13.3 Volatility Indicators

Additional Reading About Volatility Indicators

Volatility Indicators - Text Version

In the previous lesson, we outlined three rules of volatility you can apply when you measure volatility, which will help you find better, more profitable trades to enter. In this lesson, we are going to look at the most common and popular technical indicators you can find on trading platforms, which you can use to measure volatility.

The most popular indicator used to measure volatility is average true range, which is often called ATR. This indicator simply shows the average range in pips over a time the trader inputs into the indicator. For example, if you put the ATR indicator on a daily price chart, and tell the indicator to read 20 days, it will show you the average amount of pips the price moved in one day over the last twenty days.

It is possible to put two ATR indicators on the same chart, with a shorter period in one and a longer period in the other. Then you can see whether recent volatility is relatively high or low, depending upon whether the shorter-term ATR is higher or lower than the longer-term one.

Another volatility indicator is the Bollinger Band. This indicator shows a simple moving average, with equidistant bands indicating standard deviations of price. These show price areas which are likely to contain the current price over the next candlestick. You can learn more about Bollinger Bands in our Bollinger Band course.

If you put a Bollinger Band on a price chart and scroll back, you will notice there are times when the bands are much narrower, and other times when they are much wider. When they are relatively narrow, volatility is low, and when they are relatively wide volatility is high.

Another indicator which can be used to measure volatility is the Donchian Channel. The Donchian Channel simply shows the high and low price over a time period you choose. When the channel is relatively narrow, volatility is relatively low, and when it is relatively wide, volatility is relatively high.

Finally, another widely used indicator is linear regression. This draws a “line of best fit” between a past price and the current price, and marks standard deviation limits on either side of that line. If the channel is relatively wide, then so is volatility; if it relatively narrow, then volatility is relatively low.

That’s all for now on volatility indicators. In the next lesson, we present a complete volatility-based trading strategy which uses the average true range indicator to identify and filter the most profitable trade entries.