Practicalities of trading volatility

Bollinger bands

Bollinger bands consist of a middle band (typically a simple moving average or SMA) and two outer bands that represent standard deviations of the price from the middle band. They are a popular technical price indicator. Each band is plotted two standard deviations away from the SMA of the market, and they are capable of highlighting areas of support and resistance.

The width of the bands expands and contracts based on the volatility of the market. Wider bands indicate higher volatility, while narrower bands suggest lower volatility. Read more about Bollinger bands here.

Volatility index

The Volatility index (VIX, or fear gauge) measures the expected volatility of the S&P 500 index over the next 30 days, reflecting market sentiment and expectations for future price fluctuations in the stock market.

The VIX tends to rise during periods of market uncertainty and decline when investors are more confident, making it a useful indicator for gauging overall market volatility. Read more about the VIX here.

Trading checklist

1. Understand volatility: Before diving into trading volatility, you need to know what you’re getting into. Familiarise yourself with the concept of volatility and how it affects financial markets and get to grips with the factors that contribute to volatility, such as economic releases, geopolitical events, and market sentiment. Be sure to consider factors specific to the markets you’re looking to trade.
2. Define your strategy: Figure out your trading approach and strategy. Develop a clear plan for entering and exiting trades based on your strategy.
3. Implement risk management: Establish strict risk management rules and stick to them! Determine your risk tolerance, decide on position sizing, and set up stop-loss orders before entering each trade. Make sure you’re comfortable with the risk that tends to come with trading volatility.
4. Keep up to speed with market developments: Make sure you stay up-to-date with market news, economic data releases, and other events that might affect volatility.
5. Practice in a demo account: Before trading with real money, practice your volatility trading strategy in a demo account.
6. Pick your financial instruments: Decide on the financial instruments you plan to trade, such as VIX futures or volatility-related stocks.
7. Monitor volatility indicators: Keep an eye on volatility indicators such as the VIX index, Bollinger Bands, and Average True Range (ATR) to gauge the level of volatility in the market and identify potential trading opportunities.
8. Stick to your plan: Be disciplined in executing your trading plan. Avoid making impulsive decisions based on emotions or market noise. Resist the urge to deviate from your strategy during periods of heightened volatility.
9. Review and revise: Regularly review your trading performance and whether your volatility trading strategies are working. Identify areas for improvement and make adjustments as necessary.
10. Set funds aside: Ensure you can exploit volatility trading opportunities when they arise by setting some funds set aside.

Tips for trading volatility

Aside from the general tips we give in almost every course (start with a demo account and implement risk management), there are some specific tips that volatility traders might benefit from:

1. Start small: Start out with small position sizes and gradually increase your exposure as you gain experience and confidence in your trading abilities.
2. Diversify: Avoid over-concentration in any single position or asset class. Diversify your portfolio to spread risk across multiple instruments and mitigate the impact of adverse price movements.
3. Be flexible: Be willing and prepared to adapt to changing market conditions and adjust your trading strategies accordingly. Volatility is by its nature unpredictable, so it’s important that you’re ready to change things up when necessary.
4. Manage your emotions: Keep your emotions in check. Don’t let fear or greed drive your trading decisions. Stick to your trading plan and try to remain objective in your analysis, even during periods of heightened volatility.
5. Keep learning: Trading is a continuous learning experience. Keep educating yourself and working to improve your trading skills – you’ll see the benefits. Stay informed about new developments in the markets and get stuck into other IG Academy courses and webinars and join the live sessions.
6. Keep an eye on breakouts: In volatile times traders monitor a stock that is trading within an identifiable support and resistance range and buy or sell if the price breaks out of the range. Read more about breakout trading here.
7. Be prepared: While volatility may take the market by surprise, traders who have a trading plan (and funds) in place are better equipped to capitalise on opportunities as and when they crop up.