How to Calculate the Volatility for a Portfolio of Stocks
Original post by Jeff Franco of Demand Media
Calculating the volatility, or standard deviation, of your stocks can provide you with information about the overall level of risk in your portfolio. Volatility measures risk as the average range of price fluctuations for each stock over a fixed period of time. Generally, a stock that is less volatile, meaning that the range in which the price fluctuates is relatively small, is an indication that the stock is not a risky investment.
Choose the period of time for which you want to calculate volatility. It is advisable to choose a period of time that is long enough to provide a sufficient amount of data but short enough to yield a result that is representative of recent economic conditions. Generally, choosing a period between one month and one year is sufficient.
Obtain the daily price for each stock during the period you choose. You can use the price the stock opens or closes at. However, once you make the choice, it’s vital that you remain consistent with the daily price you choose to extract.
Compute the average market price for each stock during the period. The formula for computing the average is equal to the sum of the stock price on each day the market is open divided by the number of trading days in the period you are evaluating.
Calculate the deviation for each day of the period. The deviation formula is equal to the difference between the daily market price and the average price for each stock during the period.
Square the deviation for each trading day. Squaring indicates that you must multiply a number by the same number. For example, if a deviation is equal to 0.5, you multiply 0.5 by 0.5, which yields 0.25.
Calculate the average of the squared deviations of each trading day. You can compute the average by summing the squared deviations and dividing the result by the number of trading days within the period.
Compute the standard deviation. The standard deviation is equal to the square root of the average of the squared deviations.
Tips & Warnings
- To eliminate the potential for mistakes in each of the calculations, it’s advisable to use an Excel spreadsheet rather than computing all calculations manually. The Excel program allows you to input a formula for each calculation, thereby minimizing the time it will take you to assess the volatility of your stock portfolio.
About the Author
Jeff Franco's professional writing career began in 2010. With expertise in federal taxation, law and accounting, he has published articles in various online publications. Franco holds a Master of Business Administration in accounting and a Master of Science in taxation from Fordham University. He also holds a Juris Doctor from Brooklyn Law School.