What Is Volatility?

Day traders tend to think of volatility as how ‘fast’ or ‘random’ the price bars on their charts are moving, this situation actually being prevalent during high volume consolidation periods, a period of time where there are numerous erratic moves as traders ‘fight it out’ trying to break out of the consolidation -vs- buying-selling the low-high of the consolidation. This may be viewed as volatile and ‘untradeable chop’, but this is not volatility.

Volatility as a statistical measure, most frequently refers to the standard deviation of the change in value of an underlying over a specific amount of time — that amount then be used as a way to quantify risk for the given underlying.

Although day traders are impacted by statistical volatility, as a large percentage of daily volume is coming from institutions, position traders and program traders who are using this metric for their decision making and trading systems, this measure of volatility is not really usable for method day traders.

Volatility which can be used for day trading refers to the contraction-expansion of price movement-price range — volatility thus implies trading potential from wider range BUT volatility does not imply the direction of that range. Breakout traders are trying to capture volatility expansion, which they believe will occur after the breakout point. Price momentum divergence traders are trying to capture volatility contraction, which they believe will occur due to the divergence AND not only will they profit because of the contraction, they will additionally profit from a swing reverse IF this contraction then expands in the direction of the divergence.

Day Trading And Capturing Volatility

Consider our day trading method and volatility. We trade from the inside to the outside BUT once an outside extreme is reached, this does not necessarily mean that there will be a reverse, instead there can be a period of consolidation which breaks in the direction of the move before the consolidation, again expanding range AND often with ‘fast-vertical’ movement — trades that can be entered into AND benefit from the volatility expansion BUT trades that would be difficult to enter after the move.

Our base method and trading setups have been developed to capture volatility expansion, but we want to do this without having to trade breakouts, and especially without attempting to fade directional strength and pick tops or bottoms. Think about some of the trading method terminology and what it is referring to in this regard: trading into/through a breakout — trading in the direction of mex flow after a retrace — trading continuation — trading reject-failure combinations — trading matched price failure — trading diagonal breakout potential — trading mixed method failures; all of these method-setup components are intended to enter a trade during a relatively low or contracted volatility period — right as volatility begins to expand AND ideally into a high volatility period.

In light of this, our biggest method problem will be to not overtrade the low volatility periods. This is why we look for transitions into consolidation and have specific consolidation related setups, this is why we make differentiations between break1 pivot trades and break2 with mex flow pivot entries, this is why we look for a failure component as part of a trade setup, this is why we trade triple diagonal breaks -vs- horizontal line breakouts — these are all intended to help avoid the overtrading AND give a basis for the timing of when volatility is going to start to expand.

The 52t fast chart is intended to be a timing chart, that is a chart attempting to ‘find’ the best available entry price into a setup price break, which upon breaking will lead to range-volatility expansion. A fast chart is not intended to be a ‘stand alone’ trading chart, there is far too much ‘noise’ and ‘meaningless’ movement to do this. The 120t slow chart, and do understand that in terms of time this is still a relatively fast chart, is intended to both give clarity to the fast chart, as well as show a ‘next’ setup to one that was not seen or traded on the fast chart.

52t red dot1: this is a trade that was done as break2 of the blue line AFTER a ticki high double top-lower high combination — this was also a trade taken with the primary market direction — thus the ‘willingness’ to try an initial entry BECAUSE this is not base in terms of being entered with mex flow AND this is not a trade that has breakout potential-volatility expansion inherent to the setup. it’s a trade that a continuous trader may take because of direction AND the specific timing from the ticki high double top against that direction BUT it’s not a trade for the more selective traders AND IF these other components weren’t part of the trading decision — this trade wouldn’t-shouldn’t have been done. as is often the case when trades like this are taken — there will be a retrace where the fast chart indicators reverse — there was no buy setup to consider-the short was held open.

52t yellow dot — 120t yellow dot: this is the synch between the fast-slow chart — where there is a base setup on the slow chart that is entered with the fast chart. this is also a setup that has breakout potential both from the 2nd break of the diagonal line which is the area of the dark blue line on the fast chart AND through the triple break of the 2 blue squares — the entry is done into/through this break WITH additional setup components from a shift-reject of the 52t blue focus line which occurred with a ticki high AND with this retrace on the slow chart being WITH mex flow down. as you read the description of this trade setup AND the 52t-120t combined components — you understand which this is called a synch setup.

again the fast chart gives an initial indicator reverse — no trade-no exit — you can see that this does not occur on the slow chart. this is also an example of why the fast chart is used for timing-for attempting to ‘find’ the best available entry price into the breakout -vs- trading the actual breakout — this entry is easier to hold on retrace as it doesn’t go into a losing position.

52t red dot2 — 120t red dot2: this was done as an addon — can you see the setup on the 52t chart alone? IF you weren’t using the dark blue focus line — where you could see the wedge when the diagonal was drawn — i don’t see how anything would be apparent other than the indicator resumption AND even with the wedge this may not be viewed as a trade setup. BUT now look at this with the 120t — where you see that you are selling a triple diagonal with a ttmf hook-mex rolling back AND that this is a setup into/through the triple matched price break of the 2 dark blue squares WITH the additional breakout potential of the remainder of the blue diagonal — AND this should be seen differently AND as a very good trade setup. IF there is going to be range-volatility expansion the more breakout potential there is to the trade AND especially as it becomes more relevant-viewable across the chart — the more likely-greater the odds that the expansion will occur — doing this with market directional strength AND the odds have additionally increased.

