We may use volatility to our advantage while hunting for promising breakout trade opportunities.
Volatility tracks the total price swings over a specified period, and this data can be used to spot possible breakouts.
You can determine the current volatility of a pair of currencies using a few indicators.
You will find it quite helpful to use these signs when searching for breakout possibilities.
1. Moving Average
Moving averages are arguably the most popular indicator used by forex traders, and while being a straightforward instrument, it offers priceless information.
Moving averages, which may represent any number of periods of time, simply measure the market’s average movement during that period.
Applying a 20 SMA to a daily chart, for instance, would display the average movement over the previous 20 days.
Moving averages can also be exponential or weighted, but for the purposes of this lecture, we won’t go into great depth about them.
Check out our lesson on moving averages if you want to learn more about them or just want to review them.
2. Bollinger Bands
Because that is exactly what Bollinger Bands were created to achieve, they are ideal instruments for evaluating volatility.
In essence, Bollinger Bands are two lines that are drawn 2 standard deviations above and below a moving average for a given period of time, X, which can be whatever value you want.
Therefore, if we set it to 20, we would also have two other lines and a 20 SMA.
The two lines would be plotted with one line +2 standard deviations above it and the other -2 standard deviations below it.
The bands begin to close, which indicates that volatility is low.
We can determine that volatility is HIGH when the bands start to broaden.
Visit our Bollinger Bands class for a more detailed explanation.
3. Average True Range (ATR)
The Average True Range, or ATR, comes in last on the list.
The ATR, which gives us the average trading range of the market for X length of time, where X is whatever you want it to be, is a great instrument for gauging volatility.
ATR essentially depicts the range of the currency pair, which is the separation between the high and low in the time frame being examined, as a moving average.
On a daily chart, setting ATR to “20” would display the average trading range for the previous 20 days.
ATR’s downward trend is a sign that volatility is waning.
When ATR is increasing, volatility has been increasing recently.
Just keep in mind that ATR is NOT a directional indicator; it is a volatility indicator.
It works best as a technical indicator to confirm whether or not the market is enthusiastic about range breakouts.
Next Lesson: Types of Breakouts