Measuring Volatility: Talking Points
- Volatility is a measure of price variations over a period of time.
- To measure volatility, average true range (ATR) and Volatility Pro Indicators are used.
Technical analysis can bring a significant amount of value to a trader.
No indicator or A set of indicators To predict the future correctly, traders can use historical price movements to get an idea of what is going on may will happen in the future.
In this article, we’re going to take the discussion of technical analysis a step further by focusing on one of the primary factors of importance in determining market conditions: volatility.
Risk of volatility
The allure of high-live positions can be obvious: high levels of volatility mean big price moves, and big price moves mean high potential opportunity, and also potential risk.
Traders need to look at the full spectrum of this scenario: High levels of volatility also mean that price movements are even less predictable. Reversals can be very aggressive, and if a trader finds themselves on the wrong side of this move, the potential loss can be even greater in a highly volatile environment, as increased activity can cause large price moves against the trader. please
Average true range
The Average True Range indicator stands above the rest when it comes to measuring volatility. The ATR was developed by J. Welles Wilder (the same man who developed the RSI, Parabolic SAR, and ADX indicator) and is designed to measure the actual range over a period of time.
The actual limit is overstated in:
- The high of the current period is the low of the current period
- The current period’s high is lower than the previous period’s closing value
- The current period’s decrease is less than the previous period’s ending value
Since we are trying to measure volatility, absolute values are used in the above calculations to determine the ‘true range’. Therefore, the largest of the above three numbers is the ‘true limit’, whether the value is negative or not.
Once these values are calculated, they can be averaged over a period to smooth out near term fluctuations (14 periods is common). The result is a mean true range.
In the chart below, we have added ATR to illustrate how the indicator will register larger values as the range of price moves increases:
GBP/USD (Jan-Aug 2020) ATR used
How to use ATR
After traders learn to measure volatility, they can integrate the ATR indicator into their approaches in one of two ways.
- As a volatility filter to determine which strategy or approach to use
- To measure risk cost or potential stop distance when initiating trade positions
Using ATR as a Volatility Filter
Traders can approach low volatility environments with one of two different approaches.
Ideally, traders can continue to look for a less volatile environment or they can look for it to change. This means that traders can approach low volatility by trading the range (continuation of low volatility), or they can trade the breakout (increase in volatility).
The difference between the two conditions is huge; Range traders look to sell resistance and buy support, while breakout traders want to do the opposite.
Also, range-traders usually have the luxury of well-defined support and resistance for stop placement; Breakout traders do not. While breakouts can lead to big moves, the probability of success is significantly lower. This means false breakouts can be plentiful, and breakout trading requires more aggressive risk-to-win ratios (to compensate for the lower probability of success).
Using ATR for Risk Management
One of the primary struggles for new traders is learning where to place a stop loss when starting new positions. ATR will help achieve this goal.
As ATR is based on price movements in the market, the indicator will grow along with the volatility. This enables the trader to use wider stops in more volatile markets or tighter stops in less volatile environments.
The ATR indicator is displayed in the same price pattern as the currency pair. Hence, the value of ‘.00458’ EUR/USD Represents 45.8 pipes. Alternatively, a reading of ‘.455’ USDJPY Represents 45.5 pipes. As volatility increases or decreases, these statistics also increase or decrease.
Traders can use this to their advantage by placing stops based on the ATR value; Whether it’s a factor of the indicator (like ATR 50%) or the live indicator reading itself. What is important here is that the indicator read is responsive to the latest market conditions, which allows the trader an element of adaptation by using the indicator in their approach.