Inverse Volatility is an allocation method that weights each instrument in inverse proportion to that instrument's own risk: the calmer the instrument, the larger its weight, and the more volatile the instrument, the smaller its weight. It looks at each instrument on its own — it does not consider how the instruments move together, which is what Min Correlation and Risk Parity do.
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%.
where: is the weight of instrument i, is instrument i's risk over the historical window, and the sum in the denominator runs over every instrument in the strategy, so the weights always total 100%.
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.
Defaults in Fincanva
- Risk measure defaults to Annualized volatility; Max drawdown is the alternative.
- The calculation window (In-sample) defaults to 12 months and accepts any whole number of months from 1 upward.
- 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 rather than staying fixed.
- Inverse Volatility has 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.
Worked example
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?.
Where this term is used
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Fincanva provides no financial advice. Backtests show what would have happened — not what will.
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