Volatility Is Your Friend

Why You Should Embrace Volatility

Volatility is your friend. You may not realize this but it is. A lot of traders and investors, most in fact, will shy away from volatility because it implies risk, frustration and loss. The thing is, for a short term trader and/or market speculator volatility is something you need. Volatility is nothing more than market movement. It takes market movement to create gains, either negative or positive, and these gains turn into pips and profits for us. A less volatile market may be safer, but you will not make as much money trading it. In fact, you may lose money trading short term positions in a non-volatile market. In order to understand volatility, why it’s your friend and how you should embrace it I will start at the beginning.

Volatility can have multiple meanings, usually with a negative connotation, but the basic definition in terms of trading is that it is simply the amount of movement a stock makes in one day, or over a set period of time. This makes sense when you consider that the standard definition is something “that may change rapidly or with unpredictable nature”. Volatility in market respect can be current, rear or forward looking. It is easy to look on a chart and tell which assets are more volatile than another. An asset that moves 1% or more on a day to day or week to week basis is said to have more volatility than one that only moves by a 0.25% on a day to day basis. This movement could be positive or negative, volatility does not take direction into account, merely the net amount of movement. In terms of the market the amount of volatility is thought to represent the amount of risk present in the market. A higher volatility asset is more likely to move, in either direction, making it more likely to finish in the money if you choose correctly and less likely in you choose direction incorrectly.

Why Is Volatility Desirable

You want volatility so that the assets you trade move. When you take a signal you do not want the market to languish, move sideways, or take a long time to produce a profit. As a short term trader waiting around costs you money. It cost you in lost capital, but it also costs you in lost trades. Think about it like this. There is a more volatile and a less volatile asset. You choose to trade the less volatile one because it’s “safer”. Because it moves less, and based on your analysis, you choose to use an expiry of one month. Now, you wait for a signal to appear and one occurs triggering you to enter the trade. You buy your position and now you must wait for 30 days, 30. Now, with the other asset, the more risky higher volatility asset, the exact same signal appears but comes with a time horizon of only one week. This means you could have gotten into and out of the trade as many as four times in the same period you would hold the less risky trade.

Volatile Assets Can Lead To Explosive Profits

Higher volatility assets also increase your chances of profiting in another way. Assets that move more will move further into the money than ones that don’t. I know this is binary trading so it doesn’t matter that much but how many times have you entered a trade only to have it lose simply because it did not move far enough into the money to cover the spread between the current price and the price at which your option was sold? This is especially true of 60 second and other types of speed trading where the difference between loosing and winning may come down to only a pip or two. The flip side is that higher volatility assets can produce losses just as easily as those that profit. One trick is to look for high volatility assets that are trending. This will greatly increase your results and does not require a bullish or bearish trend, just a trend. If you can expect an asset to move in a certain direction, and for a certain extent you can make trades with a very high probability of moving in your direction far enough to keep you in the money, regardless of any near term pullback the asset may experience.

How I Apply Volatility To Trading

These ideas and theories can be applied to a single asset. In the course of secular, primary, secondary and near term market fluctuations the average asset, be it a stock, commodity or index, will have periods of more or less volatility. This can be driven by a wide variety of factors but can be harnessed by savvy traders. When volatility is low, use longer expiry, but also be wary of spikes in volatility. When volatility is high you can use shorter term expiry and when you get really good you will be able to catch the day to day market swings like we have been experiencing lately.