This Day On The Street
Continue to site
This account is pending registration confirmation. Please click on the link within the confirmation email previously sent you to complete registration.
Need a new registration confirmation email? Click here

How to Read and Play Volatility Signals

The markets are getting more volatile these days, or at least that's what the talking heads are telling us.

Volatility readings can help traders understand market cycles and improve price prediction. I use three technical tools to gauge current volatility and predict its expansion or contraction. These measurements often trigger immediate opportunities, but they can also yield data that don't require an instant response.

Markets alternate continuously between bursts of intense activity and periods of relative calm. We watch this pulse as prices step up or down to a new level, test a new trading range and then break toward another level. As one phase nears its end, the chart often prints a small-scale pattern that signals an impending rally or selloff.

The volatility cycle offers an important piece of trading wisdom: Price movement is easier to predict over time than price direction. This may sound vague, but in essence, volatility signals tell us to pay close attention because something important is about to happen.

Volatility removes direction from chart analysis. It stretches price change over time so relative travel is laid out end to end. Simply stated, the greater the relative distance over time, the more volatile that market is.

But these dynamics have little value if we can't find a way to trade them. Fortunately, volatility has another characteristic that makes it an excellent trading tool: It tends to move in cyclical patterns.

Many folks think the CBOE Volatility Index (VIX) is the only way to understand this characteristic of price action. Indeed, the indicator helps traders read broad market sentiment and its impact on the ticker. As I wrote last week, it's also a valuable tool for predicting turning points .

But the VIX is almost useless for individual stock analysis. In essence, it just predicts how jumpy and nervous traders will get if the market turns against them. Using this information, we can project their participation at key levels, but we can't know how this will translate into price direction.

Volatility describes a market's tendency to move up and down over time, on the basis of its recent history. This definition highlights the relativity aspect of trends. Markets develop characteristics that can be measured through price swings. But these readings must first be adjusted for periodicity, or the size of the swing being examined.

For example, Boeing (BA - Get Report) had low volatility during its rally off its September lows but high volatility within the swings of the last two weeks. This pattern also predicts that longer-scale volatility will expand soon, yielding a rally or selloff from current levels.

I'm looking for a rally, because volatility constriction at breakout levels suggests a market that wants to head much higher.
1 of 2

Check Out Our Best Services for Investors

Action Alerts PLUS

Portfolio Manager Jim Cramer and Director of Research Jack Mohr reveal their investment tactics while giving advanced notice before every trade.

Product Features:
  • $2.5+ million portfolio
  • Large-cap and dividend focus
  • Intraday trade alerts from Cramer
Quant Ratings

Access the tool that DOMINATES the Russell 2000 and the S&P 500.

Product Features:
  • Buy, hold, or sell recommendations for over 4,300 stocks
  • Unlimited research reports on your favorite stocks
  • A custom stock screener
Stocks Under $10

David Peltier uncovers low dollar stocks with serious upside potential that are flying under Wall Street's radar.

Product Features:
  • Model portfolio
  • Stocks trading below $10
  • Intraday trade alerts
14-Days Free
Only $9.95
14-Days Free
Dividend Stock Advisor

David Peltier identifies the best of breed dividend stocks that will pay a reliable AND significant income stream.

Product Features:
  • Diversified model portfolio of dividend stocks
  • Updates with exact steps to take - BUY, HOLD, SELL
Trifecta Stocks

Every recommendation goes through 3 layers of intense scrutiny—quantitative, fundamental and technical analysis—to maximize profit potential and minimize risk.

Product Features:
  • Model Portfolio
  • Intra Day Trade alerts
  • Access to Quant Ratings
Real Money

More than 30 investing pros with skin in the game give you actionable insight and investment ideas.

Product Features:
  • Access to Jim Cramer's daily blog
  • Intraday commentary and news
  • Real-time trading forums
Only $49.95
14-Days Free
14-Days Free
BA $134.80 0.00%
ELP $8.27 0.00%
AAPL $93.74 0.00%
FB $117.58 0.00%
GOOG $693.01 0.00%


Chart of I:DJI
DOW 17,773.64 -57.12 -0.32%
S&P 500 2,065.30 -10.51 -0.51%
NASDAQ 4,775.3580 -29.9330 -0.62%

Free Reports

Top Rated Stocks Top Rated Funds Top Rated ETFs