In forex signals trading, volatility is a measure of how prices or returns are scattered. It is a key metric because volatility creates profit potential. However, trading on volatility can also create losses, if traders do not learn the appropriate information and strategies.
Historical volatility also measures price action. This is a technical indicator . For example, historical volatility may be low, yet we know that if the US Federal Reserve or the Bank of England releases an interest rate announcement, this will cause increased price movement and volatility in the forex market. Implied volatility is derived from the options market, where put and call options are bought and sold.
Price action is a measure of volatility. Traders are therefore trading volatility all the time and creating it with their transactions. By watching how far or how fast prices move, traders can gain insight into whether a price move is likely to sustain itself or if the move has run its course.
How to use volatility in trading
Through understanding volatility, you can create appropriate trading strategies that help to harness profit potential. Volatility is an important metric for all traders, including short-term day traders and swings traders, whose primary focus is on daily and weekly price movements.
We host the international trading platform, MetaTrader 4, through our own software. MT4 is available to customise and provides a wide array of indicators to track and anticipate volatility changes. In addition, MT4 also supports automated trading solutions called Expert Advisors, which are computer programs that trade on your behalf. Learn more about trading with MT4 here.
So, how is volatility traded? You can trade on volatility across various markets and timeframes. In this article, we will look at volatility trading strategies that can be applied to shares, forex, commodities and cryptocurrencies.
Volatility trading strategies
Volatile stocks for day trading
If the price moves a lot in a day, especially with lots of volume, this means that a trader can enter and exit the position easily. This is one reason why volatile stocks are so popular for day trading, in particular.
Volatility breakout trading strategy
A breakout happens when the price of an asset moves beyond support and resistance levels on a trading chart, which indicates a new trend direction.
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 historical movement of the stock. Other stocks may only have certain days where they move more than 5%. You can identify the biggest risers and fallers within the share market of each trading day in the Product Library inside our trading platform, Next Generation.
For example, when day trading volatile stocks, you can set up 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 that move mostly sideways, and enter the position if the price breaks out of the consolidation in the trending direction. This is a relatively simple and effective way to trade high volatility stocks.