How this number is made
A volatility target sizes the position so the capital, scaled by the position, has the volatility you want. If the asset moves twice as much as the target, you hold half the capital in it. The rest stays in cash earning nothing in this sketch. The asset volatility has to be a forecast you believe, in the same units as the target, usually annualized.
- Both volatilities are percents per year, or both are daily. Do not mix them.
- A target above the asset’s volatility means a leveraged position, above 100% of capital.
Formula
Weight = target volatility ÷ asset volatility. Dollars = capital × weight.
Worked example
With the figures already in the form, dollars to hold is $500,000.
Questions
Is this risk parity?
Risk parity splits risk across several assets. This is one asset against cash.
What if volatility doubles after I buy?
The same formula then says cut the position in half. This page does not watch the market for you.