What in the World is Volatility and Why Should I Care?

Volatility has been the talk of the town these days as the summer months are about to end. Market participants could soon be on the lookout for larger price swings on an intraday basis and comparing this behavior to periods of less volatility.

What does volatility mean anyway?

Technically speaking, volatility refers to the amount by which an asset price fluctuates over a time period. It is measured by taking the standard deviation or the variance of price changes over a specified duration.

Woah, that’s a lot of financial mumbo-jumbo!

Simply put, volatility is a measure of how moody the markets are. As my trading bros put it, a volatile market environment is as sensitive as a girl with PMS. When something goes right, the positive reaction is typically magnified. When something goes wrong, the saying “Hell hath no fury like a woman scorned” becomes a reality.

How is volatility measured?

As discussed in the School of Pipsology, technical indicators can be used to measure volatility in the forex market. In particular, moving averages, Bollinger bands, and the Average True Range (ATR) can be used to keep track of price fluctuations.

A more common method to measure volatility is through the VIX or volatility index. Dubbed as the “fear index”, this particular tool gauges the implied volatility of S&P 500 options and is helpful in predicting overall market volatility for the next 30 days.

A rising VIX means that there is a lot of uncertainty in the markets and price action is expected to be very sensitive in the coming days. A falling VIX shows that there is lower uncertainty and market confidence is improving.

How should I react to higher volatility?

As the Brits would say, keep calm and carry on. Perhaps the worst way to deal with potentially higher levels of market anxiety is to be increasingly anxious as well. Remember that a pickup in volatility would make it even more crucial to maintain a focused mindset and keep your emotions in check.

A good way to start is by taking note of the changes in average price movements for a trading day. From there, you can make the necessary adjustments in your stops and profit targets. An adjustment in trading style, such as shifting from longer-term to shorter-term setups, might also be appropriate.

Got any other recommendations on how to adjust to higher volatility? Let us know by dropping a comment below!