Tuesday, November 20, 2012

Take Advantage of Volatility

MetaStock SPRS Series - Week 95 - TechniTrader® Stock Discussion for MetaStock Users - Take Advantage of Volatility - November 19, 2012
By: Martha Stokes C.M.T.

Many traders complain about volatile markets. They see volatility as a problem, something that thwarts their trading and frustrates them as they try to short term trade. In their trades they encounter whipsaws, bounces, and reversals that cost them profits or worse, chronic small losses.

Many Options traders use implied volatility, or what I call compression patterns as a means of anticipating breakouts and sudden moves up or down.

Most of the time traders view volatility as a bad thing, something to endure and wait to end.

But instead of viewing volatility as something negative, you need to understand the why, how, when, and where of volatility. If you understand it, you will find that volatility is actually a powerful analytical tool that you can use to improve your trading, understand the balance of power between small lots and large lots, AND use it to enter stocks sooner with more confidence.

The WHY of Volatility:

Why does volatility occur? Is it just High Frequency Traders HFTs making a lot of fast runs? Is it Dark Pools creating problems for retail traders by trading over the counter off the exchanges? Is it caused by news and events? Or is it just some mysterious event that happens and no one can explain?

None of the above are correct.

Volatility is caused by very specific trade activity. It is not random, or chaotic, although it appears that way when you are in a trade or when you are looking at charts. It is actually a powerful, dynamic signal of a major change going on beneath the surface of the news, hype, media frenzy, crowd mentality, and trading room chatter.

To understand volatility and why it occurs, we are going to use an analogy most of you are familiar with, and have experienced some time in your life.

The ocean is full of currents, rivers, canyons, and riffs. It is also controlled by the moon’s gravitational pull, which all of you know creates the tides. There are counter movements, such as under ocean rivers, the ocean continental convergence, Arctic circumpolar currents and surface currents.

Tidal changes can be minor to severe. Extreme low tides are usually followed by extreme high tides. How close the moon is to the earth also factors in. So we have two factors affecting the waves that come to shore on the beaches you walk on:

1. Underlying energy caused by the structure of the ocean itself.
2. The moon’s gravitational pull, or outside influence that changes the tides.

The same is true of the markets.

There are structural aspects of the markets that cause under currents, rip tides, eddies, and shifts to waves like in the ocean. These deep market structural currents and movement are far below the surface of what retail traders and retail news sees and understands.

These deep structural market currents affect the overall market in ways that are not visible most of the time. These are mostly the giant lot institutions, hedge funds, and other buy side or sell side market participants.

Then we have the waves that occur in the stock market due to the smaller lots, smaller funds, and HFTs. These groups create the gravitational pull of the markets, creating speculative runs up and down due to highly emotional trading OR due to huge volume flow on the millisecond.

It is when these two levels of the market collide that we encounter volatility.

I will continue this discussion next week.

Trade wisely,

Martha Stokes, C.M.T.
Member of Market Technicians Association
Master Rated Technical Analyst: Decisions Unlimited, Inc.
Instructor and Developer of TechniTrader® Stock Market Courses
MetaStock Partner

©2012 Decisions Unlimited, Inc.

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