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 guide explains what it is and how to recognize trends with the help of example charts.

What Is Volatility?

The volatility indicator, based on the true range of price, is based on the following 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.

Effect of Strong Trends on Volatility

This chart of the 5,000 ounce silver futures contract illustrates the point that strong trends might have low volatility.

Volatility increases as prices fall, volatility decreases as prices rise
Please note, this is an example trade – not a recommendation.

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

Increased Volatility and Price Bottoms

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.

This chart of the S&P 500 E-mini futures contract shows an example of how bottoms can be marked by increases in volatility.

Increases in volatility can often mean price bottoming
Please note, this is an example trade – not a recommendation.

Due to the general inverse relationship of volatility and price, the volatility indicator might be useful in determining strong trends and potential price bottoms.

Where to Trade Commodities Using Technical Analysis

If you’re interested in trading using technical analysis indicators like volatility, have a look at our reviews of these regulated brokers available in .

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CFDs are complex instruments and come with a high risk of losing money rapidly due to leverage. <b>Between 74%-89% of retail investor accounts lose money when trading CFDs.</b> You should consider whether you can afford to take the high risk of losing your money.

FAQ

How Is Volatility Calculated?

Volatility can be calculated by comparing current or expected returns against the stock or market’s mean or average. It typically represents a large positive or negative change.

It’s possible to report daily, weekly, monthly, or yearly volatility. This can be calculated using variance and standard deviation, with standard deviation being the square root of variance.

Further Reading

A similar tool to the volatility indicator is the VIX and VXN indexes that measure the implied volatility of CBOE index options.

Learn more about technical analysis charting concepts and strategies, including:

Also see our guide to understanding the basics of reading candlestick charts and option trading strategies.

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