Are these the 8 best volatility indicators traders should know?
Volatility trading is a great way to take advantage of fast-moving markets. Discover the 8 best* indicators to help you gauge and navigate volatility in the market – so you can make your move when the market shifts.
What are volatility indicators?
Volatility indicators are technical tools that help traders and analysts measure and understand the periods of high and low volatility in a particular stock, or the market as a whole. When selecting a stock, traders often look at its historical volatility or its implied volatility to help determine the risks associated with it.
It’s important for you to understand the different volatility indicators and how to use them – to help you make more informed trading decisions.
How to identify volatility in the market
To identify volatility in the market, you need to have a fundamental understanding of the forces driving each market. Many traders and analysts use standard deviation as their primary measure of volatility. This metric reflects the average amount a stock’s price differs from the mean over a period of time.
You can calculate standard deviation on our platform, alternatively, you can use the following formula:
Volatility is often placed into two categories:
- Low volatility – a security’s value doesn’t fluctuate dramatically and tends to be more steady
- High volatility – a security’s value can change dramatically over a short period of time in either direction
Different market conditions call for various strategies. While periods of low volatility could be appropriate for a more laid-back trading style, periods of high volatility are beneficial for breakout strategies and scalping.
Volatility can hit almost any market, whether driven by macroeconomic events, human psychology or factors unique to one sector. Understanding market conditions can inform your trading decisions – the indicators below can help you identify volatility in the market.
How to use volatility indicators in trading
- Learn more about volatility indicators
- Decide whether to trade using CFDs
- Pick the asset you want to trade
- Open an account or log in
- Take steps to manage your risk
- Place your trade
8 best* volatility indicators to know
- Bollinger Bands
- ATR – Average True Range Indicator
- VIX – Volatility Index
- Keltner Channel Indicator
- Donchian Channel Indicator
- Chaikin Volatility Indicator
- Twiggs Volatility Indicator
- RVI – Relative Volatility Index
* Note that these aren’t necessarily the best indicators by any specific measure and using them doesn’t guarantee a positive outcome on your trades. The indicators chosen are some of the most useful and popular among traders when it comes to measuring volatility.
Bollinger Bands
Bollinger Bands are a prominent type of technical price indicator. An upper and lower band, placed on either side of a simple moving average (SMA), make up their structure. Each band can be used to identify regions of support and resistance because it is plotted two standard deviations from the market's SMA.
Our trading platform automatically calculates Bollinger Bands for you, but it is still useful for a trader to know what the different bands mean and what can be learned from them.
Pros and cons of Bollinger Bands
| Pros | Cons |
| Strong trends produce volatility, which is seen when the Bollinger Bands widen and narrow, making them valuable trend indicators | Bollinger Bands are a trailing indicator, which means they don't forecast price patterns but rather track existing market trends. This implies that you might not receive signals until the price movement has already started |
| Bollinger Bands are incredibly user-friendly and can give you another perspective when automatically plotted by a trading software | Bollinger Bands should be used in conjunction with other technical analysis tools, according to their creator John Bollinger, who also noted that they’re not fail-safe or foolproof indicators of market trends |
ATR – Average True Range indicator
The Average True Range (ATR) indicator is used to track volatility over a given period of time. It moves upward or downward based on how pronounced price changes are for an asset, with a higher ATR value indicating greater market volatility and a lower ATR indicating lower market volatility.
How to calculate the average true range
To calculate the average true range, you first need to calculate the true range. You do this by taking the largest of these three calculations:
- The current high minus the previous close
- The current low minus the previous close
- The current high minus the current low
You’d repeat this process over a specific timeframe to get a moving average of a series of true ranges.
Pros and cons of ATR
| Pros | Cons |
| ATR is a smoothed moving average of volatility over a given time frame | The stop-and-reverse mechanism assumes that you switch to a short position when stopped out of a long position, and vice versa |
| It can be used on the forex, index, stock and commodity markets | While ATR is useful, you should use it in conjunction with other indicators to confirm forecasts |
| ATR is often used for assessing when and where to enter or exit a position, as well as at what price level to implement a trailing or guaranteed stop |
VIX – Volatility Index
The VIX is a real-time Volatility Index, created by the Chicago Board Options Exchange (CBOE). It was the first benchmark to measure market volatility expectations. However, because the index is forward-looking, it only displays the implied volatility of the S&P 500 (SPX) for the next 30 days.
The VIX is derived as a percentage using the pricing of SPX index options. The S&P 500 is most likely experiencing a decline if the VIX value rises, whereas a decline in the VIX value indicates that the index is likely to be stable.
To calculate the VIX, you have to use extremely complex mathematics, though it isn’t necessary for you to understand this to trade the index.
