Volatile markets are ones where the price moves vigorously and unpredictably. Some commodities are more volatile in character than others but volatility is mainly a varying characteristic that affects all markets at different times.
What is a volatile market?
If a market tends to be generally too volatile for your liking, then you are best advised to avoid that particular market because you will not feel comfortable having it as part of your trading universe.
Otherwise, you need volatility to some degree in your markets because if prices do not move sufficiently, you will not be able to make money trading them.
Volatility is closely related to risk. The more volatile the market, the more risky it will be to trade – but you must take risks if you want to make money. Risk is inextricably tied to prospective return as well – so we have a real tie up here!
What it all amounts to is that you must have some volatility but not more than is justified by the prospective return ‘on offer’ to you as a trader. Even if the return is well balanced with the volatility (risk) you still must not have more risk than suits your own personal comfort – otherwise you will not stick to your system.
You must also have a way of measuring volatility against the return your system can deliver – and this needs to be embodied in your trading method.
Getting back to volatile markets, how is their volatility measured?
The standard deviation indicator is the best known measure of volatility and this is commonly incorporated into other indicators and methods to produce ratios traders employ to asses market performance.
A market may be making firm progress by moving up vigorously but even in this type of market, there will be downward moves as well as upward ones. You can expect 2 or 3 days in 7 to be ‘reversal’ days when the price moves back in the opposite direction to the one the market is taking.
In a vigorous market, these reversals are vigorous too and this pinpoints a major area of risk. Is the market changing direction or is it just reversing vigorously? Nobody knows the answer and no system can predict what will happen.
As a trader, your dilemma will be - how to avoid being shaken out whilst at the same time avoid being caught by a big setback? Volatile markets are more likely than others to pose these questions – but if as a systems trader, you have tested and evaluated your system thoroughly, you will know that it will deal with these problems competently.
Copyright David Bromley 2006
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