Tag Archives: Value at Risk

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.

My goal in bearish markets: capital preservation

Markets are currently very volatile. We have lived a strong bearish period, but it is not sure that the bulls are coming, as the trend is not clear yet. In this case, panic is the worst adviser. On the contrary, investors have to analyse properly their portfolios to take right decisions. If you are not a trader, if you are a long-term investor, then you have to assume that it is difficult to avoid losses in some periods, moreover when all markets are dropping. So, your goal has to be another: capital preservation.

What does capital preservation mean? Your goal as investor must be to keep your assets with the less possible losses or, of course, to obtain benefits. As there are many changes in the long term, then you have to concentrate your worries in the bearish times: how much are you losing? The success is not to lose or lose less than the reference markets, but how can you get that information? The answer is smart benchmark.

Smart benchmark chart in T-Advisor

The picture above is very clear: my portfolio is losing, because I have invested in a market that is going hard into negative, but I only lose -2.4%, while the reference market (the smart benchmark) loses -14%. Not bad, huh?

As we regularly say, it is important to have available the right tools to analyse your investments and take decisions. Capital preservation has to be your first goal. Don’t lose money or lose the least. Then it the bullish times, your goal has to be to outperform the reference market.

The following chart is even clearer:

Portfolio risk figures

My Germany portfolio is much better than the benchmark: quite less losses in a bear period, less volatility and better Sharpe ratio.

What other tools do I have to consider risks in order to preserve my capital?

  • Analyse how your positions contribute to risk your portfolio. In this case, you can find out if you have an uncomfortable asset to be substituted.

Risk contribution chart in T-Advisor

Risk profile comment with portfolio risk in T-Advisor

  • Consider the diversification. In bearish periods, diversification is a great help to avoid hard losses. You can analyse it with the diversification benefit, that compares how much you win if your portfolio has different assets:

Diversification benefit in T-Advisor

  • Look at the Value at Risk, which measures the probability of having a certain level of losses. As you can see, my portfolio has the worst VaR, what means that I have to consider some changes in my allocation to avoid future losses.

Portfolio risk table in T-Advisor

All these figures will help you to understand your current position and risk. Then you can decide if you have to rebalance totally or partially your portfolio. The strategy is clear: keep your capital and set your portfolio to lose less in bad times and outperform the benchmark in growing times.

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.

Investor: watch these figures to select your assets

You are a new investor or with low experience in investments. You have available a good database to check possible asset to invest in, but which would be the right one? How can you select the most interesting assets for your goals? We recommend you to look into a database with high-quality reports about the assets. There you will find lots of information. Check the following figures to take a decision:

Figures to follow in investments

  • Performance: look at the historical performance. How good were the returns in the last months? And in the last years? It is true that past performances do not guarantee future results, but it show a trend about the long-term stability. It is not the same to get a share with positive and negative returns in different years than a one with regular positive returns.
  • Volatility: this is quite important. Volatility measures a deviation from a middle point. For instance, if the price goes up 4% one day and goes down 3% the following, the security is quite volatile. On the other hand, if the price goes up 0.2% three days and goes down 0.1% one day, it is less volatile. Take it into account depending your risk profile: if you are risk averse, you will not feel comfortable with a share that has high variations every day.
  • Trend: it is the development of a security in a timeframe. You have to consider the recent trend to decide to invest or not. A trend has a slope. If the slope is strong, it means that the trend has accelerated. For instance, if the slope is strong upwards, it can mean a bubble or that there is speculation behind the movement. On the other hand, if is very negative, it can mean a crisis in the company.

Chart to follow investments

  • A historical chart: an image is worth more than a thousand words. It is easy to detect the items mentioned above in a chart. The best one is an active chart where you can choose different timeframes.
  • Value at Risk (VaR): this is an advanced item, but very useful. What does it measures? The probability of losses in a timeframe. You will read “VaR one week” or “VaR one year”. It indicates that you can lose at maximum the written figure with a 95% probability. In other words: if you invest in that asset, you can earn, you can lose less than the indicated figure in the VaR, you can lose at maximum that figure with 95% probability and you can lose more than that maximum with 5% probability. These are the scenarios that you have to analyze. The highest VaR it is, the highest risk you accept.

This is the beginning. There are some more that we will comment in future posts. The T-Report in T-Advisor offers all these data. Check it in our platform.