#11 How to Trade Volatility

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by Mike Lally

A major weakness of volatility-based indicators is their inability to predict the actual direction of a major price move

Many are excellent at providing a measure of specific volatility but the trader needs some other indicator to confirm the actual direction.

Often mapping volatility information can result in producing timely signals. These signals can be in advance of a price move and occasionally put the astute trader in a potentially profitable trading position. This can happen both for long and short positions and is extremely useful for the options trader.

If volatility is steadily climbing and price has moved above a support or resistance line, the trader needs to be certain which way price is likely to head. Timely and accurate information makes a world of difference.

Perhaps the simplest method to employ is to use a moving average of price. For example, a trade to the long side could be taken if price crosses above a short term moving average. The opposite would apply to a short position – price would cross below a short term moving average.

Used in conjunction with the volatility of a recent period, this can be a highly effective, yet simple to use combination. Trading does not need to be overly complicated.

It pays to have an understanding of volatility when trading equities; it is crucial for an options trader. The relationship between price and the fluctuations in volatility, both up and down, is often timely and rewarding.

Learning how volatility plays an integral role in all forms of trading is vital given it is the origin of all price movement both to the upside and downside.


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