Learn Forex – Trading Forex Volatility
Learn Forex (FXpath.com) – The concept of volatility plays a vital role in technical analysis, especially in the subrealm of trend analysis. Many technical traders consider volatility carefully when making trading decisions. Marked changes in volatility are the main concern of these traders. To narrow it down even further, it is really the change in volatility from low to high, rather than vice versa, that is of the utmost interest.Trending conditions are most often characterized by alternating periods of low and high volatility. Low volatility is usually considered price consolidation, equilibrium, or simply sideways price action. High volatility, in contrast, is often strongly directional, although this does not have to be the case. The shift from low volatility to high volatility is often manifested as a range expansion that marks the beginning or continuation of a trend. Therefore, this type of shift is vitally important to trend traders.
Every trend will generally go through alternating periods of rest and resumption during its life cycle. The “rest” portion (low volatility) could either be in the form of a sideways consolidation or a countertrend retracement. The “resumption” portion (shift to high volatility) is often in the form of a strong directional move. One of the most advantageous locations at which to enter into a trend is when a period of rest suddenly becomes a period of resumption. This can be characterized as a volatility breakout, where low volatility shifts into high volatility, in the direction of the prevailing trend.
Continuation chart patterns like triangles, flags, pennants, and rectangles are simply diminished and/or diminishing areas of volatility that are just waiting for breakouts to higher volatility, most often in the direction of the trend. Besides these chart patterns, other methods of utilizing volatility shifts, or breakouts, include breaks of horizontal trading ranges, breaks of x-period highs or lows, and the Bollinger Bands “squeeze.” Common technical tools for measuring volatility, as well as changes in volatility, are the Average True Range (ATR), Bollinger Bands, and the Bollinger BandWidth indicator.
Measuring and taking into consideration changes in volatility can be a vital component of making wise trading decisions, as volatility changes can give important clues as to the momentum of a market.
- Excerpted from Essentials of Technical Analysis for Financial Markets (John Wiley & Sons, 2010).
James Chen, CTA, CMT (bio)
- Click here for my book, Essentials of Foreign Exchange Trading (Wiley).
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Good article, i use Boll BandWidth to measure changes in volatility. Great indicator. thanks.
Barry