A trader may do well for a year when his strategy works, and then he goes through a period when he is not so profitable. They use exactly the same strategy but it falls apart next year, why? This article will help you avoid this trap by explaining why you need to monitor volatility and use changing volatility to adjust risk/reward on trades by editing your stop distance and target profit.
This article is meant to put the idea into your head that as market volatility changes, so should your view of stops and profit targets.
Phases of volatility
Markets go through different phases of volatility and you should be aware of this. Basically what this means is that the market may currently be going through a period of high volatility where it moves a lot each day or week, but it won’t last forever and eventually it will settle down again and the daily and weekly ranges will reverse. less. If you don’t set up your risk reward profiles appropriately, you will run into some problems…
If you were doing well for a while, but now your goals are no longer being met, maybe you just do not adjust them for changes in volatility?
As market volatility or daily price fluctuations change, so should your stop losses and targets. Low volatility may seem like the market is barely moving, but really the only thing that changes is volatility, so your stop loss and profit targets should change accordingly. With lower volatility, your stops and targets should be closer than with higher volatility.
If, for example, you normally trade with a $40 target and a $20 stop, and then your targets fall short and you lose more than you should have lost relative to your risk reward, you haven’t adjusted your strategy. money management as volatility changes. As volatility changes, so does the potential risk reward on any given trade.
If you don’t adapt and lose $20 on your stop when you should have lost $15, you’ll get angry. Similarly, if you don’t adjust your profit targets for changes in volatility, you may miss your target where it could have been reached if you had a closer target.
Volatility changes as the market moves by different amounts from month to month and quarter to quarter. Look at a year ago and now, feel how the volatility compares now to then. Money management should be based on current dynamics and evolve as those dynamics change. Don’t trade the same way you did 3 years ago if the volatility is half what it was then.
For example, if the average weekly and daily price range changes by 50%, then it goes without saying that your stop losses and targets should also change by about 50%.
Look at the chart below, you will notice that the market is shifting from periods of high volatility/big daily moves to much lower volatility/smaller daily moves. So, when you see these changes in volatility, you need to adjust your money management approach accordingly.
As volatility changes, horizontal levels change.
If you have read my articles on how to draw support and resistance levels or how to place stops and targets like a professional trader, you already know the importance of support and resistance levels when placing a stop loss and target. What I didn’t take into account in these lessons, however, is that as market volatility changes, nearby support and resistance levels change as well.
You may be interested in learning about the ATR or Average True Range and where it comes into play here. Well, the ATR is a good tool to measure current/recent market volatility, but we are still going to use support and resistance levels as important barriers to look out for when placing our stops and targets. You don’t want to just place your ATR based stop loss because horizontal levels are always the best place to consider when deciding where to place your stop loss.
If you notice that market volatility has increased or decreased significantly recently, you also need to look at where the most recent support and resistance levels are when you are about to open a trade. If the market has seen a significant spike in volatility recently, you will need to look for levels further away from current prices in order to place stops. Similarly, if there has been a significant drop in volatility in the market recently, you should look to recent prices to place your stop losses. Also, remember that as your stop loss changes, so does your position size per trade if you want to maintain the same dollar amount of risk per trade that you would normally use.
We can’t just jump into the market and completely ignore the fact that this is an ever-changing, dynamic entity. Market volatility is something we as traders need to be aware of. We need to develop the habit of watching for market volatility each time we analyze the market and making sure we adjust our stop losses and targets, as well as position sizes, in line with this changing market dynamics.
Learning to recognize and analyze changing market dynamics is a function of understanding price behavior and learning to trade price. That’s what I’m here for; to help you learn price action trading and help you understand the ever-changing market dynamics. Once you fully understand how to read price action, recognizing changing market volatility will not be a problem for you, it will happen naturally. To learn more, check out my price action trading course and community.