What the Heck is Volatility and Why Should I Care?

Volatility has been the talk of the town these days, as traders are starting to observe notable changes in market behavior. Market analysts have been paying closer attention to the wild price swings on an intraday basis and comparing this behavior to periods of less volatility.

What does volatility mean anyway?

Technically speaking, volatility refers to the amount by which an asset price fluctuates over a time period. It is measured by taking the standard deviation or the variance of price changes over a specified duration.

Woah, that's a lot of financial mumbo-jumbo!

Simply put, volatility is a measure of how moody the markets are. As my trading bros put it, a volatile market environment is as sensitive as a girl with PMS. When something goes right, the positive reaction is typically magnified. When something goes wrong, the saying "Hell hath no fury like a woman scorned" becomes a reality.

How is volatility measured?

As discussed in the School of Pipsology, technical indicators can be used to measure volatility in the forex market. In particular, moving averages, Bollinger bands, and the Average True Range (ATR) can be used to keep track of price fluctuations.

A more common method to measure volatility is through the VIX or volatility index. Dubbed as the "fear index", this particular tool gauges the implied volatility of S&P 500 options and is helpful in predicting overall market volatility for the next 30 days.

A rising VIX means that there is a lot of uncertainty in the markets and price action is expected to be very sensitive in the coming days. A falling VIX shows that there is lower uncertainty and market confidence is improving.

How volatile are the markets lately?

Over the past six trading weeks, the VIX has jumped by around 42% and is moving close to the 18 level. Although this is still miles away from the 60 level reached during the 2008 financial crisis, the recent spike is relatively sharp in historical standards.

With that, several analysts warned that a big shift in market environment may be in the cards. At the moment, the VIX is cruising above its 200-day moving average and is expected to stay there in the coming trading days. If that's the case, the 50-day moving average could make an upward crossover, which would signal further increases in volatility.

What the heck should I do now?!

DO NOT PANIC! Perhaps the worst way to deal with higher levels of market anxiety is to be increasingly anxious as well. Remember that we are dealing with a potential shift in market environment so it's crucial to maintain a focused mindset and keep your emotions in check.

A good way to start is by taking note of the changes in average price movements for a trading day. From there, you can make the necessary adjustments in your stops and profit targets. An adjustment in trading style, such as shifting from longer-term to shorter-term setups, might also be appropriate.

Got any other recommendations on how to adjust to higher volatility? Let us know by dropping a comment below!