Wednesday, November 28, 2012

Volatility and Trading

MetaStock SPRS Series - Week 96 - TechniTrader® Stock Discussion for MetaStock Users - Volatility and Trading - November 26, 2012
By: Martha Stokes C.M.T.

We are continuing our discussion from last week regarding the what, when, how, and why of volatility.

Volatility is not a random event. It is not something that has no foundation, nor is it something that serves no purpose.

Volatility serves a purpose and function that most retail traders do not understand.

Whenever the markets start experiencing high volatility two major forces are at odds. It is like a rip tide that moves underneath the waves of the ocean that you see. A riptide can cause major shifts in the direction, strength, and distance that the regular ocean waves travel. Therefore understanding the rip tide effect in the stock market, is crucial for success in trading any financial market.

It doesn’t matter whether you trade stocks, options, futures, commodities, forex or other trading instruments. Volatility will intervene from time to time.

Why does volatility occur?

Volatility is the collision of two major institutional market participant groups. The most common collision occurs when High Frequency action meets Dark Pool action. These diametrically opposed groups cause most of the volatility in the markets today.

Dark Pools move in silently, hidden in the realm of over-the-counter transactions. Their goal is to buy stock at a specific price range over a long period of time as they acquire stock for a long term hold. They are not hiding from retail traders whom they don’t consider a major factor, but from the HFTs that constantly seek them out with little program robots searching for giant fund accumulation. HFTs then drive price upward, the precise thing the Dark Pools do not want to happen during their accumulation.

Volatility is the dynamic action when HFTs are on one side of the trade while the Dark Pools are on the other side. As an example, Dark Pools may be trying to acquire 25 million shares of XYZ stock. They can’t purchase that much stock all at once, or even over a few days. They must establish a price range and then set an automated formula order processing system in place, which triggers a buy of 100,000 or 500,000 shares ever so often so long as the stock remains within that price range. These orders create a specific footprint on the VOLUME and VOLUME ACCUMULATION indicators such as TTQA and TTVA.

Note: Chaikins Money Flow and Chaikins Accumulation Distribution indicators are not volume based indicators so they do not expose Dark Pool accumulation.

When HFTs are selling short the stock then smaller funds, retail traders, and independent retail investors are either selling in panic mode, or selling short along with the HFTs. HFTs are therefore on the opposite side of the trade of the Dark Pools, who have determined that the stock value has reached their buy point. The result is high volatility which invariably creates the bottom. As HFTs try to sell short the stock, Dark Pools orders are triggering buying within their predetermined price range. Since Dark Pools tend to use a range rather than a specific price to get faster fill over time, volatile price action occurs. This is how most bottoms form and this is why most bottom formations are wide sideways action, with unpredictable up and down intraday and day to day price patterns.

Whenever you see a lot of volatility during a downtrend, be aware that this is probably the riptide effect. Volatility is not random, it is the result of two powerful forces clashing at a specific price range. Bottoms are formed due to this conflict, which then evaporates and turns into a compression pattern that builds the upside energy.

Always be aware of volatility when selling short as the Dark Pools will eventually win the price war. Their buying power is vast and their positions are usually huge.

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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Wow, I never realized the connection between volatility and trading in the context of car rentals in Abu Dhabi. This article shed light on an interesting aspect of the market dynamics. Kudos to the author for such an insightful piece!

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