Have you ever wondered why the certain trading instruments are very rapid while some our extremely slow and boring?
In this educational article, we will discuss the market volatility, how is it measured and how can it be applied for making smart trading and investing decisions.
📚 First, let's start with the definition. Market volatility is a degree of a fluctuation of the price of a financial instrument over a certain period of time.
High volatility reflects quick and significant rises and falls on the market, while low volatility implies that the price moves slowly and steadily.
High volatility makes it harder for the traders and investors to predict the future direction of the market, but also may bring substantial gains.
On the other hand, a low volatility market is much easier to predict, but the potential returns are more modest.
The chart on the left is the perfect example of a volatile market.
While the chart on the right is a low volatility market.
📰 The main causes of volatility are economic and geopolitical events.
Political and economic instability, wars and natural disasters can affect the behavior of the market participants, causing the chaotic, irrational market movements.
On the other hand, the absence of the news and the relative stability are the main sources of a low volatility.
Here is the example, how the Covid pandemic affected GBPUSD pair.
The market was falling in a very rapid face in untypical manner, being driven by the panic and fear.
But how the newbie trader can measure the volatility of the market?
The main stream way is to apply ATR indicator, but, working with hundreds of struggling traders from different parts of the globe, I realized that for them such a method is complicated.
📏 The simplest way to assess the volatility of the market is to analyze the price action and candlesticks.
The main element of the volatile market is occasional appearance of large candlestick bars - the ones that have at least 4 times bigger range than the average candles.
Sudden price moves up and down are one more indicator of high volatility. They signify important shifts in the supply and demand of a particular asset.
Take a look at a price action and candlesticks on Bitcoin.
The market moves in zigzags, forming high momentum bullish and bearish candles. These are the indicators of high volatility.
🛑 For traders who just started their trading journey, high volatility is the red flag.
Acting rapidly, such instruments require constant monitoring and attention. Moreover, such markets require a high level of experience in stop loss placement because one single high momentum candle can easily hit the stop loss and then return to entry level.
Alternatively, trading a low volatility market can be extremely boring because most of the time it barely moves.
The best solution is to look for the market where the volatility is average, where the market moves but on a reasonable scale.
Volatility assessment plays a critical role in your success in trading. Know in advance, the degree of a volatility that you can tolerate and the one that you should avoid.