Volatility

Volatility puts a number on how bumpy the ride is. Two funds can post the same average return over a decade and feel nothing alike along the way, and volatility is the figure that separates them. It is quoted as an annualised percentage, so a fund described as 18 percent volatile has yearly returns that typically land within about 18 points either side of its own average.

It arrives in two forms that get confused. Realised volatility looks backwards, calculated from actual past returns as the standard deviation of returns. Implied volatility looks forwards, backed out of the prices people are paying for options right now. The two disagree often, and the gap between them is itself something traders take positions on. Volatility also scales with the square root of time rather than with time, so a daily figure becomes an annual one by multiplying by the square root of the trading days in the year, $\sqrt{252}$ on a market that has 252 of them, not by 252 itself.

The thing people get wrong is treating volatility and risk as the same word. Volatility counts a sharp gain exactly as heavily as a sharp fall, so an asset that triples in a jagged line scores as high risk while costing nobody anything. It runs the other way too: an investment whose reported price barely moves can still be carrying credit or liquidity risk that shows up in the numbers once and only once. For how much of an asset's movement comes from the market as a whole rather than from itself, see beta.