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Chapter 5. Fundamental Volatility > Using Volatility to Pick Stocks

Using Volatility to Pick Stocks

How can we use fundamental volatility as a measurement of market risk and ultimately to pick stocks? Because market risk has been defined almost exclusively by price volatility, the definition of market risk remains an important issue. We propose that the appropriate definition should include investment value as a more important risk test than price. In this regard, the degree of volatility—both price and fundamental—is the key to defining risk itself.

It is logical and appropriate to view fundamental volatility as a more dependable measurement of market risk. If we make a distinction between technical market risk (based on short-term price volatility) and fundamental market risk (based on volatility in core earnings and in post-core-earnings operating results) we may arrive at an entirely different point of view. While price fluctuates for any number of reasons, logical or not, the core earnings fundamentals show the way to a more sensible and longer-term identification of market risk.


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