Now compare the 120t with the 240t AND really be able to see the breakout potential of these trades — into/through the full diagonal break points of the yellow squares — which additionally accelerates through the daily low WITH very strong market directional strength.

This is the core of our trading method — this is the core of how-why volatility expands — this is why there is viability to continuation and addon trading. This is also the move we don’t want to trade BUT instead it’s the move we very much want to trade into/through. It comes from right side breakouts of left side prices that should be support BUT can’t hold AND as these breaks continue, there becomes a point where the acceleration-speed-slope increases, as any potential stop is broken AND those that are flat start chasing the breakout — which in the case of a strong directional move they often get away with, and this accelerates the move even further.

Now I also very much understand that these charts-trades aren’t the typical outcome-size of a base trade BUT what difference does that make — what did we do differently? We aren’t entering trades because OR with the expectation of these size moves — we are entering trades because they are method base AND especially if/when they have the additional across the chart breakout potential that may let a move like this occur.

I also want you to think about this discussion in terms of right side fast chart trading and/or pivot trading AND what you are accomplishing by doing so AND what you are missing by doing so when you get ‘shaken out’ from fast chart moves and/or miss the fast chart moves that are never entered — never seeing the most meaningful ‘trade reads’ that are available from method and across the chart.

Daily Volatility Increase 2-27-3/2 — Day Trading Implications

When I asked the following question: if increased volatility = increase potential — what does this infer for trading size — should the trader take advantage of this and also add 1+ contract to their base trading size? I was also thinking of whether the typical trader actually made more money with tremendous expansion in statistical volatility OR did they actually find it harder to trade because of the speed, and finding themselves continually getting taken out of trades because of the size of the retraces involved.

We had been trading in a low volatility environment, in a strong uptrend where the indexes were continually hitting new highs — 10 day average true range was around 9 points, with many trading days under a 7.50 range. AND then all of a sudden the market is ‘dumping’ hard with all time record volume — volatility as measured my the vix goes from 10.70 mean regression to in excess of 19 AND levels last seen last July, and for a very short period.

These moves, both in terms of volatility and daily range are aberrant. This is a tremendous change in statistical volatility AND although a selloff and increase in volatility may have been anticipated, the size and speed of what occurred, would not have been expected by most.

They are also moves that have nothing to do with day trading method and/or the trade setup range-volatility expansion we are trying to capture — so the potential may be there because of the size of some of the trading swings BUT this potential is also completely meaningless IF you find yourself either unable to hold a trade because of the relative size of a retrace OR find yourself unwilling to take a trade because you are afraid of the speed. This kind of volatility which may look great on the chart in hindsight, really isn’t a situation that most traders are prepared for, or willing to accept.

So to answer the question above — NO I do not think that the trader should add to their base trading size as a result of this kind of daily volatility expansion AND I also understand anyone who did not do nearly as well last week as they think they should have — as result of entering a trade BUT not being able to stay in it, and then not wanting to re-enter the same trade.

Actually I think there is a better case for many to decrease their trading size, because IF this additional movement is going to be taken advantage of, you obviously have to be in a trade to do so. I would rather see someone trade 2 contracts -vs- 3 contracts, and with this smaller total initial risk, be willing to take their trades along with the additional ability to hold with a bigger individual contract initial risk AND especially with a focus on trying to expand their partial size AND expand their total win size.

Additional Daily Volatility Increase Notes

results in wider moves-faster moves — especially on break-continuation to new ranges. what is break-continuation? reject-failure through a diagonal is the ‘best’ potential. the method base selective setups including reject-failure through diagonal breaks — will position you ahead of the ‘bigger-faster’ moves IF you are considering any increase in trading size — it must be with these kinds of setups.

trading the chart -vs- trading the ticks-money — this is the predominant reason why I can suggest that a trader decreases size — as an aid in being able to be more chart relevant.

ETF Option Trading

I know that for the majority options trading is a dirty word, but it can also be done very simplistically and with relatively small cost — a cost that may even be covered from some of your futures day trading profits.

The chart above is the IWM, this is an exchange traded fund [etf] on the russell index, with a chart of a march 81 put underneath. The yellow circle is 2-21 AND the day that I bought these puts for the march expiration, they were purchased for 75 cents. I understand that like everything that occurred this last week, the size of this gain was also atypical. However, getting a move where the price doubles or better and thus have the ability to close part of the position-having the remainder at ‘no cost’, is not atypical. In this case the put was bought when the IWM was around 82.00, and it had doubled when the price was around 80.00.

I trade options counter trend, meaning that I buy puts when I think the market is overbought-buy calls when I think the market is oversold. This is in complete contrast to the way the underlying is traded; this is also when options are relatively the cheapest.

My favorite options trade is a simple put buy on an overbought market. The reason for this is because volatility is one of the primary factors in the cost of an option AND volatility typically goes down as the index goes up — so not only is this where the put will be the cheapest on a relative cost basis, this is also the option that will have the ‘smallest’ amount of volatility as a component of price. Compare this to buying calls when the market is oversold. Again this will be when the call will be the cheapest on a relative basis, since volatility goes up when the market goes down, the call will have a greater amount of volatility in the price. Thus, even if the IWM then goes up, since volatility is probably going to be going down at the same time, it is going to take additionally more movement for the call to go up.