Measuring Volatility and Risk

Volatility measures how much an asset's returns vary over time. High volatility means larger price swings; low volatility means more stable prices.

Standard Deviation: The Primary Volatility Measure

Annualizing Volatility

Maximum Drawdown

Maximum drawdown measures the largest peak-to-trough decline - crucial for understanding worst-case scenarios:

Value at Risk (VaR)

VaR estimates the maximum loss expected at a given confidence level:

Complete Risk Analysis

Practice: Calculate Risk Metrics

Key Takeaways

• Volatility (std dev) is the primary measure of risk
• Annualize daily volatility: daily_vol x sqrt(252)
• Maximum drawdown shows worst-case peak-to-trough loss
• VaR estimates maximum loss at a confidence level
• Downside deviation focuses only on negative returns
• Higher returns usually come with higher volatility

Next, we'll explore correlation between assets for portfolio construction!