Volatility targeting
Scale positions to a volatility target · 8 min
- Volatility forecast (EWMA, annualised)
Calm years at around 15 to 20%, and storms that triple it.
A market’s volatility doubles from 15% to 30% a year. To keep your position’s risk at a 10% target, the position should…
Volatility targeting sizes a position so that its expected risk stays constant: weight = target volatility ÷ forecast volatility. When the market gets wild the position shrinks; when it calms down the position grows, up to a leverage cap.
Because volatility clusters, recent volatility is a usable forecast, and a constant risk budget makes results comparable across markets and years. It is not magic: the forecast reacts after the first big day, so gaps and sudden shocks still hit at full size, and after a storm the rule adds exposure as things calm, which can be early.
- Volatility-targeted
- Fixed size
- Target
- Position, multiple of capital
Both are always long the same market. Only the size differs: fixed, or target ÷ forecast volatility (capped at 4×). Each day's size uses only returns that closed before that day.
Generated markets, not real data. They show how a rule depends on the market it meets; they do not predict how real markets behave.
Resizing when volatility rises
- Capital, target
- $100,000, 10%
- Market volatility 25%
- weight 10 ÷ 25 = 0.40 → $40,000
- Volatility rises to 40%
- weight 10 ÷ 40 = 0.25 → $25,000
- Trade
- sell $15,000
You hold $60,000 at a 12% target. The volatility forecast doubles. What do you hold now?
Compared with a fixed size of the same average risk, what does volatility targeting usually do to drawdowns in a market with volatility storms?
Capital $50,000, target 10%, market volatility 40%. What position value?
Missed questions come back for review after one day, then three, then a week.
Capital $100,000. You target 15% annual volatility on a market whose volatility is 20% a year. How much should the position be worth (in $)?
Hint: Position value = capital × target volatility ÷ market volatility.
Three years of a fresh generated market are on screen; the next two years do not exist yet. Tune the rule on what you can see, commit to two predictions, then generate the future.
- Your rule so far
Over the next two years, after costs, this rule will…
What kind of market is this?
Generated markets, not real data. They show how a rule depends on the market it meets; they do not predict how real markets behave.
Want to feel it candle by candle? Size through storms in the volatility-clusters market →