Stock volatility refers to a drastic decrease or increase in value experienced by a given stock within a given period. There is a relationship between the volume of a traded stock and its volatility. When a stock is purchased in large quantities, the stock price or value goes up sharply, but if the stock is sold in large quantities a few minutes later, the price or value of the stock experiences a sharp decrease. In other words, volatility occurs when there is an imbalance in trade orders for a particular stock.
- The relationship between a stock’s volatility and trading volume depends on the type of trading orders.
- Stock volatility increases with unexpected earnings results or company/industry news.
- A superficial analysis of beta and volatility shows that stocks with higher trading volumes have higher volatility and vice versa.
For example, if all or a majority of the trade orders for a particular stock are sell orders with little or no buy orders, then the stock's value will sharply decrease. So, the relationship between a stock's trading volume and its chances of volatility depends on the types of trading orders that are being received. If the stock's traded volume is high, but there is a balance of orders, then the volatility is low.
There are two key reasons why volatility might occur in a stock:
- Unexpected earnings results—if a company reports earnings that are better than expected, then there will be a lot of buy orders, and the stock value increases. However, if the earnings report is lower than expected, then the stock value will go down.
- Company or industry news—if there is good or bad news from a company or the industry, then there is an increase in volatility for the company's stock or stocks in that industry.
Low Volatility Stocks
Also, stocks that trade at very low volumes, which are far less liquid than those with higher average volumes, can have higher volatility than their higher-volume counterparts. In relatively illiquid stocks, any trading that is performed can have a drastic effect on the stock price because so few orders are placed. It is almost always safer to trade stocks with higher average trading volumes than stocks that are considered to be illiquid.
Measuring Volatility with Beta
One of the most popular measures of a stock’s volatility is beta. Beta is how volatile a stock is relative to the broader market—generally the S&P 500, with the S&P itself always having a beta of 1.0.
Analysis of beta shows that higher daily volume can often mean higher volatility, but this is not always the case. In fact, a higher trading volume may also suggest greater liquidity, which can moderate large price swings and reduce volatility.
Consider some of the most heavily traded stocks in the U.S.—Tesla Motors (TSLA), Apple, Inc. (AAPL), Advanced Micro Devices (AMD), and Microsoft (MSFT). These stocks trade with an average of tens of millions of shares per day. However, their volatilities are quite varied: AMD and Tesla trade with around a 2.0 beta, while Apple and Microsoft have betas closer to 1.0.