The Indomitable Investor: Why a Few Succeed in the Stock Market When Everyone Else Fails

Map of the Market

Volatility is the stock market’s central nervous system. Every stock and every index is measured in volatility. At any time, you can check the volatility of, say, Apple, or Goldman Sachs, or the Dow Jones Industrial Average, or oil, or gold, or almost any stock or index that you own or want to own. These data points are in such demand among sophisticated investors that the Chicago Board Options Exchange (CBOE) has created a big business making volatility indexes, all of which are available for free on its website.

Volatility is, of course, what happens when the Dow Jones Industrial Average rises or falls by a few hundred unexpected points. But volatility is also a mathematical idea that represents how much a stock’s price has changed in the past, and how it might change in the future. Volatility is expressed as a number. From 1991 to 2011, the Standard & Poor’s 500 Index has had an average volatility reading of 20. A utility stock, such as the Southern Company, typically has implied volatility of 12 percent. That means the stock barely moves. A biotechnology stock could have implied volatility of 140 percent or more. If a stock has low realized volatility, but high-implied volatility, it indicates that the most sophisticated stock investors expect the stock to make a big move. The only drawback using volatility to analyze and predict stock prices is that implied volatility only reveals if a stock is likely to move. It doesn’t tell you if the stock will move up ...