The last couple of summers have ushered in tremendous price volatility when day trading the ES e-mini contract. There were times when the market volatility was so extreme that normal backing and filling operations (market noise) could easily stop you out of your trade. In fact, if you chose to trade during these volatile periods, you would need nothing short of 20 tick stop loss point. For me, such wide stops increased my risk tolerance to a point where many days were too volatile for me to trade. On the other hand, if you were lucky the market moved in the direction of your trade and you could realize fantastic profits. The key in the last sentence is “luck,” and luck is no way to day trade. So many days I was relegated to watching the market and hoping the market volatility would settle down some, and some days it did and there were good trades to initiate.
In recent weeks the markets have not been very volatile and we have experienced exactly the opposite phenomena as the previous two summers. So market volatility plays a major part in your ability to trade and to select trades. There is, in essence, there is a “sweet spot” in price volatility where traders can prosper. It is important to be able to recognize just where that sweet spot resides, and how to trade an optimal market volatility conditions.
For me, I like to use the Average True Range to get an idea of the market volatility that I can expect on a given trade. Like most things, the Average True Range is not a foolproof system for gauging market volatility, but it gives me a good idea as to what the market volatility has been and buying any unusual trading circumstances what I can expect based upon the last sequence of bars under measurement. I usually use a setting of 14 for the Average True Range.
A rating all about 2 1/2 or 3 seems to give day traders an optimal chance to earn sizable profits while minimizing the amount of risk tolerance a trader must endure. In my trading, as the Average True Range exceeds 4.5 or 5, I generally find myself on the trading sideline past this level of volatility presents too much risk for my appetite.
But there are other measures of market volatility that are worth a look, too.
The VIX is an indicator distributed and calculated by the Chicago Board Options Exchange. The VIX is a weighted basket of option prices based upon the S&P 500 index. While the VIX is directly related to options and option prices it can still be very useful for most traders because it indicates the implied market volatility of the S&P 500 index over the next month. It is often referred to as the “fear index” as it does not indicate a bearish or bullish bias. Rather, it implies in percentage points the amount of potential movement and the S&P 500 index over the next 30 days. As you might guess, this is a very closely watched index and is even traded as such. In my trading, I don’t have any strict interpretations for using the VIX in my intraday trades, but I am mindful of what the VIX numbers are and the potential for movement they may or may not represent. Obviously, a high reading on the VIX, say 20, implies a potential for sharp movement of 20%, either up or down, in the next 30 days. In essence, a VIX reading of 20 warns the intraday trader that there are indications of pending market volatility. That in itself is something that is good to know.
So if talk a little bit about actual volatility and how to much volatility can make trading very difficult and a very stagnant market, with low market volatility can make trading profitably just as difficult. We have talked about a “sweet spot” in the Average True Range readings that seem to be optimal for trading, at least for my style of scalping, or intraday trading. We also discussed the VIX, which is not directly related to chart trading but can be very helpful as an advisory indicator. We have concluded that sometimes the market can be too volatile to trade effectively and by the same token, it can be not volatile enough to be an effective trader. In short, market volatility is a variable that must be considered carefully and compensated for in a day trader’s daily endeavor.
I am a long time retail and institutional trader who now only trades part time, usually in the morning. I enjoy writing informational articles about my style of trading so others may benefit.
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