Volatility Trading: What is it?

Last Updated on October 27, 2020 by Alphaex Capital

What Is Volatility?

To put in simple terms, volatility is the rate at which market price fluctuates over a particular period of time deviating from the average.

In forex trading, the value of a currency is not constant.

The measure of the extent of the changes in the value of a currency is what constitutes volatility.

So, depending with far it fluctuates from the average, a currency can be termed to have high volatility or low volatility.

More rapid changes within a very short period of time show that the market or more volatile and vice vasa.

When a trading instrument experiences change in price, it exhibits volatility.

In which case, it’s is not just the price that is experiencing the change but the trade instruments as well.

This is therefore volatility trading.

So, we can say that volatility trading happens where there is no definite prediction of the direction of the trade.

Characteristics of Volatility Trading

A volatile market can exhibit the following characteristics:

1. Very rapid high and low movements within a particular range

2. A trend with deep retraces after hundreds of pips (price interest point). A pip in forex trading is the price that moves in a given exchange rate. It measures the amount of change in the exchange rate for a currency pair.

3. It is possible for a volatile market to run for many pips in one given direction without retracing back.

How to Determine Volatility Trading

Volatility is very unpredictable by every nature.

This makes it very hard to tack and determine the trend.

However, to be able to determine volatility, traders use the types of volatility to make future predictions.

Volatility Trading

Types of Volatility Trading

1. Historical volatility

2. Implied volatility

3. Market volatility-refers to the overall level of price volatility in the market at a particular period of time.

4. Currency-pair volatility-this is volatility exuded by different pairs of currency pairs in both long and short term.

Historical volatility is one that has already taken place or the current price action.

While implied volatility is one that is anticipated to take place in future.

Historical volatility charts furnish the trader with information on the clear trends of past highs and lows of the prices.

A forex trader can then use the index in line with market expectations in relation to currency volatility.

It is important to understand that the higher the volatility the higher the risk. Trading volatility can swing prices in one direction magnifying the losses or the profits depending on the direction.

How to Measure Volatility Trading

Volatility is measured using standard deviation in financial analysis.

To measure volatility then one will have the highest price change over a particular period of time, terming this as a gross move.

You then capture the lowest price change and subtract from the previous highest price change.

In the forex market, volatility is measured using the VIX index.

This is a CBOE volatility index created by the Chicago Board of Exchange for the sole purpose of tracking market volatility.

Factors That Influence Volatility Trading

The volatility of financial markets can be influenced by the following factors;

political factors, national and international economic factors, earnings and financial market reports, news reports and policies of central banks.

For instance, there is likely to be an erratic market reaction if a central bank lowers its interest rates.

Is Volatility Trading Important?

Actually, the question should be;

as a trader would you consider volatility as an opportunity or as a risk?

When you hear about market volatility do you see a door for a huge profit or do you see uncertainty?

When properly executed, volatility trading should offer huge profit opportunity though the big movement.

This is because higher the volatility triggers bigger moves that open bigger opportunities for bigger profit margins.

Volatility Trading Strategies

Volatility trading can be very dangerous.

So, is it possible to overcome market volatility?

Indeed, yes. In fact, it is possible to take advantage of it and turn it to your favour.

If you play your cards right, you can make a big move and come out with huge profits. How then you beat market volatility? I’ll tell you how;

1. Use The Straddle Trade Strategy

This strategy uses straddle trade.

In anticipation of the market price to rise or fall sharply (high volatility).

You place a bet although not sure of the specific direction.

It can be used before release significant market reports.

In this case, you make the straddle trade prior to an anticipated change in price which could be positive or negative.

Using a straddle trade, you place a bet of both options of put (anticipation price will fall) and call (anticipation the price will rise).

A straddle trade can be executed by use of a pending order.

For instance, you can place a stop order above the market price or the upper resistance and a sell order few pips below the lower support.

In this case, the orders will be triggered in either direction in which case, a profit will be realized.

A pending order is one that is re-specified and is only executed once the price is reached during a specified period of time.

2. Use Charts and Indicators.

Volatility indicators are helpful when making a prediction about the anticipated direction of future price.

You can make a decision that is more favourable by gauging the market conditions.

One of the indicators is the Average True Range (ATR) which measures the hoe much a price moves within a set period of time.

It uses up and down movements that are then used as indicators for high or low prices within a specified period of time.

ATR is used by traders to set up a trailing stop order that allows the trader to exit the trade at a position of advantage.

3. Opening Range Breakout Trading Strategy

You can simply call these trading breakouts.

Trading prices in forex have resistance and support levels.

However, there are instances when market prices go beyond these prices causing a breakout.

Trade breakout increases volatility and price trends.

To use this strategy, identifying the price range within the resistance and support level is important.

Track the trend and the number of times the levels are reached.

This will give an indication of possible breakout and timing when to trade.

There are high chances of making profits by trading when price finally breaks out.

Trading breakout ensures that you don’t miss a move when the market prices are strongly in a particular direction.

4. Fading Spikes Strategy/Parabolic Stop and Reverse

This strategy is employed when the trade direction goes opposite/against the direction of price movement.

Unlike the other strategies, trade is not made until the big move/spike in market price has taken place.

So, what is the catch here?

You can manipulate prices within a short span of time in your favour.

In this strategy, your main aim is to target obvious stop loss placements at swing highs and lows and then reverse their position.

You will have pushed prices up by creating demand for stop losses then fade briefly after the levels have reached.

This puts you at a position of advantage to make a short and long trade just below the previous high and the next.

5. Volatility Squeeze

This strategy helps you to capture a big move in a situation of high market volatility. It is a combination of both Bollinger and Keltner Channel.

The two can give an indication of a possible breakout opportunity in the Forex market.

In an ideal situation, Bollinger Bands are outside the Keltner Channel.

However, they can be pulled during a consolidation period.

This creates volatility squeeze and is an indication of a quiet moment of low volatility.

In this strategy, you enter the trade at this point of low volatility in anticipation of volatility picking up.

The narrowing, or squeeze is an indication of a possible breakout in the near future.

You can read up on Bollinger Bands explained here.

Take Away

Your trading strategy should encompass key factors of the trade such as:

Your trade entry and exit criteria, position sizes and how to manage any risks.

A clear understanding of volatility trading and volatility trading strategies will put you at an advantage in the Forex market.

Volatility can be your biggest break in Forex trade business.

You need to master the art of capitalizing on the market conditions and minimizing your risks.

  • 1