Daily Archives: December 8, 2008

The Basics of Volatility

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Leroy Rushing asked:


For the unseasoned trader, volatility can seem scarier than it is rewarding. Profitable traders are able to generate profits on volatile and slow markets alike, but the really big wins come from when the market gyrates up and down at a quick pace.

How to trade volatility

When the markets are on the fritz, strategies for gapping up, as well as strategies for gapping down, prove to be very profitable. Both are proven strategies that make money when the markets are uneasy because of the breakout potential that exists in a volatile market. Strategies for gapping up are only used when the markets are volatile for good reason; gaps only occur in an ever changing market. Very rarely do prices gap up in a slow moving market; by default, you could make a case that the definition of volatility is many large gaps up or down.

Finding volatility

The stock market actually has an index for gauging volatility in the market. Called the VIX, it is a measurement of how wildly the markets are trading. A higher number means greater volatility, while a lower number indicates better trending and less wild movements. Watching the VIX, along with other custom indicators tuned to volatile markets, will help produce the best results.

Volatility philosophy

It seems that traders either love or love to hate a volatile market. Traditional technical analysis tools are rendered useless when the market gyrates, as the indicators improperly value the market. Often, a highly volatile market warrants the use of watered down technical analysis indicators – that is, data over a longer period of time than would typically be used.

Improve your trading

The best way to improve your trading is to learn to trade both trending and active markets together. This usually requires that traders have a trending strategy dedicated to calm markets and trade the breakouts with strategies for gapping up or down. In the very active markets, gap ups are one of the few indicators that hold their integrity and the ability to decide direction. A gap up shows strength that the market will continue to rally, while a gap down shows the opposite.

Basic trading fundamentals should remain the same in any market; you should continue using reasonable profit/loss ratios and limit potential losses to less than a few percentage points of your trading account. A volatile market should push you to dilute your indicators with more data, expand the RSI 14 to an RSI 25, or push up moving averages to get a better view of the overall market. There is plenty of money to be made in any market with proven strategies. Be sure to properly test your trading plan before going live in a choppy market.



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Volatility in August?

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cordieliea asked:


There is an old saying, sell in May and go away until Labor Day.

The latter is around the corner but it seems like the market is already waking from its summer slumber a little earlier then expected. Perhaps, like the weather, things have become a little out of kilter.

The volatility index (VIX) derived from the S&P 500 stock index options, has been at or near a five year high for the last couple of weeks. This index is a good measure of broad based fear in financial markets and last peaked as the dotcom bubble burst at the seams says Betonmarket’s Michael Wright.

The financial instrument most directly effected by this occurrence is the options market, with buying options becoming a more expensive strategy, while selling options becomes potentially more profitable due to the increase in the premiums at which these options trade. The gist is that selling options becomes more rewarding because of the increased risk and buying options becomes more expensive because of the decreased risk.

While the market has been swinging wildly in both directions, the overall direction has been negative, with the SP500 losing all gains from as far back as May 2007. One of the main culprits for this bit of volatility is the earnings season, which has seen more missed estimates than beats.

Over the last few years it has become almost a norm that companies declared record earnings and forecasted for higher earning for the following quarter.

This season however more and more companies are starting to miss their previously glowing earning predictions, and to make things worse are starting to predict slowdowns and lower earnings. At the same time there is a credit worry regarding the hybrid mortgages which were issued over the last few years, like the flex adjustable rate mortgages which resets itself every 3 or so years after the low teaser rate has run out.

There are also other repercussions such as the hedge funds who invest in these mortgages. Bear and Stearns, a giant US hedge fund had two funds collapse, and had to notify investors that they won’t be getting any money from its investment due to its collapse.

All this has been affecting public confidence to a point where traders are sitting in front of their computers with itchy fingers, ready to sell at the slightest sign of a pullback.

With Betonmarket.com the average trader can potentially capitalise in the situation and do something that is the equivalent of selling options. With the charts still looking bearish a no touch higher trade could be an interesting proposition. This no touch trade is similar to selling options and compensates a trader if a predetermined level is not reached within a set time period.

One trade to take advantage of current conditions is a No touch 100 points higher than the current spot price on the S&P 500 which yields around 10% ROI within 20 days. This means that if the S&P 500 doesn’t rise 100 points over the next 20 days you win.



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