Volatility refers to the frequent upward and downward movement of price. The more prices fluctuate, the more volatile the market is. A chart of day-to-day stock prices looks like a mountain range with plenty of peaks and valleys, formed by the daily highs and lows. However, over months and years, the mountain range flattens into more of a gradual slope. What this implies is that if you are planning to hold a stock for the long term (more than a few years), the market instantly becomes less volatile for you than for someone who is trading stocks on a daily basis.
Measurement of volatility
Volatility is typically measured by the standard deviation of the return of an investment. Standard deviation is a statistical concept that denotes the amount of variation or deviation that might be expected. For example, the Stock ‘XYZ’ has a standard deviation of about 15%, while a guaranteed investment, such as a bank account, has a standard deviation of zero because the return never varies.
What causes volatility?
There are many factors that can cause the stock market to move significantly in one direction or another. This can include such things as economic data, geopolitical events, market sentiment, company earning report etc. In any stock market move, whether up or down, there is a significant difference between supply and demand side of the market.
Simply put, supply is the shares that people want to sell and demand is the shares that people are looking to buy. When there is a difference between these two groups, the prices in the market move; the greater the disparity between demand and supply, the more significant the move will be.
Problems during Volatility:
Delays – Volatile markets are associated with high volumes of trading, which may cause delays in execution of trades. Website Mayhem – You may have difficulty executing your trades because of the limitations of a system’s capacity. In addition, if you are trading online, you may have difficulty
accessing your account due to high internet traffic. To overcome these types of situation always have alternative that is telephonic trades.
Incorrect Quotes -There can be significant price discrepancies between the quote you receive and the price at which your trade is executed. Remember, in a volatile market environment, even real-time quotes may be far behind what is currently happening in the market.
How to trade volatility
An intraday trader can take advantage of volatility as long as he is disciplined and follow some trading rules, such as:
- Always have a game plan before initiating any position.
- Predetermined entry and exit door, where entry door refers to the price at which trader wants to enter into trade and exit door means where he wants to cover his position.
- Always use Stop loss, because in a volatile market one can never knows how harsh he can be hit, if price goes against him.
- Should always put limit order in advance to liquidate your position at or near your predetermined exit door. As in a volatile market the prices one sees on his montage or on his screen may differ from that of a market. We call it technically as a time lag
- Do not chase the market, that is if you miss one of the trades then forget it and be prepared for the next one, do not enter in between.
- Never catch a falling knife, that is if a market is volatile and prices are falling, do not take position because prices appear low to you. Wait for trend reversal or continuation and then initiate any position.
Conclusion : Trading in a highly volatile market requires many attributes in a trader amongst them discipline, patience, controlling emotions and greediness are few important attributes, traders have to keep in mind the problems that may arise during volatility and learn to cope with them. The higher the market is volatile the greater the risk associated with it and return too.