Volatility measures how much the returns of your portfolio fluctuate on a daily basis. You want to try to minimize the volatility of your portfolio to demonstrate you can make consistent returns.
The Math Behind Volatility
At the end of each day, we log that day's return and compare them to all of your other day's returns. The more these numbers vary the higher your volatility is.
Volatility is calculated by taking the Standard Deviation of your daily returns.
Day 1 returns: 1%
Day 2 return: 3%
Day 3 returns: -3%
Day 4 returns: 0.50%
Day 5 returns: -2%
You can use Excel or Google sheets to calculate the Standard deviation of this set of numbers.
Standard Deviation of (1%,3%,-3%,0.5%,-2%) = Volatility = 2.41%
What is Standard Deviation?
Standard deviation measures the amount of variation in a set of values, (in volatility these values are your daily return rates).
Standard Deviation will take all of your daily return rates as inputs, and determine 3 buckets of variation. Each variation bucket is known as a standard deviation, notated with the symbol "sigma": σ.
Each bucket is named 1σ, 2σ, 3σ. On the spectrum, the middle is your mean (average).
The curve fits all your data points, the wider the range, the higher the volatility.
If σ = 1.5% , and the mean (average) is = 0.5% ; +1σ = 2% and -1σ = -1%.
This means approximately 68.2% of the time your daily returns are between -1% and +2%.
Tips to Keep in Mind:
Tip#1. You don't need to thoroughly understand the math to minimize your volatility, but learning basic statistics through a few Youtube videos will give you a clearer understanding of visualizing volatility.
Tip#2. Volatility is about generating consistent returns every day. Set reasonable return goals that you can achieve think you can achieve every day.
Tip#3. Create rules of when to sell, and stay disciplined. If you can manage the upper bound and lower bound of your returns, you can manage your volatility.
While generally the lower the volatility the better, you need to generate a certain amount of volatility in order to generate returns.
To have a volatility score, the volatility of your portfolio must be greater than 1%.