Traders and investors everywhere are spooked by volatility whenever it rears its head. We hear about it every time stocks take a tumble, even if that doesn't happen so much these days. So the Investopedia definition I'll show you is probably the last thing they're thinking of.
"Volatility: A statistical measure of the dispersion of returns for a given security or market index. Commonly, [emphasis mine] the higher the volatility, the riskier the security."
Now, that doesn't sound so scary, does it?
Volatility is nothing more than a statistical tool that shows how much a stock goes up or down. Yet many see volatility as a bad thing, because they equate it to risk. And risk is bad for us, right?
Well, sometimes risk is bad. But to the smart investor, volatility is a difference maker. Because without it, you might as well just buy a CD. More importantly, you have zero chance of beating the market. And where's the fun in that?
That's right: Without volatility, you don't beat the market.
That's why one of my 10 Trading Commandments is "Volatility is a trader's best friend!"
Now, let me prove it to you…
Directional Volatility Takes You "FAR" as a Trader
Think about volatility as merely the distribution of a stock's returns. The wider the distribution, the higher the volatility.
And the higher the volatility, the more the stock is moving, and that means we're getting paid if it's moving in our direction.
To beat the market, especially using options, we want volatility on our side. I call it the "FAR Principle" – fast, aggressive, and right.
I want a fast move to happen before my option expires. I need an aggressivemove that I can leverage with an option. And I need the move to be in the right direction to agree with my call or put.
Having volatility in my corner, along with picking the right direction, is how I (and you) get paid as an investor.