Go long or short on the VIX
| Going long on the VIX | Going short on the VIX |
| You’ll take a long position on the VIX if you believe the volatility is going to increase and the VIX will rise. Going long on the VIX is a popular position in times of financial instability, when there's a lot of stress and uncertainty in the market | When you take a short position on the VIX, you’re essentially expecting the S&P 500 to rise in value. Short-selling volatility is particularly popular when interest rates are low, there’s reasonable economic growth and low volatility across financial markets |
| If there was volatility, your prediction would’ve been correct, and you could take a profit. If you had taken a long position and there was no volatility on the market, your position would’ve suffered a loss | If the S&P 500 does rise, then the VIX is likely to move to a lower level, and you could take a profit. However, shorting volatility is inherently risky, as there is the potential for unlimited loss if volatility spikes |
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Keltner channel indicator
The Keltner channel indicator looks for areas of price volatility in an asset. It uses three independent lines to assess an asset's volatility based on price movement and support or resistance levels.
If the asset's price closes above the upper band, which represents resistance, or below the lower band, which represents support, it may indicate that the trend will either change or pick up speed.
You can automatically calculate the KC on our trading platform.
Using Keltner channels on MT4
The Keltner channel is one of the most popular indicators on MetaTrader 4 (MT4), which is mostly used by forex traders because the FX market is quite volatile.
It has the functionality to automatically apply Keltner channels to your charts while using the platform. Aside from the Keltner channel, the platform comes with a host of indicators and add-ons, some of which you get for free when you download MT4 from our website.
Donchian channel indicator
The Donchian channel indicator is used by traders to spot possible breakouts and retracements. To clearly map the information provided by the channel and swiftly act on any future trade indications.
The price graph below gives an example of what Donchian channel indicators look like when set over a candlestick chart. The middle band reflects an average of the current high and the current low for that trading session, while the upper and lower bands represent the highest high and lowest low of the prior period, respectively.
You can calculate the Donchian channel indicator at the click of a button on our trading platform.
Chaikin volatility indicator
The Chaikin volatility indicator demonstrates the difference between two volume-weighted accumulation-distribution lines' moving averages.1 Volatility is measured as a widening of the range between a security's high and low price by comparing the gap between those two prices.
An increase in the volatility indicator over a brief period can suggest that a bottom is nearby. An impending top may be indicated by a longer-term decline in volatility. The Chaikin indicator should be used in conjunction with a moving average system or price envelope.
How to calculate Chaikin’s volatility
High low average = EMA of (high – low)
Volatility = (high low average - high low average n periods ago) / high low average n periods ago] x 100
Twiggs volatility indicator
The Twiggs volatility indicator is used to signal increased market risk. It’s used to track market indices like the Dow and S&P 500 but may also be useful in tracking the behavior of individual stocks.2
Twiggs volatility is mostly used to indicate rising and falling market risk, where:
- Rising troughs show an increase in market risk
- Peaks that are descending show a decrease in market risk
Relative Volatility Index (RVI)
Relative Volatility Index (RVI) was developed by Donald Dorsey, and it calculates the direction of the volatility of an asset’s price. The RVI can range from zero to 100 and unlike many indicators that measure price movement, the RVI does an exceptional job of measuring market strength.3
RVI buy and sell signals
Below are the rules that Dorsey developed for buying and selling signals when using the RVI:4
- Buy if RVI is greater than 50
- Sell if RVI is less than 50
- If you miss the first RVI buy signal, buy when RVI is greater than 60
- If you miss the first RVI sell signal, sell when RVI is less than 40
- Close a long position when the RVI falls below 40
- Close a short position when the RVI rises above 60
This RVI isn’t meant to be used as a standalone indicator for trading and should be used in conjunction with other trading tools and methodologies.
Top 8 volatility indicators summed up
- Volatility indicators are technical tools that help traders and analysts measure and understand the periods of high and low volatility in a particular stock or the market as a whole
- Many traders and analysts use standard deviation as their primary measure of volatility
- Volatility is often placed into two categories or risk – low and high risk
- You can trade volatility with us via CFDs
Footnotes
1 Barchart.com, 2022
2 Fidelity, 2022
3 Incredible Chart, 2022
4 Trading Sim, 2022
This information has been prepared by IG, a trading name of IG Australia Pty Ltd. In addition to the disclaimer below, the material on this page does not contain a record of our trading prices, or an offer of, or solicitation for, a transaction in any financial instrument. IG accepts no responsibility for any use that may be made of these comments and for any consequences that result. No representation or warranty is given as to the accuracy or completeness of this information. Consequently any person acting on it does so entirely at their own risk. Any research provided does not have regard to the specific investment objectives, financial situation and needs of any specific person who may receive it. It has not been prepared in accordance with legal requirements designed to promote the independence of investment research and as such is considered to be a marketing communication. Although we are not specifically constrained from dealing ahead of our recommendations we do not seek to take advantage of them before they are provided to our clients.
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