Weight By Inverse Volatility

A practical guide to ETF trading systems

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AFJ Garner
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Weight By Inverse Volatility

Post by AFJ Garner »

This system is similar in all respects to the other two Periodic Rebalance Systems (Equal Positions, Fixed Percentage) with one exception - the weighting scheme.

Those who do not own Trading Blox can test this system using a free on-line demonstration. Go to https://virtual.tradingblox.net/ and enter “ETFDemo” as the license name and key.

Inverse Volatility. At the start of each day, each stock is weighted in accordance with its inverse volatility. Inverse volatility is calculated as 1/standard deviation of returns over the parameter "stdDev Days" - the default setting being 90 days. Each inverse volatility measurement for each stock is added to arrive at a total for the entire portfolio. To arrive at the final allocation for each stock, the inverse volatility for each stock is divided by the total thus ensuring that the total allocations comes to 1 - in other words there is no margin incurred since 100% of available capital is invested.

The result is that more volatile instruments in the portfolio such as stock ETFs will be given a lower weighting than low volatile instruments such as a bond or money market ETF. This makes for a smoother ride, lower portfolio volatility and smaller draw downs than pure stock portfolios or even 60/40 mixes of stocks to bonds.

Other parameters need little explanation since they have been explained elsewhere.

Reallocation Timing. Allows you to re-balance at different periods from 1 week to 1 year.

Rolling Allocation Start. Periodic re-balancing dates are rolling not fixed to enable a more realistic picture than mere "end of period" re-balancing. The first reallocation date will be test start date+ 7 days for weekly (14 days for bi-weekly etc) + the "Rolling Allocation Start". At each subsequent periodic roll date, the next date will be calculated by adding 7 days, 14 days and so forth depending on the frequency chosen.

Adjustment Threshold. Set at 5%, no rebalancing will be made unless a stock is more than 5% over or underweight. Set at 0 rebalancing will occur regardless. The idea is to contain unnecessary turnover.

Buffer Setting Buffer to 5% means that an allocation will be reduced to 95% thus helping to ensure no margin is occurred; prices change from those an allocation was calculated on to those actually achieved when a trade is executed.

Rebalance? Setting Rebalance? to "none" will achieve a Buy and Hold System.

I am not giving investment advice - merely providing code and "education". Experiment with different portfolios, parameters and timescales and see if the system makes sense to you. If not, discard it!
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