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How To Deal With Volatility

What Do You Do When Volatility Is High

Volatility is a common feature of the market place and a fact of life that all traders must come to terms with. Volatility in and of itself is nothing more than the movement of the market but can be force in and of itself. Sooner or later volatility will bite you in the ass and that is a simple truth. Volatility c an be either up or down, high or low and does not take trend into consideration. Of course, a trending market can said to be volatile if it is moving at a rapid pace, or if momentum picks up, or if it is affected on a day to day basis by news or fears. The key is knowing how to apply volatility to your trading and what to do when it strikes.

  • Volatility – the basic definition of volatility states that is a statistical measure of movement in an assets price relative to a standard deviation, past price history or both. In layman’s terms it means a measure of how much an asset is moving in relation to how much it has moved in the past. This relation is used an indication of risk, the more volatility the riskier the asset. The assumption being that an asset with higher volatility is more likely to move against you.

The first question to answer is if volatility is high or low? This can be done using a variety of indicators that focus on this metric. Common ones include relative volatility, historic volatility, implied volatility and Bollinger Bands ™. They all use different formulas, and compare price movements in different ways but are all based on comparisons of price movement. I myself like to use Bollinger Bands(tm). These are an envelope trading tool designed by John Bollinger in the 1980’s. The envelopes use a moving average as the central signal line and then the same data is used to create the two bands based on the standard deviation.

Bollinger Bands, Volatility And Trading

Bollinger Bands are a great tool for traders. They are a fantastic tool for measuring market volatility as well as for providing technical clues and entries for traders. The bands give two kinds of signals. The first is the widening and narrowing of the bands. When the bands are narrow volatility is low and when they are wide volatility is high. As a trader you can use these signals as indications of when you may or may not want to trade a specific asset.

The second kind of signal, and those that are more useful as a short term trader, is price action. There are some generally accepted rules for using price action along with Bollinger Bands ™. The thing to remember is that these signals do not take trend or conditions into account so you will probably need to use some other trend identifying analysis as well.

How It Works 

The bands provide a target, or limit, to how much movement to expect. They represent an extreme of price. When prices reach the upper level the market is extremely bullish, when they reach the lower level they are extremely bearish. You can use these extremes for entries. If the bands are narrow, and prices move up to touch or cross either band it is likely that prices will continue to move in that direction into the near future. If prices move outside the band it is particularly strong signal.

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The moving average is also a good place to take signals. If prices moves from one extreme to the other you can take a signal on a crossover. You can also use it for support or resistance. If prices are moving from one band to the moving average and do not cross you can assume they will move back to the other band. In order to get the best signals, and to weed out the falsies, you really need to use support/resistance, trend and momentum to help confirm them.

So, What To Do When Volatility Is High? 

If you are a risk averse trader you may want to take a step back and wait for things to calm down. If you are quick and savvy enough you can use it as an opportunity for profits. Volatility means the market is moving and movement is what we want as traders. More movement means more chances for profits, you just need to be quick to get them.