Tips for trading volatility

Volatility is an enticing prospect for traders – offering the opportunity of fast returns, if you’re willing to take on additional risk.

When the markets are on the move, here are a few tips to help you stay profitable while keeping your risk in check.

1. Use trendlines

Trendlines are an invaluable tool for trading volatility. They enable you to cut through the noise and see the underlying trend in a market, even when it’s experiencing wide upswings and downswings.

Before you consider opening a position on a volatile market, draw some trendlines to ensure you know precisely how it’s performing overall. It’s also worth identifying where key levels of support and resistance are forming – remembering that previous support will often turn into resistance, and vice versa.

2. Don’t just follow the herd

One significant cause of market volatility is the ‘herd’ mentality.

As more and more traders jump onto an asset, they drive its price further. This causes more traders to join the opportunity, which only adds to the trend.

While riding these trends can provide handsome profits, it’s rarely a good idea to trade only because of FOMO: the fear of missing out on a popular opportunity. Instead, make sure you do your research properly. Once the herd mentality turns, things can get ugly quickly.

Of course, you can also take a contrarian view if you think a trend lacks substance. However, markets can remain irrational for a long time. So before you trade against a trend, make sure that the opportunity fits your trading plan.

3. Take your position on news early

When major market events – such as NFP, interest rate announcements and more – occur, your best bet might be to stay out of any related markets entirely. However, if you do want to trade the fallout, you’ll want to ensure that you open your position before the release hits.

To make this work, you’ll need to do a lot of research so that you can make your call on how the release will affect your chosen markets.

It’s worth checking any other related releases that might offer a hint to the final figure. If you’re trading NFP, for example, you could try to get a gauge of overall employment for the month by checking the ADP employment report, jobless claims and more.

Once you’re able to make an educated guess about where the release will land, you can decide how it might play out across the markets. Remember, though, that analyst predictions for a release tend to be priced in early. If you think the analysts have got it right, there might not be much volatility at all.

4. Filling the ‘gap’

We’ve already seen how markets can ‘jump’ from one price to another when trading is closed overnight or over the weekend. Often, it will then ‘fill’ the gap by returning to its previous closing price.

In the above example, AUD/USD gapped 35 points over a weekend due to some poor economic data from China. But then, over the next 12 hours, it steadily climbed back up to its original price.

A simple way to trade volatility is to look for these gaps and trade the subsequent return to the pre-gap price. But just like any strategy, it doesn’t work every time. So be sure to place your stops and targets at reasonable levels.