Typical Volatility Distributions

It is often convenient to look at a volatility distribution of prices. This can provide us with a graphic indication of where prices might be in the future. The normal bell curve is sometimes used to represent the distribution of prices in any market. The y axis is the chance of the price occurring and the x axis is the price of the future.

A much wider distribution of prices suggests there is a greater chance the market will make more extreme price moves than the distribution. The second distribution is more volatile because there is greater percentage price movement. This means there is a greater chance of observing a wider range of prices in more volatile markets than in less volatile markets. Note how there is a better than 5% chance of seeing the price of 10 or 90 with the more volatile market.

The lognormal distribution has a characteristic skew which allows for greater price movement on the upside than the normal distribution. This type of distribution is generally more representative of a market for various reasons. For example, some markets have exhibited a historical bullish bias such as the stock market, so there may be a greater probability for the stock market 10 go higher than lower. Another reason is that some commodities, such as coffee or oil, have manifest large explosive up-moves in the past which have been much greater than the downside moves. There are floor prices to many commodities which are not always apparent on the upside.