VolatilityThe Simple Strategy With Volatility


  • Before looking into volatility based strategies, it is necessary to define what volatility really is.

    Technically, volatility can be defined as the percentage rate of price variation measured within a time span. In practical terms it measures the price velocity and helps estimate fluctuations that may occur in a short period of time. The market is volatile when an intense amount of trades causes large and fast price movements within a short period of time.

    The volatility of a security can be measured in two ways. This includes the historical volatility which is measured by the standard deviation, and the implied volatility which can be measured by the VIX. For our operational purposes we will consider the historical volatility.

    The standard deviation is only one way to analyze the historical volatility. There are other indicators with which we can measure the deviation of prices, for example, one of these is the average true rage (ATR).
    It is important to point out that volatility does not express the direction of an asset but only the amplitude of movement.

     

    • Bollinger Squeeze Strategy

    This strategy is based on the Bollinger bands indicator. When the lower and upper bands wrap prices i.e. point inwards with prices in between, this is most likely the beginning to a possible strong movement. This configuration only indicates a possible next move and not any direction. Here are some example figures.

     

     

     

     

     

     

     

     

    Figure 1: Short Squeeze period

     

     

     

     

     

     

    The setup in the figure above does not best demonstrate the ideas as indicated by the orange box, due to the squeeze period being too short. In the next figure, we can see the right setup the squeeze period lasts for at least 10 candles.

     

     

     

     

     

     

     

     

     

     

    Figure 2: Correct Bollinger squeeze Setup.

     

     

     

     

     

    • ATR - Volatility Strategy

     Average true range is an excellent historical volatility indicator, compared to standard deviation of Bollinger bands it produces less lagging signals. ATR gives us the real price movement with no amplification. In order to use ATR properly, it should be set to a fairly short Period between 5 to 10.

    From a practical point of view ATR is simple to use. When the indicator is bearish and suddenly reverse upwards, it means that prices are ready for a huge movement. Like in the previous case we will graphically illustrate the correct setup conformation.

    Figure 3: ATR VOLATILITY INDICATOR

     

    • Trade Entry Pattern

    In the two above mentioned strategies we have only discussed the possible movement in prices, but we have not spoken about any input setup needed to detect prices direction. An easy way to figure out which direction prices will move is to use Japanese candlestick especially a long breakout candle. This candle is an explicit signal of price acceleration in itself towards a certain direction.

Interviews

  • the Analyst's answer

    Jean Grossett - Financial analyst

    Monitoring volatility of a trading vehicle for example currencies, arms a trader with one of the required tools for success. This tool in a trader’s arsenal helps in determining when huge volumes in the form of more liquidity have come into the markets. Unlike the Forex markets, most cryptocurrency exchanges allow traders to see their order books. This lends a new source of information in the form of being able to see the prices where high volume traders AKA Whales have their pending orders. These levels often create high volatility in the market.

  • the Manager's answer

    Robert Danvil - Investment Manager

    Oscillator based volatility indicators such as Bollinger bands are often times lagging indicators. They should be used with caution, and not to be confused as directional indicators. Also monitoring volatility on higher time-frames are often more reliable than on lower time-frames.

    Other than the Bollinger band and ATR (Average True Range) indicator, I personally make use of a price action based volatility based indicator. This price action volatility based indicator is the mother bar of an inside bar price pattern. Although this is not a directional indicator, it indicates volatility in a security.

    Another variant of this inside bar pattern is one which I personally discovered. I call it body only inside bar, this pattern is as shown below.

     

    For this pattern to be correctly identified, the mother bar and child bar have to be of similar color. Once this is identified in the case of bullish bars, the low of the child bar is identified as a support level. As represented in the figure above, the mother bar represents volatility, while the child bar shows the support level. A price close below the support level nullifies the setup which intends to represent beginning of future consecutive bars of the particular time frame. This body only setup has been further developed into a Metatrader4 indicator, where the bullish setups are represented by the blue arrows, and the bearish setups are represented by the yellow arrows.

Leave a Reply