Volatility

Active investors, in order to be successful, require volatile markets with a direction. The ATR (Average True Range) is a useful concept to monitor a market’s volatility. The ATR is the range within which a financial instrument usually evolves. If an index has a Day-ATR of, say 100 points, it means this index can easily move 100 points in a day.

Understanding volatility is crucial. Firstly, volatility is not static. It evolves over time. These evolutions are often substantial. Secondly, volatility differs from time period to time period (example below). And, thirdly, each underlying instrument (market indices, commodities …) has a different volatility.

If you are trading a future on an underlying instrument which sees a significant drop in volatility and/or which has no clear direction, it might be wise to change the product you trade.

The below table contains very interesting data. It shows that volatility is not static. Indeed the volatility on these market indices nearly doubled over a 2-year period. It also shows that not all indices have the same volatility. So it is important to know what you trade! Not all indices are the same.

Index  ATR Mid 2006 ATR Mid 2008
CAC40 index 77 points (1,6%) 106 (2,4%)
FTSE Index 
DAX Index 98 (1,8%)  146 (2,3%)
AEX Index 5,1 (0,9%) 10,1 (2,5%)
DOW Index  129 (1,2%) 220 (1,9%)

 

 

 

 

 

The table below is again very interesting. It compares the volatility of the Dutch AEX index in different time frames. It gives an impression within which ranges this index can evolve in these different time frames.

ATR mid-2008
1 Day  10,1 points (2,5%)
1 Hour 1,5 1,5 (0,4%)
10 Minutes  0,8 (0,2%)
1 Minute 0,2 0,2 (0,05%)

 

 

 

 

Knowing this information about the index you want to trade is absolutely crucial. Why? Because it helps you determine price objectives and stops for your open positions. Put your stop too close and the natural oscillation of the index will stop you out. If you trade in a 10-minute time frame with stops of 0,5 or 1 point on this index you will be stopped out unnecessarily.

Placing stops at distances which do not keep into account the natural oscillation of the instrument is a typical beginner’s mistake which can easily be avoided by knowing the instrument’s volatility.