What is market volatility?
“Volatility is a statistical measure of the dispersion of returns for a given security or market index. In most cases, the higher the volatility, the riskier the security. Volatility is often measured as either the standard deviation or variance between returns from that same security or market index.” – Investopedia
In simple terms, volatile markets are markets that move. I personally believe a certain level of volatility is required to be able to make money on the financial markets. It does not matter if you are a long term buy & hold trader or a day trader, if the markets don’t move, you can’t really make money.
The two images above show the same financial instrument but at different times in the last 12 months.
The first shows an example of low volatility in the market. This is shown by price appearing flat and very low deviation away from the mean price. I have applied the Bollinger Band tool which shows this as low volatility with the bands appearing very tight. The historical volatility indicator at the bottom of the chart shows that the levels remained below 5.0 at this time.
The second chart shows much higher levels of volatility. You can see price swings much more and deviates much further away from the mean price. The Bollinger bands and their shape shows this with them becoming much wider on both sides of price. The historical volatility indicator shows it remained above 6.0 for most of this time period with levels above 12.0 being achieved at one point.
How to trade changes in volatility.
Due to the wonderful continuous evolution of the financial markets with new products being created every year, we are now able to place trades based on the movement of volatility levels relating to a specific financial instrument. Therefore it is possible to profit when volatility levels increase or decrease instead of relying on the levels of volatility to create trading opportunities on other financial instruments.
The easiest way to do this is to buy or sell a volatility index. The largest volatility index in the world is the S&P500 VIX.
The VIX Index is a calculation designed to produce a measure of constant, 30-day expected volatility of the U.S. stock market, derived from real-time, mid-quote prices of S&P 500® Index (SPXSM) call and put options. On a global basis, it is one of the most recognized measures of volatility — widely reported by financial media and closely followed by a variety of market participants as a daily market indicator. – http://www.cboe.com/vix
In its basic format, if you believe market volatility is going to increase then you can buy VIX and profit if it increases. It is also to possible to profit from a decrease in market volatility by trading VIX futures and options and entering short positions.
Over the past few weeks I have been working on a strategy and investigating the potential to profit from a recurring pattern that occurs in short term volatility around the time of high impact economic data releases.
When trading economic data releases you are effectively trying to predict the positive or negative nature of the data released, its expected and actual impact on the financial markets you are trying to trade and the intended/best possible duration of the trade. I am working with a strategy that removes all of these variables and instead trades just one market theory.
This strategy is designed to be used alongside my normal trading and to increase my bottom line annual returns by trading a select few key economic events each year. The lower frequency, high reward:risk nature of this trading means it should be easy to use for those of you with little free time available to trade the financial markets during the week.
If you are interested in learning more about how market volatility is calculated, what it means and the various volatility products out there available to trade then visit the Chicago Board Options Exchange website as they are the creators of these products.
If you are interested in learning my personal trading strategies, please consider my Mastering The Markets – Retail Trading Course. Head over to my Financial Analysis Education page to check out all of my education packages and the deals available.
All my technical analysis is done using the TradingView platform. You can get access via the link below.
My preferred broker of choice is IC Markets. Low spreads and trading costs really help long term profitability. A link to their site is below.
FTMO Trader Funding Programme.
Thanks for reading and please don’t forget to LIKE, SHARE and FOLLOW my blog to stay up to date with the latest market analysis and trading education posts.
DISCLAIMER: None of the information posted on this site is to be considered investment/financial advice. Trading is high risk and you should only trade with money you can afford to lose.