Investors talk about volatility all the time. Before the COVID-19, many complained that market volatility was subdued. Then back in the first quarter of 2020 – the height of the corona crisis – investors were faced with intense levels of volatility and many of them panicked.
Volatility is a two-edge sword. It can work with you or against you. You will have to master the markets and be able to trade in both conditions of high and low volatility in order to succeed.
Definition of market volatility:
Asset prices move up and down all the time. That movement up and down can be sharp: an asset price (such as the price of Bitcoin, for example) can move up and down in increments of several thousands of dollars in a matter of days. That is considered high volatility. On the other hand, other asset prices, such as silver for example, do not fluctuate much. Silver’s volatility is not too high. Volatility is the extent to which an asset price fluctuates around a mean, and you need a good broker to navigate through volatility.
What does volatility mean for your trading?
Volatility can be an opportunity or a threat, depending on how you look at it and how you trade the instrument in question. In the ten years following the 2008 financial crisis, major stock indices continued to climb. The market was pretty much one sided and volatility was low (no intense fluctuations). This was a good environment for traders who do not want to assume high levels of risk. They could simply implement a buy and hold strategy, and cash out later. However, in 2020, volatility spiked. For many investors, this was an opportunity. For others, it was a disaster as they kept entering and exiting the market at the wrong points. They suffered huge losses because they weren’t prepared to deal with it.
Market volatility usually increase risk and stress. Experienced traders can handle their own emotions and can withstand volatility storms enough for them to make a profit. Others cannot and lose money as they flounder. Therefore, if you cannot manage your own emotions, it is better that you trade in moderate or low volatility conditions.
How do you measure volatility?
There are mainly two ways to measure volatility. The first is general, and the second one is more specific.
- Looking at the VIX (the volatility index);
- Using the Average true range indicator on any chart.
Choose a trading strategy that matches the current level of volatility
Volatility is good if you are a scalper. The market moves quickly enough for you to capitalize on short term moves. If it does not, then your scalping strategy may fall short. On the other hand, in low volatility conditions, you are better off implementing a long-term strategy, such as swing trading or even position trading in extremely low levels of volatility.
Most traders prefer to trade in conditions of moderate volatility. However, the market is often either highly volatile or extremely slow. A good trader adapts to those circumstances and manages the risk of high volatility well, as low volatility is usually associated with high risk.