How volatility can become your best friend

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Bulls on Wall Street

In the past few weeks we’ve seen some crazy moves in the market. Every trader, regardless of their level of experience, knows that volatility equals opportunity. For momentum traders, volatility is extremely beneficial for a number of reasons. On the other hand, traditional investors panic when they see the market shake!

This is mainly due to different perspectives and goals for the market. As momentum traders, we have the opportunity to benefit from extended ranges and increased volume / liquidity.

There are a number of important things that you as a trader need to be aware of when market volatility increases. All of these things can have great benefits once you know how to use them.

Let’s dive right in and start with how you can really measure an increase in overall market volatility:

How do you measure volatility?

Sure, it can be easy to look at a $ SPY chart and see the sharp moves in expansion and conclude that overall volatility has increased, but there are a few other things that you should keep an eye on.

The $ VXX index is the volatility index that measures fear in the market. Whenever this index begins to rise in price and volume, it is a strong indicator that true volatility is increasing overall.

Benefits of Increased Volatility

Extended ranges

An increase in volatility provides momentum traders with a variety of benefits and solid trading opportunities due to a few things. The main reason for this is the expanded ranges that the market offers for individual names. The average true ranges (ATR) of individual stocks increase significantly, meaning you can play with less size and reap strong rewards.

Increased liquidity

Whenever the market starts to falter, the volume and liquidity as a whole increase. You will find that you can easily be occupied by trains on the buy or sell side. Your shopping cart of “tradable” stocks based on volume criteria increases significantly as market participants enter more and more trades, resulting in normally illiquid names trading smoothly.

Cleaner trends

Another thing that you will notice when trading in volatile market conditions is the fact that stocks tend to be much cleaner. As momentum traders, that’s huge for us. The combination of increased volume and expanded ranges results in stocks trending up or down for much longer periods of time without countermoving. You’ll be able to read and drive trends a lot easier when volatility skyrockets.

How can you trade safely in volatile markets?

So now you can look forward to the next round of volatility, but how do you actually trade it safely?

It all comes back to the expanded ranges and higher average true ranges that stocks will have in times of volatility. During wilder market conditions you need to downsize. The wider trading ranges that you will see allow you to do more with less size as the movements in stocks are much larger than usual.

Extended ranges are a double-edged sword when you are playing things wrong and carelessly with your position size. If you play too big when the volatility increases, not only will your winnings increase, but your losses can be catastrophic in certain scenarios.

It doesn’t take a lot of cash to make a sizable amount of money when stocks are moving way outside of their normal ranges.

Realize that stocks have more leeway to move in either direction as volatility increases, and make sure you scale down to make up for it.

Learn How to Trade Market Volatility (Live Webinar)

Don’t miss this week’s free webinar with Kunal Desai. Learn the best strategies and tactics to deal profitably with market fluctuations!

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