Indicators of Market Volatility
Key Takeaways
There are several techniques to assess volatility, including the VIX, ATR, and Bollinger Bands.
The VIX, an indicator derived from option prices, measures the implied volatility currently reflected in a strip of S&P 500 Index options.
A charting indicator called average true range (ATR) measures the size of a stock's or commodity's historical daily trading ranges, with larger values indicating greater volatility.
Bollinger Bands, developed by John Bollinger, are useful for identifying times of calm and frantic trading.
Cboe Volatility Index
One of the most widely used indicators of market volatility is the Cboe Volatility Index. The VIX index, continuously updated during the trading day, reflects the implied or predicted volatility currently priced into a strip of short-term S&P 500 Index options. It is calculated using an option-pricing algorithm.
The Cboe Volatility Index typically fluctuates between 12 and 35, although it has sometimes fallen into the single digits and climbed as high as 75. In general, VIX readings above 30 denote higher volatility, whereas those in the low teens denote lower volatility.
The ProShares Ultra VIX Short-Term Futures ETF (UVXY) and its companion ProShares Short VIX Short-Term Futures ETF (SVXY) are two leveraged exchange-traded funds that are based on the volatility index.
Average True Range
The average true range indicator, created by J. Welles Wilder Jr., is a technical chart indicator that may be used on any stock, exchange-traded fund, forex pair, commodity, or futures contract.
The 14-day exponential moving average (EMA) of the true range, which Wilder referred to as the "true range," is how ATR determines the true range. The greatest value produced by one of three equations is used to determine the true range:
True range = Current day's high minus the current day's low
True range = Current day's high minus the previous day's close
True range = Previous day's close minus the current day's low
The EMA is then computed from the ATR. A larger ATR indicates higher trading ranges and hence more volatility. Low ATR values typically correspond to quiet or uninteresting trading sessions.
Bollinger Bands
Another chart indicator is the Bollinger Bands, which consists of two lines or bands spaced apart by two standard deviations from the 20-day moving average, which is shown as a line between the two bands.
The narrowing of the bands indicates reduced volatility, whereas the widening bands indicate more volatility. Bollinger Bands can be used on any stock or commodity chart, just as ATR.
The Bottom Line
Market volatility experiences highs and lows in cycles. To track volatility and choose the best entry or exit opportunities for deals, analysts and traders use a range of various indicators.
Although high volatility frequently discourages hazardous trades, increasing fear during sharp market movements can sometimes lead to trading opportunities and offer an exceptional trading environment for seasoned investors.
Conversely, low volatility periods accompanied by complacent investor behavior might signal frothy market conditions and potential market tops.
The average true range (ATR), Bollinger Bands, and the Cboe Volatility Index (VIX) are some of the instruments that are most frequently used to determine relative degrees of volatility.