eople sometimes com- plain about excessive mar- ket volatility, but volatility is a trading necessity for one
simple reason: Once a position is en- tered, the market has to move to a point where a reasonable profit is available.
Low volatility and sideways markets result in small profits and more losses. High volatility and trending markets mean good trades and more of them. It follows that identifying when a market is moving from a low-volatility environ- ment to a high-volatility environment would improve the odds of profitable trading. The BandWidth Indicator (BWI) \u2014 a derivative of Bollinger Bands \u2014 can be used for this purpose.
Bollinger Bands, developed by John Bollinger, are price envelopes plotted two standard deviations above and below a moving average of the closing prices. (For more information, see \u201cJohn Bollinger: Focus on the markets,\u201dActive
price envelope essentially captures his- torical volatility \u2014 identifying bound- aries price is likely to fluctuate between based on past volatility levels. Wide envelopes are indicative of high volatili- ty (upward or downward price trends), and narrow envelopes signify low volatility (sideways price action).
Experienced traders know that a low- volatility market condition often pre- cedes up or down price trends (see the discussion of flag patterns in this month\u2019s Technical Tool Insight). Therein lies the opportunity: If you are patient and wait for a low-volatility situation, you can take advantage of an increase in volatility. Bollinger\u2019s recognition of how the bands contracted and expand-
Volatility is essential for profitable
short-term trading. The BandWidth
Indicator can help you identify points at
which a market is poised to switch from
a low-volatility to a high-volatility phase.
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