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Monday, September 12, 2016

How and Why We Must pay attention to Volatility

Hello Traders
When we analyze a market, it is very important to take into account its volatility for the different time frames and times where we plan to trade.
If volatility is too low we may have little or no chance at all of entering and leaving the market in a timely way with our expected targets and stops.
If volatility is too high, we will surely have many opportunities for trades, but possibly the Stop needed will be much higher than expected.
Let's see now how to measure volatility using the ATR (Average True Range) indicator
The Range of a bar is the distance between its maximum and minimum price.
The True Range includes the gap that may exist from the previous bar, therefore the True Range is equal to or slightly higher than the Range.
The ATR is the True Range Average in the last N bars.
In this example we see the ATR (14) on a Crude Oil & Euro Futures 5 Minutes Charts.

As we see, the ATR is a number expressed in terms of price, so we can not compare the ATR of 2 instruments.
Unless We express it in Ticks, with the custom indicator TIS_ATR_Ticks ;

Now we see that even though both instruments have very different ATR values, its volatility expressed in ticks is very similar (6 to 20 ticks).
Overall we have to keep in mind that the minimum necessary stop should be between 1.5 to 2 times the 1 minute ATR.
Example ; with a maximum ATR of 10 ticks, the minimum stop is 15 ticks .

If we look at this 1 minute chart, we can also observe areas with low volatility where we should not participate.
In practice I always try to avoid trading a market where the ATR is less than 4 ticks or more than 15 ticks, so it is clear the time windows where we can trade;

Same procedure should be done with the volume, as a general rule We must operate liquid instruments that trade several times our size trade per minute.
When we analyze several instruments together, it is important to convert the value of ATR scale from Price to Ticks or its currency value as shown in the following table;
This is a Market Analyzer NinjaTrader table, where I have added my preferred instruments and 3 columns; the classic ATR, showing the volatility in price scale for each instrument, and 2 copies of the indicator TIS_ATR_Ticks , one configured to show ticks and the other to show $ in the corresponding currency.
The table is sorted by cost, and allows us to know what instruments are within reach of our maximum stop size  (the stop should be 1.5 to 2 times that value)

The Market Analyzer allows us to perform various functions, such as highlight values (in this case are highlighted in blue ATR> = 4 ticks and in Red greater than 15), filter rows and generate alerts.
More info about Market Analyzer on this YouTube Video