Do Volatility Indicators Do What Their Name Suggests? An Expert Explains

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The Volatility technical indicator is helpful in seeing potential market reversals. This Volatility indicator based on the true range of price is based on the premise:

  • Strong trends upward are marked by decreases in volatility.
  • Strong trends downward show a general increase in volatility.
  • Reversals in trend usually occur when volatility increases.

The chart below of the 5,000 ounce Silver futures contract illustrates the first point, that strong trends might have low volatility:

Volatility increases as prices fall, volatility decreases as prices rise

As the price in silver futures was increasing, the volatility was steadily decreasing. The change in trend was characterized by increased volatility.

Bottom Reversals

When prices bottom, they are usually accompanied by increased volatility. An increase in the Volatility indicator after a recent decline, could signal that the price is bottoming. A trader might exit or reduce the size of short positions during this time of increased volatility at a bottom. Other indicators would be used to determine when a trader might enter a long position.

The chart below of the S&P 500 Emini Futures contract shows an example of how bottoms can be marked by increases in volatility:

Increases in volatility can often mean price bottoming

Due to the general inverse relationship of volatility and price, the Volatility indicator might be useful in determing strong trends and potential price bottoms. Another similar tool is the VIX and VXN indexes that measure the implied volatility of CBOE index options (see: VIX & VXN Volatility Indices).

The information above is for informational and entertainment purposes only and does not constitute trading advice or a solicitation to buy or sell any stock, option, future, commodity, or forex product. Past performance is not necessarily an indication of future performance. Trading is inherently risky. shall not be liable for any special or consequential damages that result from the use of or the inability to use, the materials and information provided by this site. See full disclaimer.

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