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An Introduction to Volatility in Stock Investments

How often have you heard a financial guy analyzing stock investments on TV say, “Well it looks like a volatile day as the markets plunge 700 points. . . .”? Volatility has garnered a bad reputation because roller coasters and weak stomachs don’t mix — especially when your financial future seems to be acting like a kite in a tornado.

People may think of volatility as “risk on steroids,” but you need to understand what volatility actually is. Technically, it isn’t really good or bad (although it’s usually associated with bad movements in the marketplace). Volatility is the movement of an asset (or the entire market) very quickly down (or up) in price due to large selling (or buying) in a very short period of time.

Volatility tends to be more associated with the negative due to crowd psychology. People are more likely to act quickly (sell!) due to fear than to other motivators (such as greed). More people are apt to run for the exits than they are to run to the entrance, so to speak.

Not all stocks are equal with regard to volatility. Some can be very volatile, whereas others can be quite stable. A good way to determine a stock’s volatility is to look at the beta of the stock.

Beta is a statistical measure that attempts to give the investor a clue as to how volatile a stock may be. It’s determined by comparing the potential volatility of a particular stock to the market in general. The market (as represented by, say, the Standard & Poor 500) is assigned a beta of “1.”

Any stock with a beta greater than 1 is considered more volatile than the general stock market, whereas any stock with a beta of less than 1 is considered less volatile. If a stock has a beta of 1.5, for example, it’s considered 50 percent more volatile than the general market. Meanwhile, a stock with a beta of 0.85 is considered 15 percent less volatile than the general stock market.

Therefore, if you don’t want to keep gulping down more antacid, consider stocks that have a beta of less than 1. The beta can be found easily in the stock report pages that are usually provided by major financial websites such as Yahoo! Finance and MarketWatch.

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