Inverse volatility is an allocation method that weights each instrument in inverse proportion to its own risk: the calmer the instrument, the larger its weight. It looks at each instrument on its own and ignores how the instruments move together, which is what Min correlation and Risk parity take into account.
Also seen as: inverse-variance weighting, volatility-weighted allocation, inverse-volatility weighting, 1/σ weighting
How does Inverse volatility set weights?
Inverse volatility gives every instrument a raw score of one divided by its risk, then rescales those scores so the weights add up to 100%.
- the weight of instrument i
- instrument i's risk over the historical window
- the sum of the raw scores of every instrument in the strategy, so the weights always total 100%
How does Fincanva handle it?
- Risk measure defaults to Annualized volatility; Max drawdown is the alternative.
- Inverse volatility is included from the Starter plan, at the strategy level and inside a Combined alike; the Free plan does not offer it in either place. See what each plan includes.
- The calculation window (In-sample) defaults to 12 months. With Annualized volatility it is a choice of 1, 2, 3, 6, 12, 18 or 24 months, the only lengths the engine accepts for that measure; with Max drawdown it takes any whole number of months from 1 upward. See which window lengths you can choose.
- Weights are recomputed at every rebalance from the risk figures measured over the window ending at that date, so they change over the life of a backtest.
- There is no weight floor or ceiling: a very calm instrument can end up with a large share, and adding a highly volatile instrument barely moves the totals.
Which risk measure does Inverse volatility use?
The Risk measure control decides what "risk" means for this method, and the app describes the two options exactly like this: "Annualized volatility = how much the price fluctuates · Max drawdown = its worst historical loss".
| Risk measure | What it reads | Effect on weights |
|---|---|---|
| Annualized volatility (default) | each instrument's annualised standard deviation of returns | instruments whose price fluctuates less get more weight |
| Max drawdown | each instrument's largest peak-to-trough decline | instruments whose worst historical fall was smaller get more weight |
Both measures are read over the calculation window — the field labelled In-sample in the strategy editor — which sets how many months of history the risk figures cover. What changes when you switch between them is covered in risk measure selection.
Where can you use Inverse volatility?
Inverse volatility is available at both levels. Inside a single strategy it weights the instruments the strategy holds; inside a Combined it splits capital across the strategies the Combined contains. A Direction control (Long-only or Long/short) appears only at the strategy level — a Combined's split across its member strategies is always positive.
What does it look like in practice?
A strategy holds two instruments. Over the window, instrument A has an annualised volatility of 10% and instrument B of 30%. The raw scores are 1 ÷ 0.10 = 10 for A and 1 ÷ 0.30 = 3.33 for B, which total 13.33. Rescaling gives A a weight of 10 ÷ 13.33 = 75% and B a weight of 3.33 ÷ 13.33 = 25%. The calmer instrument ends up with three times the weight of the volatile one, purely because its volatility is three times smaller.
How is Inverse volatility different from Risk parity?
Inverse volatility reads each instrument's risk in isolation, while Risk parity equalises how much risk each instrument contributes to the finished portfolio, which depends on correlations as well as individual volatilities. The two coincide only in the special case where every instrument is uncorrelated with every other; as soon as some instruments move together, they produce different weights.
Fincanva describes how these methods work; it does not recommend one. See Is this financial advice?.