How to Trade Low Volatility Stocks

Many people firmly believe that the higher the risk taken in investments, the greater the reward. In a 2012 study, economists Nardin L. Baker and Robert A. Haugen showed that low risk, low volatility stocks provided greater returns over time than did high volatility stocks. They found this to be true during the period 1990 to 2011 for all major markets and most emerging markets around the globe. Moreover, the low volatility anomaly -- better returns from low volatility stocks -- was demonstrated by market data as far back as 1929 for both stocks and bonds. The study clearly showed a negative relationship between risk and return.

Accumulate money that you can afford to leave in your low volatility portfolio for the long term. Studies on the low volatility anomaly prove higher returns over 40 years or longer, so investing in low volatility stocks is appropriate for retirement portfolios and trusts that are intended to be held indefinitely.

Select high quality value stocks or invest in a mutual fund or exchange traded fund (ETF) that emphasizes low volatility stocks. Value investing consists of avoiding three types of risk: company, valuation and earnings risks. Top value investor Warren Buffett reduces company risk by investing in companies that have shown financial strength during strong and weak economies. He reduces valuation risk by purchasing these stocks at low prices relative to their historical high prices, and he carefully monitors each company for bad earnings announcements that may signal an erosion of their financial strength. Low risk, low volatility stocks are essentially blue chip stocks, Standard & Poor's 100 or S&P 500 stocks -- in other words, the top public companies trading on the market.

Resist the urge to trade in and out of the stocks in your portfolio unless the financial strength of one of your holdings shows a fundamental breakdown. That is the time to sell it and replace it with another low risk, low volatility stock.