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What Actually is Volatility Trading?

By Louis H-P on March 4, 2020

5 (100%) 1 vote[s]

Ask anyone about financial markets and one of their first thoughts is volatility. Many ordinary people fear volatility but retail Forex traders love volatility! Traders see volatility as an opportunity, where the mis-pricing of securities leads to the possibility of profiting from trading. Yet every form of trading is risky, and requires hard work to take advantage of the opportunities presented!

What is volatility?

Volatility is a statistical measure of the dispersion of returns for a given security or market index.  In simpler terms it is the response of an asset price to an unexpected piece of news. This response can be positive, i.e. the asset price goes up or negative, the asset price go down. Any market, be it foreign currency or stocks values its assets by information available in the public domain (or sometimes not!).

Business news is useful for volatility tradingWhen there is a new piece of news, markets adjust their future projections and therefore their asset prices. What financial markets really really hate is a sudden piece of news which it does not understand, and critically cannot quantify! Enter the Coronavirius stage left. Uncertainty and an inability to correctly price an event leads to differing opinions as to the true value of a security, which means different prices. These differing prices translate to a volatile chart or graph as the financial market responds to the different price points. 

Difference between trading and investing

Trading and investing are often used interchangeably to describe buying and selling listed investments. Yet there is a subtle and actually rather large difference between the two. Investing is buying and holding the investment. You are analysis the cash flows of the company and compounded your return by re-investing dividends or interest earned. Trading you are focusing on the chart, and ignoring news such as company reports and economic forecasts. This is also known as technical trading.

The opportunity in volatility trading?

Market analysis is useful for volatility tradingTypically volatility trading is associated with stocks which are known to be volatile. Recently after the stock market had its worst sell off in 10 years, the S&P 500 responded by having one of it’s best days in 10 years! And that is with a virus spreading that no-one understands and whose financial effects we cannot as yet quantify! The risk with stocks is that you lose everything, just ask shareholders of Carillion.

Lowering your risk…

If you are thinking of trading volatility and have limited experience of any form of trading, why not trade Forex? Learning to trade Forex has its advantages. The advantage of Forex zero-sum game is not to be underestimated. With the recognised major currencies, you have a degree of certainty that they are unlikely to disappear. Tried and tested measures such as the risk reward ratio ensure that you can limit your losses.

Forex volatility trading?

Forex volatility trading is a good place to startYet most attractive for anyone looking to trade volatility is that the Forex market is the deepest in the world. Anyone who has traded stocks will know the frustration when they cannot place a trade. Few stockbroker platforms can truly handle the volume of trades in a volatile period.  When you ring the dealing desk you get placed on hold for minutes on end while watching your opportunity disappear.

Conclusion

Embracing volatility, uncertainty, change and being flexible is hard for humans. We are creatures of habit who like to do things our own way. Not being able to control events is hard for humans. Yet in this organised chaos that are financial markets, there are Forex trading opportunities to take advantage of. Knowing how to do so is the next step and having a trading plan is critical!

 

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Louis H-P

Louis is a portfolio manager and a trader who brings a wealth of experience in private banking to The Lazy Trader. A fundamentalist and a trouble-shooter, Louis makes a firm contribution to the trading team.

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Louis H-P

Louis is a portfolio manager and a trader who brings a wealth of experience in private banking to The Lazy Trader. A fundamentalist and a trouble-shooter, Louis makes a firm contribution to the trading team.

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