Trading markets cannot exist without volatility. The word ‘volatile’ has garnered a negative reputation when it could help traders and investors in many ways. The risk of making a loss in a volatile market, like the crypto market, is high, but it is the same volatility that allows traders to maximize their profits. Without it, the profit margin will be negligible. There are various ways to keep a check on the volatility of a security or instrument and get positive results. You can take the help of tools, charts, and indicators for the same. This article will discuss different volatility indicators that can help you in becoming a better trader.
What are Volatility Indicators?
Volatility indicators represent trading statistical indicators that describe the degree of variation of a trading price series over some period of time. In simple words, volatility presents how much the price of a currency pair fluctuates and measures the dispersion of returns for a given security or market index.
You will come across different types of indicators, each focusing on a different thing. Most traders rely on volume indicators that tell you about price change and the market’s reaction towards it. Similarly, volatility can also tell you about the behavior of the stock price. The indicators have expanding and contracting ranges that depict uptrend and downtrend, respectively. They also tell us about the possible breakouts.
List of Volatility Indicators
Our list of volatility indicators includes the top five indicators that are preferred by traders. These have been further divided into two parts.
*The three indicators given below are based on daily high and low:
1. Chaikin Volatility: Developed by Marc Chaikin, this indicator equates volatility with the trading range for each period, lying between the highs and the lows. Here, trading gaps are not considered. It produces the best results when used with price envelopes or any of the moving averages.
As far as trading signals are concerned, you should check for any sharp increase in the security volatility before market tops and bottoms. If this is followed by low volatility, it shows that the market has lost interest.
For example, consider the graph given below that shows Dow Jones Industrial Average with price envelopes set at 10%, exponential MA (21-days), and Chaikin Volatility.
As soon as the market enters a trading range after retreating from a new high, there is a Chaikin Volatility peak. We have a narrow band that shows low volatility, and the breakout from the range is also not accompanied by any significant volatility rise. Volatility rises only when the prices rise above the current high. Just before a new market peak is formed, there is a sudden rise in volatility. If there is a sharp decline, it signals that there could be a reversal.
2. Volatility Ratio: This ratio is similar to the ratio used in Technical Analysis by Jack Schwager to find wide-ranging days. Its default period is 14 days, but you can customize it by changing the Indicator Panel settings.
Like other indicators, it works better with averages. You can find out the Volatility Ratio by using a simple formula:
True Range/Exponential Moving Average of True Range (past n period).
3. Average True Range (ATR): J. Welles Wilder developed this indicator. It compares everyday range and measures commitment, an excuse that buyers use to force price rise. It helps us to understand the eagerness of the market. You can get two basic signals from this indicator – high value and low values.
4. Volatility: It measures the coefficient of variation that is a statistical interpretation of volatility. It denotes closing price deviations from its SMA. It is used to assess the risk profile of managed funds. Its default period is of 125 days, which can be easily altered.
When you divide the standard closing price deviation for a period of time with the average closing price for the same period, you get the volatility.
5. Bollinger Bands: Bollinger Bands have been named after their creator, John Bollinger. These bands are generally used to identify whether the market is overbought or oversold. By pairing them up with a momentum indicator, you can spot trading signals as well.
Bollinger bands show us volatility through expansion and contraction. When the bands expand, it shows that the market is volatile. It is the perfect time to make trades. When the band’s contract, they show that the market is stable. A stable market might not be an ideal trading place, but it shows that the market will soon show some trends.
You can also use these bands to spot entry and exit points. If the prices are over the upper band, it’s time to enter the market, and if they are below the lower band, you must exit.
There is nothing positive or negative in the trading market. It all depends on your strategies, calculations, and timing. Volatility is a necessary aspect of trading. Without it, there will be no significant profits. While new traders are usually discouraged from trading volatile instruments like crypto and Forex, with the help of these indicators and some other tools, you can turn the odds in your favor.