Thursday, January 14, 2016

What I learned from two Market Wizards about volatility

Given that the markets have taken off to the downside so far in 2016, readers may be wondering why I have not taken any positions so far this year.

The latest version of the scans I use have incorporated some of the ‘visual characteristics’ I look for into the scan code. Prior to doing this I could probably eliminate at least 80% of the charts that came up as those visual criteria were not met. This means I now have far fewer charts to go through – further leveraging my time. If a setup doesn’t meet my criteria, then it won’t get traded. This is designed to keep myself out of what may be classed as ‘sub-optimal’ trades.

Now, my criteria are quite stringent, but they are based and refined on the characteristics of my previous big winning trades, plus other major trends that I have seen. This remains an ongoing process.

Part of the scan criteria now includes interpreting both the volatility factor indicator and the 2ATR measurement.

As mentioned in previous posts, I look to identify a contraction in these readings prior to an entry, with hopefully an expansion of those readings after entry (look here for more).

This idea I got from a couple of trading legends, who talked about this in their Market Wizards interviews:

The basic premise of the system is that markets move sharply when they move. If there is a sudden range expansion in a market that has been trading narrowly, human nature is to try and fade that price move. When you get a range expansion, the market is sending you a very loud, clear signal that the market is getting ready to move in the direction of that expansion." - Paul Tudor Jones

"The fourth thing Mint does to manage risk is track volatility. When the volatility of a market becomes so great that it adversely skews the expected risk/return ratio, we will stop trading that market." - Larry Hite

In other words, for me to take a position not only does does the 'structure' of the price chart need to be correct, but there also needs to be a contraction in volatility prior to entry. It is this element not being met that means I am getting so few signals at the moment.

This may differ from the ‘pure’ trend following method such as those traded by Richard Dennis and the Turtles, who seemingly took entry signals when price reached a particular level almost regardless of the current level of volatility in that instrument.

Again, to quote Larry Hite “I see risks, rewards and money”.

This is partly how I have refined my own trading methods over the years. While the basic concept is that of trend following, I have refined my rules to add in additional filters or elements such as looking at volatility. As such they have become a major cornerstone of my overall approach to the markets.

As it is, the current volatility levels are keeping me safe in cash until I start to see opportunities where the risk:reward profile is more appealing.


  1. Hi Steve,
    thanks again for this interesting post. Can you explain your criteria mentioned in the following sentence in more detail?

    Part of the scan criteria now includes interpreting both the volatility factor indicator and the 2ATR measurement.

    Many thanks!

    1. Hi,

      Previously, I looked at those readings on those two indicators and made a visual interpretation of them, as to whether they met my own 'visual' criteria. This was something I did manually, as it did not form part of the original scan code. Now, however, I have simply included extra conditions within the code to 'formulate' that part of the process. This has had the benefit of reducing the number of charts I have to go through.

      As it is though, I am getting almost no set ups to look at because of the jump in volatility since the start of the year.

      There are still aspects that I look at outside of the scan results which I consider when deciding whether to take a trade - these include width of spread, proximity of earnings, existing exposure in the markets etc. These elements still have to be considered externally.

      Hope this helps.


    2. Hi Steve,

      thanks for your answer to my question, but it does not fully answer my question. Can you describe more specifically the extra conditions and code parameters? I would like to better understand how your criteria could also fit to my selecting criteria.

    3. Basically, those conditions interpret both of the two volatility measurements against their own moving average. I need those readings to be below the moving average to denote a contraction in volatility, and therefore satisfy the condition. Previously I simply did that 'visually'.

      As mentioned on the blog post, I periodically update the scan code as well as the parameters used. These can (and probably should) be suited to your own particular entry/exit parameters, experience and beliefs. My own trading is relatively short-term, so the parameters I use are geared towards that.

      The original base code I use is set out and explained in my e-book, and the latest updates (and the rationale behind those changes) are available to members of the mentoring group.

    4. Hi Steve,
      thanks very much again for your very fast answer. I understand that you do not want to give away the base code but your answer this time is sufficient to me and I understand the idea behind. Are there any plans to update your ebook, too? (as I have purchased it :-)).


    5. Hi Christoph

      No immediate plans to update the e-book at the moment, although it is on my 'to do' list!