Techniques For Profiting From Volatility In The Forex Market – Spread bets and CFDs are complex instruments and come with a high risk of losing money quickly due to leverage. 71% of retail investor accounts lose money when spreading bets and/or trading CFDs with this provider. You should consider whether you understand how spread bets and CFDs work and whether you can afford to take the high risk of losing your money.

In trading, volatility is a measure of how prices or returns are distributed over time for a particular asset or financial product. It is a key metric because volatility creates profit potential. However, trading with volatility can also create losses if traders do not learn the right information and strategies.

Techniques For Profiting From Volatility In The Forex Market

Techniques For Profiting From Volatility In The Forex Market

Price action is a measure of volatility. Therefore, traders trade volatility all the time and create it with their transactions. By seeing how far or how fast prices move, traders can gain insight into whether a price move is likely to hold or whether the move has run its course.

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By understanding volatility, you can create appropriate trading strategies that help exploit the profit potential. This can be done by trading volatile assets, tracking changes in volatility to aid selection, including technical indicators or volatility-based software, or focusing on low-volatility assets.

Volatility is an important metric for all traders, including short-term day traders and swing traders, whose main focus is on daily and weekly price movements.

So how is volatility traded? You can trade with volatility in different markets and time frames. In this article, we will look at volatility trading strategies that can be applied to stocks, forex and commodities.

If the price moves a lot in a day, especially with a lot of volume, it means that a trader can get in and out of the position easily. This is one reason why volatile stocks are so popular for day trading, in particular.

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A volatile stock is one whose price fluctuates by a large percentage each day. Some stocks consistently move more than 5% per day, which is the expected volatility based on the stock’s historical movement. Other stocks may only have certain days where they move more than 5%. A volatility trader can look for either a consistently volatile stock or one that is simply showing big moves that day. You can identify the biggest movers and decliners within the stock market of each trading day in the Product Library within our trading platform, Next Generation.

For example, when day trading volatile stocks, you can create a five-minute chart and wait for a short-term trend to develop. For day trading, a 10-period moving average will often highlight the current trend. You should then wait for a consolidation, which is at least three price bars moving mostly sideways, and enter the position if the price breaks out of the consolidation in the trend direction. This is a relatively simple and effective way to trade high volatility stocks.

For example, as shown in the chart below, American Airlines stock was moving more than 6% per day for most of the first half of 2020 and often had big trend days. In this case, a trader can place a $0.02 loss outside the other side of the consolidation. Then, a target should be set at twice the risk. Risk is the difference between the entry price and the stop loss price. In the example below, a downtrend is in progress. A consolidation is formed with a low value of $12,975. A short entry can be taken when the price drops $0.01 below, to $12,965.

Techniques For Profiting From Volatility In The Forex Market

The top of the consolidation is $13,035 and a stop loss can be placed at $13,055. The risk on the trade is $0.09 per share (calculated from $13,055 – $12,965). The target is $0.18 earnings per share, set at $12.785.

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A day trading strategy can be used on any trending stock, but tends to produce more favorable results on volatile stocks because larger price movements mean the target move is more likely to be achieved.

A more dynamic strategy is to use a stop loss, such as a 20-period moving average, which allows the trader to catch large trends if they develop. They should then exit when the stock price touches the moving average indicator line.

As a general guide, when a major stock index such as the S&P 500 is experiencing volatility above the market average, individual stocks within the index will also experience more volatility.

A breakout occurs when the price of an asset moves beyond support and resistance levels on a trading chart, which indicates a new trend direction. One way to measure volatility changes is through technical indicators, such as the average true range (ATR), which tracks how much an asset typically moves in each price candlestick. A sharp rise in ATR can alert traders to potential trading opportunities, as it most likely indicates that a strong price move is underway and a breakout is about to occur.

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The hourly gold chart below shows some possible volatility trades on the hourly chart. To help highlight breakouts, a 20-period simple moving average has been added to the ATR in our trading platform.

Only when the ATR crosses above the simple moving average is there a possible trade. Price should also break above or below recent highs or lows for better opportunities. This helps to filter out times when the ATR crosses the moving average, yet the price does not move significantly.

Four examples of trade setups are shown in the chart below. This is primarily an entry technique, although it can be turned into a strategy by placing a stop loss below the last swing low if it goes long, or above the last swing high if it goes short. Consider using a 20-period simple moving average for the exit point. Moving averages are a common indicator and in trending environments, they can provide timely exits. When the price touches the moving average, it means that the price is starting to move in the opposite direction, or that the price momentum has stalled, allowing the average price to reach the current price. A reversal or slowdown in price momentum is a valid reason to consider exiting a trade.

Techniques For Profiting From Volatility In The Forex Market

As we’ve discussed, the moving average true range is a particularly effective tool for tracking how much an asset moves, on average, for each price bar.

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Historical volatility also measures price action. This is a technical indicator shown below on the EUR/USD chart. Implied volatility predicts what may happen in the future. For example, historical volatility may be low, yet we know that if the US Federal Reserve or the Bank of England issue an interest rate announcement, it will cause increased price movement and volatility in the foreign exchange market. Implied volatility derives from the options market, where call and call options are bought and sold.

The relative volatility index (RVI) is another indicator that analyzes price direction and volatility. It is the bottom indicator shown on the EUR/USD chart below. When the indicator is above a level of 50, it means that volatility is increasing. When the indicator is below 50, it means that the volatility is on the downside. Therefore, if a buy signal appears and the indicator is above or crosses above 50, it helps to confirm the buy signal. If a sell signal appears and the indicator is below or crosses below 50, this helps to confirm the sell signal. It is not reliable as an indicator when used alone, but can be used to confirm entries in relation to other strategies.

Quantitative volatility trading uses software and algorithms to exploit changes in volatility. Using software means that a strategy can be implemented in much shorter timeframes, or more trades can be taken, than is possible for a human. For example, a computer can place trades in milliseconds, potentially placing hundreds or thousands of trades per day for small profits, using a variation of the strategies discussed earlier. Read more about quantitative trading strategies.

We host the international trading platform, MetaTrader 4, through our software. MT4 is available to customize and offers a wide range of indicators to track and predict volatility changes. Additionally, MT4 also supports automated trading solutions called Expert Advisors, which are software programs that trade on your behalf. Learn more about MT4 trading here or sign up for an MT4 account now.

Coping With The Dynamic Volatility Of The Forex Market

Our award-winning online trading platform, Next Generation, provides a variety of volatility indicators required to trade the strategies discussed, as shown in the charts above. The platform comes with charting tools, price projection tools and chart forums so traders can display their data clearly and easily.

Open a live account now to start trading on volatility. It comes with a free demo account that allows you to practice with virtual funds before depositing real money.

When trading volatility on our platform, we require traders to trade on margin. Leverage products have the potential for bigger profits, but just as big losses. For example, if an unleveraged EUR/USD position moves 1% or an unlevered stock

Techniques For Profiting From Volatility In The Forex Market

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