the mean value over the
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| | an investor's profits related to market
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| chosen time period.
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| | action as opposed to the willingness to
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| 2. Measure the deviation of each data
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| | take risk. In essence this means how
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| point from that mean.
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| | much added value there has been as
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| 3. Square each deviation (this ensures
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| | opposed to just the luck from being in
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| all the deviations are positive).
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| | rising markets.
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| 4. Total up the squared deviations.
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| | If one is highly bullish about the
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| 5. Divide that figure by the number of
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| | underlying market, it makes it easier to
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| data points less one.
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| | beat the market over the term in question
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| 6. The Standard deviation is the square
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| | by choosing high beta stocks. Equally,
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| root of that figure.
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| | if a big fall is expected imminently, a
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| There are some variations on the way the
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| | CFD trader might prefer to take low beta
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| STD can be constructed, but the above is
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| | long positions and high beta shorts if a
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| the usual formula supplied with most
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| | balanced trading list was required.
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| trading software systems.
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| | The average true range indicator
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| Problems with standard deviation
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| | This is an important indicator that can
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| 1. If using short term action, the
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| | be used for setting stops and is also
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| validity of the STD becomes less certain
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| | another way of measuring volatility, and
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| due to the usual short term randomness in
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| | is included in most software systems.
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| the market.
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| | The ATR determines a share's volatility
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| 2. It is a retrospective measurement, and
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| | over a set period that can be defaulted
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| is of little use if there is a major
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| | as desired. The daily ATR indicator is
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| change in volatility due to outside news.
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| | very simple to calculate and is the
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| Having said that, there are certain
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| | highest of:
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| technical buy and sell indicators which
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| | The difference between the current high
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| search for changes in volatility to
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| | and the current low
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| establish potential new trading
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| | The difference between the current high
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| opportunities, and here it is very
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| | and the previous close
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| useful.
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| | The difference between the current low
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| Implied Volatility
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| | and the previous close
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| Many traders in the options markets will
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| | Basically this is the maximum range in
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| be aware of the use of implied volatility
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| | which the share has traded from the
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| in terms of option pricing, and here the
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| | previous close to the current high and
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| trader can use both the underlying price
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| | low. The average is then taken over a
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| of the security and the prices of puts
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| | set number of days (ten is often used),
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| (rights to sell) and calls (rights to
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| | and the stop is then calculated as a
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| buy) to establish an expectation of
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| | multiple of the ATR.
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| future or implied volatility.
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| | The reason traders like the ATR is that
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| This creates arbitrage possibilities if
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| | it captures more intra-day information,
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| the stock, or market, is incorrectly
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| | while the standard deviation only
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| priced compared to underlying options
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| | measures the volatility of closing prices
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| available in it, and these disparities
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| | (although it can be refined to include
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| often occur after big price moves or
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| | highs, lows, etc).
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| panicky action. The formula for implied
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| | Reasons for volatility and what to look
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| volatility is much more complex, but it
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| | for
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| is an interesting area for more
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| | On a short term view, shares that have
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| sophisticated players to analyse, as it
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| | quotes in more than one market or
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| also includes dividend payments and
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| | currency may exhibit high volatility, but
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| interest rates.
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| | not necessarily a high beta. This is
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| What is beta?
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| | simply because of arbitrage
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| Beta is another measure of volatility,
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| | possibilities, where traders buy the
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| and whilst totally different from
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| | stock on one market and sell in another
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| standard deviation, it nevertheless
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| | to take advantage of price discrepancies.
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| provides another angle in portfolio or
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| | Changes in technology naturally affect
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| trade construction.
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| | the volatility of individual stocks
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| Standard deviation determines the
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| | because it takes a while for this
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| volatility of a fund, market, sector or
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| | information to become available to the
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| stock according to the disparity of its
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| | wider investment community, so a period
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| returns over a period of time, whereas
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| | of volatility often ensues. Once the
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| beta determines the volatility in
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| | stock becomes more mainstream or loses
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| comparison to an index or other
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| | its super-growth tag, volatility can
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| benchmark.
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| | often die down.
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| If an investor has a portfolio of shares
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| | News-led events often lead to big changes
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| with a beta of 1, this means that the
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| | in volatility, again as traders and
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| list should generally match the
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| | investors begin to adjust expectations
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| underlying movement in that benchmark
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| | for future prices. This can include
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| over time. It doesn't mean that it will
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| | profit upgrades or warnings, unexpected
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| naturally perform better or worse on an
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| | changes in economic policy, natural
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| individual stock basis, but if the FTSE
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| | disasters or geopolitical events.
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| 100 index was to rally by say 10% over
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| | If the volatility increases for the same
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| one year, the portfolio with a beta of 1
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| | investment amount, so does the potential
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| would in total expect to improve by a
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| | risk and reward and trade sizes/stop
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| similar amount.
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| | losses should be adjusted accordingly for
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| On a trading level, each stock has its
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| | CFD traders.
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| own beta which is important for CFD
| |
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|
