How to use the Stockopedia RiskRatings™
The RiskRating is available in four core Stockopedia product areas:
StockReports: You can find the RiskRating at the top of all StockReports in the Classifications label, alongside the Size Group and StockRank Style. Reading the Classification sentence allows fast insight into the risk and investibility of a stock.
StockRank Portal: You can also filter for various RiskRatings in the Stock Rank portal (available under the Ranks tab in the main site navigation). You can customise results according to your tolerance for market volatility or risk.
Stock Screener: For more advanced filtering, you can use the Stock Screener. Simply click the “Add a new rule” green button, select “Size / Risk / Style” then select the RiskRating from the dropdown menus. You can select multiple RiskRatings at once using this method and add other filters to your screen.
Table Displays: The Risk and Style classifications are available as default in the “Ranks” tab of all tables. If you want to add the RiskRating to any table display, launch the Table Editor by clicking the blue pencil icon in the active table tab. Open the “Profile” folder and select RiskRating from the menu. You will then have it available as a column in your table.
Technical Guide
We use proprietary measures of volatility, which accounts for the fact that some stocks have shorter histories and/or are traded less frequently than others.Underlying the RiskRating is a proprietary measure of volatility based on the standard deviation of three year daily price returns adjusted for auto-correlation and sample size. If a straightforward standard deviation is used as a measure of volatility, some stocks can appear to be low risk options when in fact the opposite is more often the case. We make two key adjustments to counterbalance this:
The first is adjusting for sample size. This measures how much price history we have to base our estimate on. We are always conservative and take the upper bound of the measured confidence interval to be the observed volatility.
The second is autocorrelation. This measures how highly a stock’s returns are correlated with themselves. When scaling observed daily volatility to annual volatility, we make an additional adjustment for the amount of autocorrelation observed. We use the upper bound of the confidence interval for autocorrelation just like we do with the volatility measurement. This is a technique sometimes used in assessing the volatility of Real Estate funds or other assets which aren’t priced as frequently as ordinary shares.
The RiskRatings themselves are based on the annualised adjusted volatility that we compute and split into 5 buckets with proportional weights as follows:
Conservative - lowest volatility 10% of the market.
Balanced - the next lowest volatility 15% of the market.
Adventurous - the next 20% of the market.
Speculative - the next 25% of the market.
Highly Speculative - the highest volatility 30% of the market.
The actual volatility underlying these categories can drift over time, but on average Conservative stocks stocks have less than 25% annualised volatility, Moderate stocks less than 35%, Aggressive stocks less than 45%, Speculative stocks are up to 70% annualised volatility, and highly Speculative are above this level.
Why do we not use Beta for our RiskRatings?
The use of Beta has become very popular amongst investors seeking Low Volatility stocks. The Beta is a simple to understand measure of the amount a share’s price movement is correlated with the market returns. Beta is hinged around the number one. A beta greater than one suggests a share’s price moves up further on up days (and down further on down days) than the market as a whole, while a beta of less than one suggests a share’s price moves less than the market’s move up or down.
But if you run an analysis of the Beta of all equities you’ll find something surprising: almost all equities are Low Beta. While for large caps there’s almost an equal distribution between high and low beta shares, amongst the rest of the market over 75% of stocks have a Beta of less than one.
For large cap investors, and ETF providers, using Beta as a portfolio construction technique may be ideal, but it’s a problem for individual investors who like to hunt amongst small caps. The majority of stocks you look at will be “Low Beta” shares.
This is obviously not optimal. The better measure, as well illustrated by van Vliet and Blitz in [1] is to use Total Volatility. It is our preferred measure for the RiskRatings.So if you really want to find low volatility shares, the RiskRatings are a much more optimal measure than the Beta across the breadth of the market.