Tag Archives: liquidity

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.

What market opportunities do we post and why?

T-Advisor, your suite for self-directed investment management, has a module to help investors find new ideas to improve their returns. These “Investment ideas” has a list of market opportunities from exchanges around the world that our algorithm selects and update every Monday. That is why we post every week a selection of them, but what criteria do we use to choose you some of them?

First of all, we look into all the markets to find what stocks have been selected. The screen shows initially just some figures from the securities of each market. We take into account the trend. We opt for the ones with bullish trend and with less than 1% slope. Why? Because we prefer stable and progressive increases instead of sudden ones which makes the security more volatile.

Market opportunities screen in T-Advisor

The selection keeps on checking several figures in the T-Report:

  • The liquidity grade: it has to be higher than 5
  • The score: it has to be also higher than 5 or 6
  • The performance: it has to be positive in the year and show also a positive figure in the last year, to confirm that the stock did not suffer a strong variability.

T-Report screen with liquidity, score and performance

Finally, we also look the 1-year chart. We avoid charts with strong variations or sudden jumps upwards. We prefer steady positive trends to avoid high risks. You can find the difference clearly in these charts:

Chart with low slope in T-Report

Chart with high slope in T-Report

We consider that investments should be for a long-term. Trading is also a possibility for investors. We are not critical with it, but we prefer a more stable model. That is why our weekly proposals tend to be bets for that idea. Of course, markets change daily, but it does not mean that investors have to react immediately to every event. Portfolios should tend to be stable and include changes when your goals and risk profile change, because you evolve also as investors, or when your securities do not play a positive role anymore. That is why it is relevant the long-term view. That avoids sudden changes… and mistakes guided for the moment.

Investment risk: some figures to watch in the assets

Risk chapter in a T-Report in T-Advisor

When you are an investor, you accept some risk. We have already written about the different kind of risks in investments. The question is: can we measure the risk? Well, risk is a qualitative ratio, but we can obtain some clues through quantitative measures.

Volatility is one of these measures. Does it mean that high volatility is the same as high risk? It depends on the asset. First of all, volatility does not measure the risk, but the price variation in a certain period. If there is a high diversion from the average price, it is very volatile. Of course, it is risky, as far as the prices change sharply and the investor can win or lose suddenly. However, think about another asset, as housing. Prices are no so volatile, but it is risky, because you have another risks: counterparty risk, inflation risk…

The liquidity grade is also important to measure the risk, as an investor can perceive how often the asset is purchased or sold. A low liquidity shows that the asset has a high risk that you cannot find a buyer when you want to sell it.

One of the most important measures for risk is Value at Risk, broadly know by its initials VaR. This index shows how much an investor can lose at the most with a probability of 95% in a certain period. The higher is the figures, the more risky is to lose money.

Correlation offers also a clue about the risk. This figure has a range between -1 and 1. In this case, the asset is compared with another asset, with its sector or with the reference stock index. If the correlation is 0 or near to 0, there is no correlation. If is 1 or near 1, there is a high correlation: the asset moves following the trend of the reference. On the other side, if is -1 or near -1, there is an inverse correlation: the asset moves in the opposite trend of the reference. This is very useful for negative waves, for instance.

As you can see, risk has no concrete measure. You have to look into figures to discover if the asset is risky and if the risk level of the asset is acceptable for your profile. The T-Report in T-Advisor gives full details about all the data about risks that an investor need to know to take decisions.

Liquidity and volatility, inverse relationship

T-Advisor volatility and liquidity figures

Finance markets have a steady factor to be considered: risk. When we invest our money in any asset, we take a risk, because it is not given for sure that the value will increase so much as we expect. Even we cannot be sure if the value will increase.

The analysis about the risks in our investments has to take into account two measures: liquidity and volatility. The liquidity reports about the asset’s ability to be sold without changing significantly the price and with the minimum loss. For instance, housing is less liquid than bonds or stocks. This example is easy to perceive, but it is not so easy, when we compare stocks or bonds. Technical and fundamental analysis tools are needed.

On the other hand, volatility reports about the variability of an asset’s price in a certain period. In other words, how far are current prices from its average. The more changes up and down, the more volatile. There are many reasons that alter highly the prices: a crisis, rumours, figures, political or economical decisions. There are some references to measure volatility in stocks indexes: VIX for S&P500, VXN for Nasdaq or VXD for Dow Jones, just to mention some of a long list.

Separately, both measures offer the investor some information, but linking both the investor obtains much more. There is an inverse correlation, because a very volatile asset is less liquid. Money exposes to more losses when we play so risky. But the ones who follow markets and use tools to be reported about stocks for trading can get higher revenues profiting from this violent changes in the prices.

This is, for instance, the case of T-Advisor. The suite offers graphical studies about volatility and liquidity of every stock. An investor has available the last 6 years volatility figures and the risk evaluation. It also compares the stock volatility with the main stock indexes as MSCI or Euronext. After having the best information, it is just the investor decision: how risky is your investor’s profile?

T-Advisor board for volatility compared with indexes