Volatility drag
How do large price swings quietly shrink compounded returns even when the average price change looks unchanged?
In plain words
Volatility drag is the way wide price swings reduce the compounded result over time. Because a percentage loss and an equal percentage gain do not cancel (a fall of half needs a doubling to return to even), markets that swing more end up compounding to less than their average move would suggest.
Why it matters
Traders often look at average daily or weekly returns without accounting for the path taken. A highly volatile market can post a respectable average arithmetic return while its compounded growth lags far behind, which affects how sustainable a trend or a strategy's reported performance really is.
In a real week: ETH, week of 18 January 2021
ETH in the week of 18 January 2021 rose 12.98%, from 1232.5 to 1392.51, yet its realised volatility reached 149.6% annualised with a 37.99% range between the high of 1438.3 on Tuesday and the low of 1042.31 on Friday. Its worst day fell 19.3% and its best day gained 12.89%, so the week's net gain of 12.98% came after swings far larger than the result itself.
A common mistake
Reading volatility only as risk and not as a drag on growth. A market can average positive moves yet compound to a smaller gain because each drawdown requires a larger percentage gain to recover.