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Thursday, November 07, 2024

5 Best Volatility Indicators Every Trader Should Know

By Century Financial in 'Blog'

5 Best Volatility Indicators Every Trader...
5 Best Volatility Indictors Every Trader Should Know

Why Are Stock Markets Volatile During Uncertainity?

The word "volatility" comes from the Latin word volatilis, meaning “fleeting” or “swift”—much like the wild swings we see in the stock market.

In the trading world, volatility can feel like trying to predict the weather—calm one moment, stormy the next. But just like weather forecasts help you plan your day, volatility indicators can help you confidently navigate market shifts.

In this guide, we’ll explore five must-know volatility indicators and how you can harness them on the Century Trader App for better strategic trades. Whether you're spotting trends, setting stop-losses, or timing breakouts, these indicators are essential for every trader’s toolkit.

 

What is Volatility?

Volatility refers to the degree of variation in trading prices over time. High volatility often indicates uncertainty or instability in the market, where asset prices are fluctuating rapidly within a short period, while low volatility suggests stability where asset prices are moving within a narrow range without large fluctuations. But how can you effectively measure and respond to these changes?

Let’s dive into the top volatility indicators you should know.

1. Average True Range (ATR)

Understanding ATR

The Average True Range (ATR) is a technical indicator that measures market volatility by analyzing the average range between the high and low prices of an asset over a specific period. A stock experiencing a high level of volatility has a higher ATR, and a lower ATR indicates lower volatility for the period evaluated. It is typically derived from the 14-day simple moving average of a series of true rate range indicators.

How to Use It

Traders commonly use ATR to set stop-loss levels, identify potential breakout points, and assess overall market conditions. You can easily incorporate ATR into your trading strategy on the Century Trader App. For instance, if you notice an increase in ATR, it might be a signal to set up broader stop-loss orders. The ATR is an exit method that can be applied regardless of the entry decision.

Why? A rising ATR suggests that prices are moving more dramatically, which could lead to more giant swings in your trades.

Did you know that ATR was developed by trader J. Welles Wilder, who also created the RSI (Relative Strength Index)?

 

Average True Range

2. Bollinger Bands

What Are They?

Bollinger Bands are a popular technical analysis tool that helps traders visualize an asset's volatility and identify potential overbought or oversold conditions. These have a moving average and generally two standard deviation lines above and below. The center line is the stock price's 20-day simple moving average (SMA). The distance between the bands widens when volatility is high and narrows when volatility is low.z

How to Use It

Bollinger Bands are useful for spotting trends, reversals, and potential entry and exit points based on volatility patterns. With the Century Trader App, you can visualize Bollinger Bands easily. When the price touches the upper band, it might signal an overbought condition. Conversely, touching the lower band could indicate an oversold condition.

Watch for ‘squeezes’ which are periods of low volatility, often preceding significant price movements.

 

Bollinger Bands

3. Keltner Channels

What are Keltner Channels?

Keltner Channels are a technical analysis tool like Bollinger Bands, used to assess volatility and potential breakout opportunities.

How to Use Them

The Keltner Channel has three lines: a middle line and two channels above and below. The middle line is usually a 20-period exponential moving average (EMA) of the price, but this can be changed according to the trader’s preference. The channel lines are calculated by adding and subtracting a multiple of the average true range from the middle line. On the Century Trader App, you can use Keltner Channels to identify potential trend reversals or confirm breakouts. When prices breach the upper channel, it might indicate a solid upward trend; conversely, a break below the lower channel could signal a downward trend.

 

Keltner Channel

4. Donchian Channels

Understanding Donchian Channel

These are volatility-based technical indicator used to identify trends and potential breakouts.

How to Use Them

It is formed by taking the highest high and the lowest low of the last n periods. The area between the high and the low is the channel for the period chosen. Suppose an asset is trading in the middle of the range with no significant deviations toward the upper or lower bands. In that case, the market is experiencing minimal volatility, and there may not be a clear overall bullish or bearish trend. They can be handy for trend-following strategies. On the Century Trader App, you can set entry and exit points based on price action relative to these channels. A breakout above the upper band could signal a buy opportunity, while a drop below the lower band might indicate a sell signal.

 

Donchian Channels

5. VIX – Volatility Index

What is VIX – Volatility Index?

The CBOE Volatility Index (VIX) often referred as “fear index” is a real-time indicator of market expectations for near-term price changes in the S&P 500 Index (SPX). It projects 30-day volatility, often called “the VIX”. Created and maintained by the CBOE Options Exchange, VIX is crucial for measuring market risk and investor sentiment in trading and investment.

How to Use Them

VIX signals the level of fear or stress in the stock market—using the S&P 500 index as a proxy for the broad market. Typically, the VIX moves inversely to the stock market. When the market declines or uncertainty increases, the VIX tends to rise as demand for options increases. Like all indexes, one cannot buy the VIX directly. Instead, investors can take a position in VIX through VIX-based exchange-traded products (ETPs). For example, the ProShares VIX Short-Term Futures ETF (VIXY) and ProShares Short VIX Short-Term Futures ETF, available on the Century Trader Platform.


The Importance of Combining Indicators

Creating a Robust Strategy: While each indicator offers valuable insights, combining them can provide a more comprehensive view of market conditions. Use the Century Trader App to create alerts and track multiple indicators simultaneously.

Personalising Your Approach: Your success as a trader hinge on your ability to adapt to changing market conditions. Experiment with different combinations of volatility indicators to find a strategy that works best for your trading style and risk tolerance.

The Bottom Line

Volatility is an unavoidable part of trading, but with the right tools, research and knowledge it doesn't have to be unpredictable. Mastering these five key indicators—ATR, Bollinger Bands, Keltner Channels, Donchian Channels, and the VIX—can give you an edge in managing risks and seizing opportunities.

Remember, no single indicator guarantees success. With the Century Trader App, you can effortlessly track, analyze, and act on market signals.

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