Volatility is the metric that measures how much the price of an asset or financial product has changed over a given period of time. If a trading price has gone up or down frequently and significantly, the underlying asset or product is considered highly volatile. This metric is helpful to investors since it can give an indication of the future risk associated with any investment. If the price has historically risen and fallen frequently, you might end up investing just before the price plummets again, losing a lot of value in the process.
If most or all of the goods, products, and financial instruments traded in a specific market sector are highly volatile, these markets are called volatile markets as a whole. For example, his is the case for the energy market, which has experienced long periods of prices jumping up and down. In many cases, this has to do with the stock market being influenced by macro-scale events such as OPEC limiting the amount of crude oil they produce. However, many observers argue that trader behavior can also lead to high volatility in entire stock market sectors. For example, herd behavior can lead to the majority of traders selling or buying a specific stock simply because everyone else is doing it. Such a sudden spike (or drop) in stock prices may cause the respective stocks to be considered more volatile.
While there are various ways of calculating volatility, depending on which parameters a specific trader prefers to rely on, the most popular method is standard deviation. This metric is based on the difference between the mean price of an asset and its average price over a specific period of time. What's important here is that this means that volatility cannot be predicted with 100% accuracy since it is measured based on past performance. In other words, when it comes to determining the volatility of an investment opportunity, investors will usually have two metrics to work with:
- Historical volatility uses historical price data to describe accurate volatility numbers over a specific timeframe in the past.
- Annualized volatility describes how volatile an asset may be over a year, extrapolated from past data and from a shorter timeframe.
This means that volatility is a valuable tool that you can use to influence your investment decisions, but it should never be taken as a guarantee of future results.
If you don't want to calculate volatility manually, you can also rely on others to do it for you. The CARL app shows the annualized volatility of all funds currently available, while various indices such as the Chicago Board Options Exchange's CBOE Volatility Index (VIX) track stock market volatility. In the case of the VIX, it calculates according to the stocks tracked by the S&P 500 index.
Market volatility as a whole or stock volatility individually can bring a measure of uncertainty into your investments. Buy stock on highly volatile markets, and your boldness may be rewarded with significant returns because prices suddenly rise – or prices may plummet, leaving you only two options: hold out and hope for better days or sell at a loss to get out of the investment before the situation turns even worse.
So while volatility is often negatively equated with risk, this assertion only tells half the story. Volatility does mean higher risk, but with the potential of significantly higher investment returns. Hedge funds all over the world have proven that high-risk investments aren't something to be avoided entirely, but rather an opportunity to generate significant returns as long as you use hedging strategies to protect yourself from potential adverse effects.
This investing style aims to only invest in assets with low volatility. The investor determines the maximum amount of risk they aim for and then invests only in bonds, stocks, futures, and similar securities, which are less risky than their chosen threshold. This approach doesn't often lead to great returns in the short term, but low-volatility investing has been shown to be very effective over very long periods of time. This is because of the "Low Volatility Anomaly", which poses that low-volatility investing often becomes comparatively profitable over very long-term timeframes.
In other words, if you're looking to maximize your returns over the next couple of years, this investment style may not be the one for you. But if you have multiple decades of time to spare, you can actually do very well investing only in less volatile markets.
This investment style is typically employed by hedge funds – invest in highly volatile assets (while hedging your bets through strategies like long/short) to get significant returns in the end.
In investment terms, taking greater risks often corresponds directly with generating greater returns. Or, as the saying goes: Nothing ventured, nothing gained!
In fact, quantitative hedge funds such as the ones that CARL offers can perform particularly well in high-volatility environments. That's because their computer algorithms are typically able to predict macro-scale market changes to a certain extent. Computer simulations are also able to react more quickly to small-scale changes, which allows them to take advantage of minor inconsistencies and short-term developments in asset prices. This is similar to high-frequency trading, though quantitative hedge funds can invest in a variety of securities and other investment vehicles, which may not be available to all high-frequency traders.
Day traders operate on a similar principle – they keep track of an asset's price on a minute-by-minute basis and buy or sell whenever small fluctuations occur. Swing traders follow the same principle, except they work on a time scale of days or weeks. Both of these types of investors benefit from high volatility, but they can rarely bring the investment capital to bear which quants have at their disposal.
"Short vol" and "long vol" are terms that describe a number of investment strategies that feature either
- focusing on having long positions in your portfolio, which benefit from rising market volatility or
- having a portfolio with lots of short positions which benefit from markets becoming less volatile.
Alternatively, you may want to take a look at options as an alternative investment opportunity. Options allow you to buy or sell an asset at a pre-determined price at a pre-determined future date. This means you can essentially "bet" on volatile stocks to gain more value over time – and if you turn out to be wrong, all you've lost is the premium you paid for the option.
If you're looking to seriously grow your wealth, CARL can give you access to sophisticated quant hedge funds as well as the tools you need to start investing. Being a type of hedge fund, these quants are primarily focused on high-volatility trading, offering a magnificent 15%+ targeted returns.
That being said, hedging strategies make sure to limit the risk your money is exposed to. And the CARL app provides you with a variety of valuable metrics to inform your investment decision. From historical analyses to annualized volatility for each of our quants, you'll get to understand our quants fully before you invest even a single cent in them. And you don't even need to do the calculations yourself to know how volatile they are.
You can also use CARL's real-time portfolio overview to take a look at the exact structure of your investments at a moment's notice. This is very helpful when trying to determine the overall risk to which your portfolio is exposed – just take a look to determine if you should start diversifying. And if the risk turns out to be too much for you, you can withdraw your capital on a monthly basis, as our quants have no lock-up periods.
Make informed investment decisions to invest in high-yield hedge funds with CARL or combine our quants with low-volatility investments to diversify your portfolio – it's up to you to take your financial future into your own hands today.