Different Approach to Volatility

In many academic circles volatility is a measure for risk. Though it is accepted by many investors because they believe that low volatility in their return is equivalent to low risk, I believe otherwise.  I believe that volatility has different forms.

High Volatility

Low Volatility

By itself high or low volatility really is confusing. As most of you probably know, there are times when there is an uptrend paired with high volatility. Also there are times when there is a sideways market paired with high volatility.

To light up the place, I have come across different ways to measure good and bad volatility. The man behind the blog Engineering Returns, Frank Hassler has come up with his own Trend strength Index which takes in to account both volatility and momentum (direction). Another indicator of interest would be Kaufmans Efficiency Ratio. Over at CSS Analytics, their proprietary LTR ranking index uses something similar I am guessing.

Both of the above indicators measure volatility along side with direction. There are so many applications for this in different strategies. To take it further why not find the correlation between volatility and momentum? Rank it and overlay it with a rotational system would be a great idea.



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