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Why Volatility Uses the Square Root of Time
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ticker lesson
Breakdown
0:00lesson
Volatility annualization and time adjustment
- Volatility expressed as annual number
- Annual volatility implies 1-year change ±78%
- Need to adjust to shorter timeframes for trading
- Use square root of time to convert annual to 17-day volatility
- Square root of time used in option pricing models
2:37lesson
Why square root of time is used in volatility
- Percentage changes in stock price are compared
- Average percent change of up/down 1% cancels to zero
- Square returns to calculate variance
- Variance is linearly related to time
- Standard deviation is square root of variance
5:10lesson
Volatility annualization for comparison
- Volatility numbers are annualized for apples-to-apples comparison
- Shorter timeframes show lower volatility numbers
- Longer timeframes show higher volatility numbers
- Annualization helps traders identify high/low volatility
- Example of volatility adjustment shown in slides
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