MEASUREMENT OF VOLATILITY: CONVERSION POINTS
- Volatility is the measure of price changes over a given period of time.
- To measure volatility, the Average True Range (ATR) and Volatility Pro indicators are used.
Technical analysis can bring a significant amount of value to a trader.
While there is no indicator or set of indicators will perfectly predict the future, traders can use historical price movements to get an idea of what may happen in the future
In this article, we will take the discussion of technical analysis a step further by focusing on one of the main factors of importance in determining market conditions: volatility.
THE RISK OF VOLATILITY
The appeal of high volatility conditions may be obvious: higher levels of volatility mean bigger price moves, and bigger price moves mean more potential opportunity, but also more potential risk.
Traders need to see the full spectrum of this scenario: higher levels of volatility also mean that price movements are even less predictable. Investments can be more aggressive, and if a trader is on the wrong side of the move, the potential loss can be even greater in a high-volatility environment, as increased activity can lead to larger price moves. grains against the merchant as well as in his environment. please
RANKING TRUE MIDDLE
The Average True Range indicator stands above most others when it comes to measuring volatility. The ATR was created by J. Welles Wilder (the same gentlemen who created RSI, Parabolic SAR and the ADX indicator) and is designed to measure the True Range over a given time period.
The true range is specified as the larger of:
- Current period high minus current period low
- The current period’s high minus the previous period’s closing value
- The low of the current period minus the closing value of the previous period
Since we are trying to measure volatility, absolute values are used in the above calculations to determine the “true range”. So the largest of the three numbers above is the “actual range”, regardless of whether the value was negative or not.
Once these values are calculated, they can be averaged over a period of time to smooth out short-term fluctuations (14 periods is common). The result is Average True Range.
In the chart below, we have added ATR to illustrate how the indicator will record larger values as the range of price movements increases:
GBP/USD (JANUARY-AUGUST 2020) WITH ATR APPLIED
HOW TO USE ATR
After traders have learned how to measure volatility, they can try to 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 the risk expense, or the possible stop distance when starting commercial positions
USE ATR AS A VOLATILITY FILTER
Traders can approach low volatility environments with one of two different approaches.
Simply put, traders can look for the low volatility environment to continue or they can look for it to change. That is, traders can approach low volatility by trading the range (low volatility continuation) or they can look to trade the breakout (volatility increase).
The difference between the two conditions is enormous; as range traders look to sell resistance and buy support while breakout traders look to do the exact opposite.
Also, range traders usually have the luxury of well-defined support and resistance for placing stops; while breakout traders do not. And while breakouts can lead to big moves, the likelihood of success is significantly lower. This means that false breakouts can be plentiful, and breakout trading often requires more aggressive risk-reward ratios (to compensate for the lower probability of success).
USE OF ATR FOR RISK MANAGEMENT
One of the main struggles of new traders is learning where to place the protective stop when initiating new positions. ATR can help with this goal.
Since ATR is based on price movements in the market, the indicator will grow along with volatility. This allows the trader to use wider stops in more volatile markets or tighter stops in low volatility environments.
The ATR indicator is displayed in the same price format as the currency pair. So a value of ‘.00458’ on EUR/USD it would indicate 45.8 pips. Alternatively, a reading of ‘.455’ a USDJPY it would indicate 45.5 pips. As volatility increases or decreases, these statistics will also increase or decrease.
Traders can use this to their advantage by placing stops based on the ATR value; either a factor of the indicator (such as 50% of ATR) or the direct indicator is read. The key here is that the indicator read would respond to recent market conditions, allowing for an element of adaptation by the trader employing the indicator in their approach.
