Risk and volatility: they are not really the same

risk and volatility in T-Advisor screener

We often read comments about the high volatility of any asset, as it would be a sign of a high risk. That is not necessary true, because you can find different assets with similar volatility and different returns: some positive and some negative.

Volatility reports about the variation of an asset price in a certain period or the deviation of its returns from the average. A high volatility suggests strong ups and downs in the asset price. That means for current investors that it is more risky, as they can lose money more quickly… but they can obtain also higher returns.

The question is that volatility is not a measure of risk taken as an only figure. It has to be linked with other measures. For instance, you have to watch the liquidity, because an illiquid asset is more risky, as it is more difficult to sell and obtain your money back.

Volatility also reports about the past, because it is the mirror where you find the information about what happened with the prices till today. You cannot obtain other information about risk. For instance, it does not report about the counterparty risk, let’s say, you invest in bonds and the issuer has no money to pay your coupon. To obtain those data, you have to look at other parameters.

The list of risk is long, but you cannot perceive them through the volatility. It is very important for investors to understand the difference, as many get good returns trading with the volatility of the asset. As we commented above, it can be an opportunity.

A relevant measure for the risk is the Value at Risk, also known for their initials VaR, but you have to watch also the diversification (in the case of a fund or your own portfolio), the correlation with other assets or the liquidity. To sum up, if you consider the volatility as the only way to control the asset risk, you will make a mistake. The risk analysis is a combination of several figures that have to be linked to obtain a global perception.

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