Traders generally like to see market volatility. That is where the profits usually lie. The problem is successfully taking advantage of price variations instead of losing money because with volatility comes risk as well. Long term investors, on the other hand, are generally not in love with volatile markets but rather long term, steady, upward trends. How to take advantage of market volatility is by learning how to be a benchmarked trader such as someone who completes the DayTradeSafe course.

How Are Volatility and Risk Related in an Investment?

Volatility is the change of the price of an investment or traded entity like futures on wheat. The problem for investors and traders is that prices go down as well as up. Thus, to be successful, the trader needs to buy or sell at the right time in order to profit from the price change instead of losing money. Volatility and risk are closely related as are volatility and profit potential. Learning how to enter, manage, and exit trades successfully is critical to turning volatility into profit instead of loss.

How to Deal With Market Volatility

Prices of stocks, commodities, currencies, and futures prices are driven by two factors. Eventually fundamentals determine how much something is worth. But along the way traders and investors try to predict where prices are going. By using technical indicators a trader can use the market’s own price movements to project where prices will go next. In day trading it is common to enter a trade and immediately set price targets for leaving the trade with a profit or with a minimal loss. Traders can reset their price targets throughout the course of a trade in order to maximize profit and hedge against loss.

How to Predict Implied Volatility

Traders who stay in their trades for days, weeks, or even months try to predict how much a commodity, stock, or currency pair will vary during the coming year. This is called implied volatility. This measure is reported in standard deviations. Low implied volatility tells you that the market as a whole is not expecting prices to move very much in the following year. A high implied volatility indicates an unstable price structure going forward. The VIX index is a commonly used implied volatility measurement.

Is High Implied Volatility Good or Bad?

Investors commonly dislike high implied volatility because they like very predictable markets. Traders and especially day traders can reap handsome profits during periods of high volatility. Thus, high implied volatility is often good for traders and not so great for the long term investor. That having been said, high implied volatility does not guarantee profits for the day trader. Volatile price movements provide the potential for successful trades providing that trader has learned how to successfully enter, manage, and exit their trades.

Do ETFS Increase Volatility?

Exchange traded funds are popular investing tools. Over the last decade or so many investors have found that by putting their money into an ETF that tracks the S&P 500 they outperform most managed investment funds. However, ETFs have a strong effect on market volatility. The SEC has studied this phenomenon and notes that stocks with higher ownership by ETFs are more volatile. This translates to more non-fundamental “noise” in the market for day traders as these behemoths buy, sell, and directly affect market prices.

What Is a Long Volatility Strategy?

Most commonly a long volatility strategy involves trading options. To the extent that one expects prices to go up, one buys calls on the equities involved. When a trader is uncertain about which way the market will head, a viable alternative is to buy calls on the VIX, the CBOE’s “fear index” as this measure of implied volatility goes up when traders expect volatility and down when they expect the market to settle down. Traders typically cash out of these trades as soon as they realize a profit as the VIX tends to self-correct because, besides being a predictor of future market movement it itself is traded.

How Does Volatility Affect Option Prices?

Options provide traders with the ability to buy or sell stocks, futures, or currencies at set prices no matter where market prices go. The buyer pays a premium for having this option (but not an obligation). Volatility commonly drives option prices up. Call option prices tend to go up when volatility tends to the upside and put option prices tend to rise when volatility is likely to drive the market down. Traders who learn how to successfully enter and manage their trades can earn substantial profits as volatility affects option prices.

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