11 Volatility Trading Strategies: Backtest, Rules, and Performance Insights

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Mohammad Sufyan
in Forex Trading
December 29, 2022
6 min read

This is a financial indicator that shows how much the price of an asset changes in a short period of time. Standard deviation is a statistical measure that is used to quantify the volatility of a security’s returns. The two types of volatility are historical volatility and implied volatility. Market volatility can also be seen through the Volatility Index (VIX), a numeric https://forexhero.info/ measure of broad market volatility. The VIX was created by the Chicago Board Options Exchange as a measure to gauge the 30-day expected volatility of the U.S. stock market derived from real-time quote prices of S&P 500 call-and-put options. It is effectively a gauge of future bets investors and traders are making on the direction of the markets or individual securities.

When there is a rise in historical volatility, a security’s price will also move more than normal. At this time, there is an expectation that something will or has changed. If the historical volatility is dropping, on the other hand, it means any uncertainty has been eliminated, so things return to the way they were. If prices are randomly sampled from a normal distribution, then about 68% of all data values will fall within one standard deviation.

You’ll be notified whenever a market moves by the percentage or number of points you specify. Casual market watchers are probably most familiar with that last method, which is used by the Chicago Board Options Exchange’s Volatility Index, commonly referred to as the VIX. These should be considered if you are seeking a more predictable and less risky trading environment. They can disrupt xcritical supply chains, affect production, and alter investor sentiment. Central bank decisions on interest rates, particularly from major central banks like the Federal Reserve, can have far-reaching effects. AxiTrader Limited is a member of The Financial Commission, an international organization engaged in the resolution of disputes within the financial services industry in the Forex market.

  1. It is the less prevalent metric compared to implied volatility because it isn’t forward-looking.
  2. The S&P 500 is most likely experiencing a decline if the VIX value rises, whereas a decline in the VIX value indicates that the index is likely to be stable.
  3. It allows you to hedge your portfolios during periods of uncertainty and market stress.
  4. But note that put options will also become more pricey when volatility is higher.

Volatility traders frequently take positions on markets that are derivatives of other underlying markets. For example, the popular Volatility Index (VIX) is based on movements in the US S&P 500 index. Discover how to take advantage of volatility in a variety of ways – and trade over 17,000 markets with tight spreads – at IG. Plus explore the range of tools we offer to help you find the right trade quickly in turbulent markets.

The VXN indicator

Log in to your account now to access today’s opportunity in a huge range of markets. You can also trade the EU Volatility Index (VSTOXX), which tracks the volatility of Euro Stoxx 50 options. Oil has a long-standing reputation for volatility, as its price is readily destabilised by political unrest and economic developments. The 2020 oil price war is a case in point, with record increases in supply alongside waning demand causing the Brent Crude price to plummet.

But a certain amount of risk is good for investors… after all, if you invested in a stock and the price never increased, you’d earn no profits from capital gains. SV is basically used by traders to get an idea of how much the price of an underlying security will move, based on its speed of change in the past, rather than predicting an actual trend. A clear understanding of volatility trading and volatility trading strategies will put you at an advantage in the Forex market. One of the indicators is the Average True Range (ATR) which measures the hoe much a price moves within a set period of time. This information has been prepared by IG, a trading name of IG US LLC.

Firstly, their relatively small market capitalization compared to traditional assets makes them more susceptible to price swings driven by supply and demand imbalances. Secondly, the lack of regulatory oversight, coupled with speculative trading, can result in abrupt price movements. Investors can find periods of high volatility to be distressing as prices can swing wildly or fall suddenly.

Ninety-five percent of data values will fall within two standard deviations (2 x 2.87 in our example), and 99.7% of all values will fall within three standard deviations (3 x 2.87). Without getting too much into the weeds, you can use the strangle strategy as a cheaper alternative to a long straddle position. Though it is cheaper than the long straddle, the tradeoff is you need a higher level of volatility to make money. You could then either use a buy to close order to buy them back and close your position for a profit, or wait and hope the contracts expire worthless. Either way, you have profited from both the change in the value of the underlying security and the change in the IV.

If the information corresponds to the forecast, the volatility practically does not change. If the discrepancy is significant, an imbalance in the direction of sellers or buyers immediately appears on the market. The Relative Volatility Index (RVI) is another indicator that analyses the direction and volatility of price. When the indicator is above a level of 50, this means that volatility is on the upside. When the indicator is below 50, this means that volatility is on the downside.

Top 8 volatility indicators summed up

It is, therefore, useful to think of volatility as the annualized standard deviation. This is a strategy to use when you expect the volatility of a security to increase. You can accomplish this by buying a call option and a put option on the same security. The two options also must have the same maturity date and strike price to work correctly. In financial markets, the more risky a particular security, the higher return you have the potential to earn.

How much does trading cost?

The hourly gold chart below shows several potential volatility breakout trades on the one-hour chart. To help highlight breakouts, a 20-period simple moving average has been added to the ATR on our trading platform. 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.

They should then exit when the stock price touches the moving average indicator line. In addition to hedging, one can also look to fundamental analysis to understand the risk of an individual stock. That can result temporarily in an inefficient stock price that’s not reflected in its beta.

There is a standard deviations formula in economic theory with the denominator “n” instead of “n-1”. The stocks of two companies involved in a potential merger or acquisition often react differently to the news of the impending action and try to take advantage of the shareholders’ reaction. Often the acquirer’s stock is discounted while the stock of the company to be acquired rises in anticipation of the buyout. Note that if the stock never falls to the strike price by its expiration, it will simply expire worthless and you would lose the premium paid for the put.

What are the Factors affecting Volatility?

This material does not contain a record of our trading prices, or an offer of, or solicitation for, a transaction in any financial instrument. You should not treat any opinion expressed in this material as a specific inducement to make any investment or follow any strategy, but only as an expression of opinion. This material does not consider your investment objectives, financial situation or needs and is not intended as recommendations appropriate for you. No representation or warranty is given as to the accuracy or completeness of the above information. IG accepts no responsibility for any use that may be made of these comments and for any consequences that result.

The risks of loss from investing in CFDs can be substantial and the value of your investments may fluctuate. 70% of retail client accounts lose money when trading CFDs, with this investment provider. CFDs are complex instruments and come with a high risk of losing money rapidly due to leverage.

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