Sunday, September 21, 2008

Volatility and the markets

There are basically 4 combinations of states that the markets can be operating in:

1. They are either trending or non-trending;
2. They are either quiet or volatile.

Trend followers prefer quiet markets that also trend. Day traders prefer volatility. Swing traders prefer volatile trending markets to catch swings from a couple of days to a couple of weeks.

Since the 'credit crunch' started around August last year, we have seen volatility increase towards last weeks crescendo, with the Dow having daily moves of up to 500 points, and the FTSE having it's biggest one day rise. Trading off a daily chart has been a nightmare for me, the pattern of one day up, one day down with massive intra-day swings being too much for me to cope with. Two ways to deal with this:

1. Trade shorter-term;
2. Trade longer-term.

I am uncomfortable trading shorter-term, mainly because I am not in front of a screen all day (and do not particularly wish to be). Therefore my tendency would be to look at longer-term trades which 'filter out' the volatility to a degree.

With that in mind, here is the current state of the FTSE100 on a weekly chart:

Some things to note:

1. The market is still in an overall downtrend;
2. The 20 ATR (Average True Range) which tracks the average range of an instrument for the last 20 weeks clearly shows the increase in the volatility, which is now showing an average weekly movement of around 250 points.
3. As the volatility increases, the counter-trend rallies become more agressive, as traders either cover their short positions or people buy in thinking the bottom has been reached.

One needs to be aware of the state and the volatility of the overall markets, and these factors can have an adverse impact on trading methods and systems that were designed to take advantage of 'quieter' market conditions.

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