Glossary
Volatility Targeting
Position-sizing rule that scales exposure inversely with realized volatility to hit a constant target risk level. Standard in CTA and systematic equity portfolios.
Sentivue Capital··4 min read
Volatility targeting is a position-sizing rule that scales exposure inversely with realized volatility to maintain a constant target risk level. If realized vol doubles, position size halves.
Mechanic
position_size = (target_vol / realized_vol) × notional
Realized vol is typically a 20- to 60-day exponentially weighted standard deviation of returns. Target vol is set institutionally — common values: 8–12% annualized for diversified portfolios, 15–20% for single-strategy futures programs.
Why it works
- Vol clusters. Today's high vol predicts tomorrow's high vol better than chance. Scaling down preempts drawdowns.
- Smoother equity curve. Compounding penalizes vol — a constant-vol strategy compounds faster than the same strategy with vol drift.
- Comparable units. Strategies sized to identical target vol can be combined and compared on equal footing.
When it hurts
- Mean-reverting markets after vol spike. You scale down right as the move reverses. Common in equity index reversals.
- Persistent regime shift to low vol. You lever up into a complacent market and get whipsawed when the regime breaks.
- High-frequency strategies where the realized-vol estimate lags the relevant horizon.
Practical guardrails
- Cap maximum leverage. The formula will happily recommend 10× when realized vol crashes.
- Floor minimum position size when realized vol explodes. Below ~10% of notional you're effectively flat — better to honestly flatten.
- Use exponential weighting; equal-weight rolling vol overweights stale observations.