Equity markets have plenty of reasons to be volatile. Whether you stay invested for the long term or short term, everything investors do does impact the market and share prices. Other reasons such as geopolitical tensions and macroeconomic development can also cause market volatility, a measure of price fluctuation. So higher the volatility, higher the price fluctuation.
It is important to understand how volatility plays a key role in selecting stocks. Standard deviation is the primary parameter to measure volatility and is a number used to measure a fund’s volatility and risk. So a low standard deviation means most numbers are close to the average and a high standard deviation means the numbers are more spread out.
An average gives us a single value which represents the numbers it is calculated from, so using an average from the actual numbers is comparatively easier. For example, the average age of children in kinder garden is three years. But if you walk into a school thinking the average age of students would be around 12, it wouldn’t be completely wrong. But generally, the average age would be around 5-18 years. The average here isn’t wrong but the accuracy here isn’t hit the mark either. The figures would have been more accurate or useful if you were told, most individual ages in the kinder garden were close to the average, and most of the individual ages in school were far from average and this is what standard deviation does. It helps you with a quality rating of an average and tells you how closely an average represents the underlying numbers.
The standard deviation concept was introduced by Karl Pearson in 1893 in the most widely used measure of dispersion. This method is free from the defects which afflicted in previous methods and satisfies most of the properties of a good measure of dispersion. It takes the deviation of the items from the actual mean and assumed mean.So when a fund has high standard deviation, it means the range of performance or greater volatility. Though it is not a thumb rule, in general an investor should avoid funds with a high standard deviation of over 20 percent.