Volatility can open up opportunities for investors willing to ride it out, but for those who don’t have an iron stomach, there are low-volatility strategies that can be built into an exchange traded fund (ETF).
Inflation fears combined with geopolitical tensions between Russia and Ukraine are certainly fueling market movements in 2022. High-volatility equities can certainly cause market pain during a downturn, but they can also provide the biggest returns when a rally occurs.
When investors see red in their portfolio, it can be difficult to resist the urge to sell the biggest losers.
“If there’s been one constant through the first few months of 2022, it’s that volatility has come back with a vengeance,” a Kiplinger’s article says. “And yet as counterintuitive as it might sound, investors should think twice before dumping high-volatility stocks from their portfolios.”
However, there’s another choice if investor pain tolerance is low. As mentioned, investors with a low penchant for risk can look into funds like the First Trust Dorsey Wright Momentum & Low Volatility ETF (DVOL).
The fund seeks investment results that correspond generally to the price and yield performance of the Dorsey Wright Momentum Plus Low Volatility Index. The index is a rules-based equity index that is designed to track the overall performance of 50 stocks within the NASDAQ US Large Mid Cap Index that exhibit the lowest levels of volatility while maintaining high levels of relative strength.
Gauging Momentum While Limiting Volatility
If the trend is an investor’s friend, then momentum could be their biggest ally. That’s especially the case when markets are trending higher.
To construct the index for DVOL, Dorsey, Wright & Associates (DWA) begins with the eligible constituents of the NASDAQ US Large Mid Cap Index. They are determined using certain criteria, including maintaining a minimum average daily dollar volume of $1 million for the 30-day period prior to evaluation.
Next, each security is assigned a relative strength score according to forward price momentum compared to the momentum of a broad market benchmark index. Those that show a minimum level of relative strength are added to the index.
To assess volatility, potential holdings are assigned a volatility score based on their daily percentage price changes over the trailing year. The top 50 securities with the lowest volatility scores are selected for inclusion in the index.
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