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Getting started in trading financial markets can be overwhelming at first, so we thought we’d put together some pointers in developing a trading strategy. This guide includes understanding volatility and trends, as well a quick explanation on quantifying your trading strategies’ basic testing.
What is volatility?
Volatility is a measure of the amount an asset’s price changes over a period of time. Assets are financial securities like shares, forex, commodities, etc.
This is essentially a measure of risk. The wider the range of price movement, the higher the risk assumed for the asset or market in question. The narrower the range of price movement, the lower the risk assumed for the asset in question.
From a trading perspective, the level of volatility speaks to both the potential for reward and risk in the marketplace.
How can we determine volatility in trading?
There are a number of trading tools that can help assess the volatility of a market. One such indicator is called the Average True Range (ATR).
The above daily price chart of Apple has the ATR indicator added to it (bottom window). The value of the indicator at $6, highlights that the Apple share price is moving on average $6 between the low and high of each day.
When the ATR indicator is rising, volatility and the assumed risk is increasing. When this indicator is falling, volatility and the assumed risk is decreasing.
How is this useful?
The ATR indicator gives us the current volatility of the share (or security) and an expectation of the probable size of a market move. You can use this volatility indicator when trading financial markets. With so many to choose from, knowing what a probable size move in a market could be, can help you determine feasible profit targets and risk control metrics.
Determining market direction and trend
Sir Isaac Newton’s law of inertia states, ‘if a body is at rest or moving at a constant speed in a straight line, it’ll remain at rest or keep moving in a straight line at constant speed unless it is acted upon by a force’.
In markets, many traders subscribe to a similar concept, that markets move in trends and those trends are likely to continue until acted upon by an external force. The external force being new fundamentals or news pertaining to the market – which could change perception, sentiment and, in turn, the direction thereof.
A simple but dynamic tool traders can add to price charts to help assess trends is a moving average, or MA. A moving average, as the name suggests, is an average of the security’s price data.
A 20-day moving average (20MA) would be a rolling average of the last 20 days’ price data and represents a short-term trend in market direction. A 200-day moving average (200MA) would be a rolling average of the last 200 days’ price data and represents a longer-term trend.
There are a number of platforms that provide these tools to clients. The below graph highlights the use of moving averages on a price graph sourced from IG.
The above daily price chart (blue line) has a 20MA (red line) and a 200MA (black line) added to it. If we consider the 20MA to be a short-term trend indication and the 200MA to be a long-term trend indication, we can say that the short-term trend is down, but the long-term trend is up.
If you want to buy the security, you might prefer to wait for the short-term trend to align with the long-term trend, i.e., for the price to be greater than both the 200MA and the 20MA. On the other hand, if you want to sell (short) the security, you might prefer to wait for the price to be less than both the 200MA and the 20MA.
IG’s advanced charting tools give you access to these strategy testing facilities simply by clicking on a chart and filling in a series of drop-down menus.
The strategy testing features enables you to determine whether your technical strategy has had a statistical edge in the marketplace. The below chart shows how you can access analytical reports on your proposed trading strategy.
This includes things such as your gain to loss ratio, percentage of winning trades, time in the market, average gains and average losses, to name but a few.
Based on revenue excluding FX (published half-yearly financial statements, June 2019); for forex based on number of primary relationships with FX traders (Investment Trends UK Leveraged Trading Report released July 2019).
About IG Markets South Africa: IG Markets South Africa was established in 2010 and is regulated by the Financial Sector Conduct Authority (in South Africa) as an over-the-counter derivative provider and an authorised financial services provider (FSP No 41393). IG has an office in Sandton which serves a dual purpose. Firstly, to give South African traders access to thousands of financial markets, and secondly, to provide an operations hub that provides services to the wider IG group. IG’s board and senior management in South Africa consists largely of South Africans making it a truly South African operation.
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