Before reading through this lesson, you should have previously read through:

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What is market volatility?

Volatility is the measurement of how much an asset changes in value over a given period of time. If a trader buys an asset, they expect that asset to increase in value during the course of that trade. Conversely, if a trader sells an asset, they expect it to decrease in value during the course of the trade. The more its value changes, the higher its volatility. If the price of an asset has a high volatility, there is more risk associated with trading it, but greater potential for profits. If an asset has a low volatility, there is a lower risk trading it, but less profit potential. Market volatility can also be referred to as price volatility, or trading volatility.

Volatility is the measurement of how much an asset changes in value over a given period of time.

As a trader, you are always looking for ways to increase profit. Thus, you will seek out the most volatile assets which give higher potential for profit.

Measuring market volatility

In trading, volatility is measured using certain indicators including moving averages, Bollinger bands and average true range (ATR). Each of these indicators can be used slightly differently to measure the volatility of an asset and more importantly, interpret this data in a different format.

Volatility is measured using certain indicators. Each of these indicators can be used differently to measure volatility and interpret data in a different format. Moving averages are displayed on the price chart and the distance between the moving average and the price shows the volatility of the asset.

Moving averages

Moving averages are displayed on the actual price chart and the distance between the moving average and the price shows the volatility of the asset. The further away the price is from the moving average, the higher the volatility of the asset.

The image below shows the moving average line far away from the price above it, demonstrating that this asset has a high volatility.

Moving average high volatility

The next image demonstrates an asset of low volatility; the moving average is close to the current price.

Moving average low volatility

You can practice identifying periods of high and low volatility in the following exercise:

Exercise 1: Find the periods of high and low volatility Show exercise
Exercise 2: Find the periods of high and low volatility Show exercise
Exercise 3: Find the periods of high and low volatility Show exercise

Learn more about moving averages here:

Lesson
Learn how to use moving averages to determine trends and changes in market direction.
You haven't attempted the quiz yet.
37

Bollinger bands

The Bollinger bands indicator displays several lines to the price action, which squeeze together when volatility is low and expand when it increases.

Another very common tool used to measure price volatility is the Bollinger bands indicator. Bollinger bands display the volatility in a slightly different way. Several lines are applied to the price action which squeeze together when volatility is low and expand when it increases. An asset with expanded bands is in a high volatility state.

The image below demonstrates what Bollinger bands look like on a price chart when volatility is high.

Bollinger bands high volatility

The image below demonstrates what the bands look like when a pair has low volatility.

Bollinger bands low volatility

You can practice identifying periods of high and low volatility in the following exercise:

Exercise 1: Find periods of high and low volatility Show exercise
Exercise 2: Find periods of high and low volatility Show exercise
Exercise 3: Find periods of high and low volatility Show exercise

Learn more about Bollinger bands here:

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Average true range (ATR)

The ATR indicator measures volatility using an actual value. The higher the value, the higher the volatility.

Another common measurement of market volatility is the ATR indicator. This tool measures the volatility and gives an actual value. So rather than observing the price in relation to a tool, such as a moving average or Bollinger bands, the ATR gives a value – the higher the value, the higher the volatility.

The ATR also shows whether the volatility is increasing or decreasing, as well as what the volatility is at a given time.

The image below shows that the asset not only has a high range, but that the range has also been increasing over time, indicating increasing volatility.

ATR high volatility

number_1 High range
number_2 Range increasing over time

The image below shows an asset with a low range which is decreasing, indicating lower volatility.

ATR low volatility

number_1 Low range
number_2 Range decreasing over time

It is important to note that the ATR indicator does not give the direction of the trend, simply whether the volatility of that asset is increasing or decreasing. When the ATR line goes up, the volatility has gone up.

You can practice identifying periods of high and low volatility in the following exercise:

Exercise 1: Find the periods of high and low volatility Show exercise
Exercise 2: Find the periods of high and low volatility Show exercise

Learn more about average true range here:

Lesson
Learn how to use the ATR indicator to measure the volatility and see how much price has been moving over a period of time.
You haven't attempted the quiz yet.
16

How to use volatility

If the volatility is low and decreasing, it is much safer to avoid placing any trades on that pair as the probability of a profitable move occurring is greatly reduced.

If volatility is low and decreasing, it is safer to avoid placing trades because a big move towards profit is less likely. When volatility is increasing, the chance of a large move occurring that increases profit is higher.

In contrast to this, when anticipating large moves, particularly breakouts, it is important to trade in times when volatility is increasing. When volatility is high, the probability of a large move occurring is higher and traders have a greater chance of making money.

Summary

So far, you have learned that ...

  • ... market volatility is a measurement of how much the value of an asset changes.
  • ... the higher the volatility, the greater the profit potential for that asset.
  • ... we can use various indicators to tell us the volatility of a pair at any given time.
  • ... if a moving average is far away from the price, this indicates high volatility and if the moving average is close to the price, this indicates low volatility.
  • ... if the Bollinger bands have expanded apart this indicates high volatility and if the Bollinger bands contract this indicates low volatility.
  • ... a rising ART value indicates high volatility and a decreasing ATR value indicates low volatility.

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  • Assuming one doesn't use all 3 indicators for volatility, which one do you use and why? What are the advantages one has over the others?
  • Hey Fr0z3nByt3,
    I certainly won't be able to talk about advantages that one provides over the others, but as example, I can say that I use ATR to define my stops.

    What I could recommend you is to select the indicator in function of the information you need to gather. The use of such an indicator should answer to a lack of information in your overall decision-making process.

    By hoping that it helps.
    Sebastien
  • Thanks a lot!
    I use the Bollinger bands, because it's the first indicator I studied, but I'll try the others too in the future
  • you can bounce play with BB if play correctly. bollinger on bollinger bands is a must read. smile

    for now, I will try guppy. :3
  • Hi there,
    Is the volatility indicator something like strength indicator?
    Thanks.
  • Hi JHTAN,
    it can be interpreted as strength, but while momentum, RSI shows more clearly a potential for the price to move in one specific direction (momentum over 0 means up, RSI over 50 means up), volatility has no direction and can warn you that moves in both direction might be just as likely and strong as well. Picture a situation where RSI is oscillating between 40 and 60 (typical ranging market) yet volatility can be high with spiky candles that would take your stop. Hope that was helpful. Regards.
    Peter
  • Is it safe to say the the least useful of the three-volatility indicator is the MA, and the more accurate one is the ATR?
  • Hi deeny111,
    deeny111:
    Is it safe to say the the least useful of the three-volatility indicator is the MA, and the more accurate one is the ATR?

    My mind is that "useful" or "accurate" might not be really appropriate. If you have a look on what those indicators are build on, they almost share the same raw data and are all based on averages. Their respective calculations remains quite similar (the most of differences could be seen with the ATR...)

    I would recommend you to choose the indicator which seems to be the easier to read and to interpret for you, and helps you in your making decision process.

    Hoping that I help you a little. smile Regards,
    Sebastien
  • I guess that the beginner strategy doesn't perform well in low volatility. I'm judging based on former experience especially when setting the take profit to the next pivot point which in low volatility is way far!
    Am I right?

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