When the Benchmark S&P BSE Sensex moves 500 points in a single day and then retraces that move entirely the next day, it appears volatile. Market volatility seems to be racing upwards with the benchmark indices flip-flopping 1-1.5% on a daily basis. While the absolute levels of spikes in the benchmark prices might make it appear that the volatility is at a peak, if you consider the numeric indicators, current volatility is below average. Here is how you can measure the volatility in an index and compare it to understand the change.

Standard deviation

This is the most commonly used measure to determine volatility. Volatility refers to the change in price of an index or a security; this change can be an upward or a downward movement. Standard deviation measures the movement away from the average in a data set. So, if the standard deviation of annual returns for an index is 5% and the rolling average annual return is 8%, then the expected return most of the time will be in the range of 3-13%. Currently, the standard deviation of daily returns on the Nifty is 1.6-2.0%; this isn’t much higher than the seven-year average of 1.5%.

Standard deviation is a backward looking or a lag indicator and, often, isn’t considered the most accurate measure of volatility for market-linked securities, as there can be sharp spikes in performance in either direction, which distorts the picture. It is used to analyse the market movement along with other relevant data.

India VIX

Another measure of market volatility, which has gained relevance in the past few years, is the Volatility Index (VIX). India VIX is an index created and computed by the National Stock Exchange. The index measures markets’ expectation of volatility in the near term. This is computed by looking at the change in order book of the underlying Nifty options. Unlike the Nifty, which is a price index, this is reported as a percentage and is a forward-looking indicator. The VIX uses the bid ask quote of Nifty options in the near- and mid-month contracts.

The India VIX index shows the current expectation of market’s volatility. More specifically, it shows the expected market volatility over the next 30 days. The way to read it is that higher the index value, higher is the expected volatility in the benchmark index.

At present, India VIX is around 20%, up from 14-15% a month ago; but this is still lower than the seven-year average of 24.5%.

How volatile are markets?

While markets have become relatively more volatile in the past 10 days, the overall volatility isn’t extraordinary if you consider the historical averages of both indicators. For example, towards the end of January 2008, India VIX had moved up to a range of 40-50% and the daily standard deviation for Nifty returns moved to 3-6%. In more recent months, India VIX has largely been in 13-15% range and the daily standard deviation of Nifty around 1% or less. Hence, the recent volatility is in focus.

Given the uncertainty around domestic news and events, the volatility in markets is expected to continue from the next few weeks.

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