We have discussed at length about Volatility in our blog. More recently, we spoke about the Vix index and the risk-on/risk-off theme. Earlier this year, we spoke about volatility in various contexts. Many traders assume volatility means “risk”, so just as the VIX Index rises when the proverbial hits the fan, other volatility measurements should also rise.
However, volatility per se just means “a liability to change rapidly and unpredictably”. There are also various ways to gauge volatility, depending on what a trader wants to utilize it for. Let us highlight the different strokes for different folks.
In the following chart we have overlayed 4 lines:
- EurUsd weekly closing price from January 2010 to March 2017 (Orange)
- The absolute weekly range (Yellow)
- The Average Weekly Range (Blue)
- The Standard Deviation of Weekly Ranges (Pink)
Now before looking too hard at the chart, remember that the measurements of volatility are different because:
- The absolute deviation measures the High-Low range. It tells you how far price has moved during the week.
- The average true range tells you, on average, how far price has moved in the past N weeks. Obviously, the longer the lookback period, the more smoothing there will be. You will receive a more stable reading, but you won’t be up to date with the more recent range expansions or contractions.
- The standard deviation measures the Close-to-Close volatility. So even if we have signficant movement during the week, but we close more or less where we open, there will be a low reading in terms of standard deviation. We need the week to close far away from the previous week’s close, in order to enhance standard deviation readings.
Then we have the VIX Index, which you will notice is not entirely correlated to the ATR (Blue) or St.Dev (Pink) with a few exceptions. Of course if we were to measure the volatility of AudJpy, things would be a bit closer together given the risk-on/risk-off component of that currency pair. But this is just to highlight the differences in volatility measurements.
So what do you want to do with your volatility measurement?
ATR vs. StDev vs. Internal Volatility
In the chart above we have the usual measures of ATR (Blue) and StDev (Pink) overlayed on a bar chart. Positive values are simply Weekly High – Weekly Open. Negative values are Weekly Low – Weekly Open. What we’re doing is dividing the Absolute Weekly Range into 2 segments, to see if there’s any useful information to capture. Let’s call this Internal Volatility for lack of a better term.
I think that short-term traders might appreciate this measure because it offers a long-term perspective of just how much positive & negative movement we can expect from EurUsd (but of course you can replicate this study on any other instrument on any other time frame). The chart doesn’t show it but the most populated are extends roughly 200 pips above and below the opening price.
Over to You
Have you ever thought about the various ways to measure volatility, and how they may assist you in either stalking or managing your trades?
Let us know your thoughts or observations in the comment section below the article!
About the Author
Justin is a Forex trader and Coach. He is co-owner of www.fxrenew.com, a provider of Forex signals from ex-bank and hedge fund traders (get a free trial), or get FREE access to the Advanced Forex Course for Smart Traders. If you like his writing you can subscribe to the newsletter for free.