Monday, 26 August 2013

How to Beat Volatility if You’re a Beginner

If you’re a relative newcomer to the world of forex, then there’s a good chance that you’ve found that your positions tend to be more profitable during less volatile times of day. There are quite a few reasons for this, but if you’re going to become successful, you need to learn how to take advantage of the markets at any time; even if volatility is high.

The first thing to think about is why volatility is having such an impact. Most traders start out by learning about support and resistance levels. When a price appears to be sliding down to a known support, there’s a temptation to buy, in the belief that when the support is hit, the price will bounce back up. On the other hand, if a price is working its way up to a resistance point, strategy often dictates that you should sell in anticipation of the subsequent drop. The problem of course, is that when things are volatile, these two levels can frequently be broken, rendering your strategy less than effective.

The best way to capitalise on volatility is by using the breakout strategy. This method of trading relies on the fact that when prices are fluctuating considerably, they are indeed likely to break levels of resistance and support. When a price moves beyond a resistance cap, you buy, in anticipation that it will continue above that level. When a price drops below support, you sell, again believing that the value will continue to drop.

Using this technical strategy, you’re theoretically able to trade in any situation. You’ll also be better able to cope at different times of the day.

There are two very important things to remember when using the breakout strategy. The first is that the market must be sufficiently volatile. If it’s not, then you’ll find that resistance and support isn’t often broken, rendering the strategy useless. You must also be prepared for when the price inevitably changes direction, which could happen very rapidly after the ‘breakout’.

There are generally a few different ways of measuring volatility, and you should use whichever you find suits you best. Generally, standard deviation over a particular period is enough to show you the times of day that are volatile and those that aren’t.

A final note is of course measuring support and resistance. A simple Donchian channel is generally the best method for this. Simply, this is a channel drawn on a price chart which takes the highest high of the previous x amount of time as the resistance level, and the lowest lo of the previous x amount of time as the support. The time you choose is up to you, but 20 hours is one of the most common for day traders. The CMC Markets education section has more information on identifying trends if you’re unsure.

Article contributed by Options-Trading.com – a guide to the world of stock options.

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