Trading Systems  |  FEB 2005

The Truth About Volatility by Jim Berg

Stocks & Commodities V. 23:2 (14-20): The Truth About Volatility by Jim Berg Many indicators can help identify volatility. But can you use them to target specific price areas for entry signals, trailing stops, and profit-taking opportunities? Typically, volatility indicators are used to determine the direction, strength, and momentum of a security. The average true range (ATR), one of the more popular volatility indicators, measures volatility by looking at the average price ranges over the past x number of periods, taking gaps into account. The true range indicator is the greatest of the following for each period: • The distance from today’s high to today’s low • The distance from yesterday’s close to today’s high • The distance from yesterday’s close to today’s low. Most trading software packages include ATR in their list of indicators, which you can usually overlay on top of a bar chart, as can be seen in Figure 1. ANALYZE IT Typically, when analyzing ATR volatility, you would focus on volatility at tops and bottoms and during price consolidation and retracements. However, if you incorporate the ATR into a few simple formulas, you may be able to identify where to enter and exit trades, and make a reasonable profit. Before going any further, I think it’s fair to say that I apply my ATR volatility analysis only to securities that are in a rising trend. After all, it is the path of least resistance. Who wouldn’t want to buy securities when they are rising and sell them when they are no longer in a rising trend?

by Jim Berg