# What All Volatility Calculations Are Missing

Volatility is one of the main ways we describe risk in the managed futures world, and it’s reflected in the calculation of several other measures of a CTA risk/return profile (like Sharpe Ratio). But last November, Newedge released a paper arguing that the typical method of calculating volatility is flawed because it leaves out an important factor: autocorrelation. Recently, Futures and Options World summarized Newedge’s findings in a more layman-friendly write-up, so we thought it would be worth revisiting the topic for those who wanted the plain English version. (Or you can read the original Newedge research here).

Typically, volatility is calculated by multiplying the standard deviation of a CTA’s returns by the square root of the time series. In other words, if you’re looking at a monthly time series, you would multiply the standard deviation by the square root of 12 (the number of months in a year) whereas if you had a weekly time series you would multiply it by 52 (weeks in a year) and for a daily time series you would use 252 (roughly the number of trading days in a year). This gives you the volatility in percentage terms.

Newedge’s research argues that the drawdowns CTAs experience don’t always match what we would expect based on their volatility, and they point to autocorrelation as the missing piece of data. You see, the typical volatility formula assumes that one period’s returns are independent of any others – that whether a CTA made or lost money in one month will have no bearing on whether or not it makes or loses money in the next month. But when a CTA exhibits autocorrelation that assumption no longer holds true. Positive autocorrelation means that whatever happened last is more likely to happen again (winners win and losers lose) while negative autocorrelation means that whatever happened last is less likely to happen again (reversion to the mean).

And according to Newedge’s work, trend following CTAs tend to exhibit negative autocorrelation. (Just more reason to listen to our advice about the benefits of allocation during a drawdown, although of course past performance is not necessarily indicative of future results). So for most trend following CTAs, Newedge’s work would suggest that we are consistently overestimating their effective volatility (and underestimating it for managers who exhibit positive autocorrelation).

We won’t be switching over all of our volatility calculations to incorporate autocorrelation just yet, but it’s definitely something to keep an eye on.

Disclaimer
The performance data displayed herein is compiled from various sources, including BarclayHedge, and reports directly from the advisors. These performance figures should not be relied on independent of the individual advisor's disclosure document, which has important information regarding the method of calculation used, whether or not the performance includes proprietary results, and other important footnotes on the advisor's track record.

Benchmark index performance is for the constituents of that index only, and does not represent the entire universe of possible investments within that asset class. And further, that there can be limitations and biases to indices such as survivorship, self reporting, and instant history.

Managed futures accounts can subject to substantial charges for management and advisory fees. The numbers within this website include all such fees, but it may be necessary for those accounts that are subject to these charges to make substantial trading profits in the future to avoid depletion or exhaustion of their assets.

Investors interested in investing with a managed futures program (excepting those programs which are offered exclusively to qualified eligible persons as that term is defined by CFTC regulation 4.7) will be required to receive and sign off on a disclosure document in compliance with certain CFT rules The disclosure documents contains a complete description of the principal risk factors and each fee to be charged to your account by the CTA, as well as the composite performance of accounts under the CTA's management over at least the most recent five years. Investor interested in investing in any of the programs on this website are urged to carefully read these disclosure documents, including, but not limited to the performance information, before investing in any such programs.

Those investors who are qualified eligible persons as that term is defined by CFTC regulation 4.7 and interested in investing in a program exempt from having to provide a disclosure document and considered by the regulations to be sophisticated enough to understand the risks and be able to interpret the accuracy and completeness of any performance information on their own.

RCM receives a portion of the commodity brokerage commissions you pay in connection with your futures trading and/or a portion of the interest income (if any) earned on an account's assets. The listed manager may also pay RCM a portion of the fees they receive from accounts introduced to them by RCM.

Disclaimer
The performance data displayed herein is compiled from various sources, including BarclayHedge, and reports directly from the advisors. These performance figures should not be relied on independent of the individual advisor's disclosure document, which has important information regarding the method of calculation used, whether or not the performance includes proprietary results, and other important footnotes on the advisor's track record.

Benchmark index performance is for the constituents of that index only, and does not represent the entire universe of possible investments within that asset class. And further, that there can be limitations and biases to indices such as survivorship, self reporting, and instant history.

Managed futures accounts can subject to substantial charges for management and advisory fees. The numbers within this website include all such fees, but it may be necessary for those accounts that are subject to these charges to make substantial trading profits in the future to avoid depletion or exhaustion of their assets.

Investors interested in investing with a managed futures program (excepting those programs which are offered exclusively to qualified eligible persons as that term is defined by CFTC regulation 4.7) will be required to receive and sign off on a disclosure document in compliance with certain CFT rules The disclosure documents contains a complete description of the principal risk factors and each fee to be charged to your account by the CTA, as well as the composite performance of accounts under the CTA's management over at least the most recent five years. Investor interested in investing in any of the programs on this website are urged to carefully read these disclosure documents, including, but not limited to the performance information, before investing in any such programs.

Those investors who are qualified eligible persons as that term is defined by CFTC regulation 4.7 and interested in investing in a program exempt from having to provide a disclosure document and considered by the regulations to be sophisticated enough to understand the risks and be able to interpret the accuracy and completeness of any performance information on their own.

RCM receives a portion of the commodity brokerage commissions you pay in connection with your futures trading and/or a portion of the interest income (if any) earned on an account's assets. The listed manager may also pay RCM a portion of the fees they receive from accounts introduced to them by RCM.