Volatility measures how much and how quickly prices change over a given period. A highly volatile asset has large, rapid price swings — it might move 5% in a day. A low-volatility asset moves slowly and predictably. Volatility is neither good nor bad; it creates both opportunity and risk. Understanding it is essential for stop placement, position sizing, and strategy selection.

Historical Volatility

Historical volatility (HV) is a backward-looking measure calculated from actual past price movements. The standard calculation is the annualized standard deviation of daily log returns over a set period (typically 20 or 30 trading days). A stock with a 30-day HV of 40% has been moving at a rate that, if continued for a year, would produce a 40% standard deviation in annual return.

ATR (Average True Range) is a simpler, more trader-friendly measure of historical volatility. Rather than calculating standard deviation, it averages the actual daily price ranges, making it easier to translate directly into stop loss distances.

Implied Volatility

Implied volatility (IV) is derived from options prices — it's the market's forward-looking estimate of how much an asset will move over the option's lifetime. If a stock's options are priced at an IV of 60%, the market expects roughly a 60% annualized standard deviation in price movement. Unlike historical volatility, IV represents consensus expectation, not measured past behavior.

IV spikes around binary events: earnings announcements, FDA decisions, FOMC meetings. After the event passes, IV typically collapses — this is called an IV crush — and options bought before the event often lose value even if the price move was large.

Using Volatility in Trading

Stop loss sizing: Wider stops are needed in high-volatility conditions. An ATR-based stop automatically accounts for this — it widens when ATR increases and tightens when conditions calm.

Position sizing: Higher-volatility instruments require smaller position sizes to keep dollar risk constant. A stock with a 3% average daily range requires a smaller position (fewer shares) than one with a 0.5% average daily range, if both are set to the same dollar risk.

Strategy selection: Trend-following strategies work better in high-volatility conditions; mean-reversion strategies often work better in low-volatility, range-bound markets.