What it is and how to use it
What is it?
Historical Volatility (HV) measures the standard deviation of price changes over a specific period. It provides an empirical measure of how much the price of an asset has fluctuated historically. HV is commonly used to understand the past volatility of an asset and predict future price movements.
Who made it?
Historical Volatility is not attributed to a single creator but is a fundamental aspect of quantitative finance.
How is it calculated?
The formula for Historical Volatility (HV) is similar to Standard Deviation but applied to returns:
HV = sqrt((1/(N-1)) * sum((log(P_i / P_(i-1)) - μ)^2))
Where:
N is the number of periods.
P_i is the price of the asset at each period.
μ is the mean (average) log return over the periods.
Code (ProRealTime)
How do you use it?
Historical Volatility can be used in several ways:
Volatility Analysis:
Identify periods of high and low volatility to adjust your trading strategies accordingly. High historical volatility suggests larger price movements, making it suitable for traders looking for breakout opportunities. Low historical volatility indicates a more stable market, suitable for mean-reversion strategies.
Risk Management:
Historical volatility lets you set more informed stop-loss levels and position sizes.
Options Pricing:
HV is a key input in options pricing models to estimate the expected volatility of the underlying asset.
FAQ
Q: What are the best settings for Historical Volatility?
A: The default setting for Historical Volatility is 14 periods. You can adjust this based on your trading strategy and the asset you're analyzing.
Q: How does Historical Volatility compare to Implied Volatility?
A: Historical Volatility measures past price movements, while Implied Volatility is based on market expectations of future volatility. Both are useful but serve different purposes in trading.
Q: Can Historical Volatility be used alone to make trading decisions?
A: While Historical Volatility gives a good sense of past market volatility, it's usually best to combine it with other indicators to confirm signals and make more informed trading decisions.
Strategies using Historical Volatility
None so far.
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