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Duration: 12:51

Level: Beginner

Contributed By: MarketLife

What is volatility, how do we measure volatility, and why do we care about volatility? Volatility is a little bit different than many other aspects of the market. We can see patterns, we can see volume, we can see movements between price levels but volatility is hidden, volatility must be calculated. Adam will cover True Range volatility, volatility compression, implied volatility and more!

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Study Notes:

Why Volatility Is Different

We can “see” most aspects of the markets’ movements easily.

  • Movements between price levels
  • Volume
  • Patterns or cycles

Volatility is different.

It must be calculated.

The volatility we see is a reflection of both

  • “Actual” volatility
  • The way we measure it

What Is Volatility?

An academic definition:

  • A measure of risk
  • Calculated as the standard deviation of returns

A more practical definition:

  • How much something moves around

How about this?

  • How much something is likely to move around in the future

Measuring Volatility in TWS

Ways to Measure Volatility

Historical Volatility

  • Standard deviation of returns, usually annualized

Average True Range

  • Range is high – low of each bar.
  • Could be averaged over a time window
  • True Range adds any gap from the previous close

Daily/weekly volatility-adjusted measures

  • SigmaSpikes

Implied Volatility

Must be “backed out” from observed options prices

There are many academic models and measures

  • GARCH-family models

Volatility Clustering

Volatility Compression

When the ratio of short-term volatility to longer-term volatility is low, the market can be said to be in volatility compression.

When in volatility compression:

  • Big moves out of compression are likely to continuation. In other words, momentum is likely to “win”.

Implied Volatility

Options are priced according to five factors:

  • Price of the underlying
  • Strike price of the option
  • Time to expiration
  • Interest rates (and dividends, if applicable)
  • Volatility

Volatility is the only one of these that is not concrete.

We can look at existing options prices and calculate the volatility needed to “justify” those prices. This is implied volatility.

Options prices are often inflated ahead of anticipated events.

  • Earnings for a company
  • Crop report
  • Etc.

Elevated implied volatility can be a warning that the market expects something to happen.

Lessons from Academic Models

Volatility is often modeled with complex mathematical models.

Volatility in most markets has a long-term average level to which it will tend to return.

In the short-term, recent volatility is the best measure of future volatility.

Volatility shocks fade away. (Think of the example of a large rock thrown in a quiet pond.)

The timing and arrival of volatility shocks is unpredictable.


Volatility must be calculated from prices and cannot be directly observed.

There are different ways to measure and calculate volatility. Understand which is best for you.

Disclosure: MarketLife

These videos and accompanying educational materials (collectively, “the Educational Materials”) are created and authored by Adam Grimes (the “Content Creator”) and are published and provided for informational and entertainment purposes only. The information in the Educational Materials constitutes the Content Creator’s own opinions. None of the information contained in the Educational Materials constitutes a recommendation that any particular asset, instrument, security, portfolio of securities, transaction, or investment strategy is suitable for any specific person. You understand that the Content Creator is not advising, and will not advise you personally concerning the nature, potential, value or suitability of any particular security, portfolio of securities, transaction, investment strategy or other matter. To the extent any of the information contained in the Educational Materials may be deemed to be investment advice, such information is impersonal and not tailored to the investment needs of any specific person. Any statements about income, expressed or implied, does NOT represent a guarantee. Your actual trading may result in losses as no trading system is guaranteed. From time to time, the Content Creator or its affiliates may hold positions or other interests in assets mentioned the Educational Materials and may trade for their own account(s) based on the information presented. The Content Creator may also take positions inconsistent with the views expressed in the Educational Materials.

Hypothetical performance results have many inherent limitations, some of which are described below. No representation is being made that any account will or is likely to achieve profits or losses similar to those shown. In fact, there are frequently sharp differences between hypothetical performance results and the actual results subsequently achieved by any particular trading program.

One of the limitations of hypothetical performance results is that they are generally prepared with the benefit of hindsight.  In addition, hypothetical trading does not involve financial risk, and no hypothetical trading record can completely account for the impact of financial risk in actual trading. For example, the ability to withstand losses or adhere to a particular trading program in spite of trading losses is material points which can also adversely affect actual trading results. There are numerous other factors related to the markets in general or to the implementation of any specific trading program which cannot be fully accounted for in the preparation of hypothetical performance results and all of which can adversely affect actual trading results.

Futures Trading Disclaimer: Transactions in securities futures, commodity and index futures and options on futures carry a high degree of risk. The amount of initial margin is small relative to the value of the futures contract, meaning that transactions are heavily “leveraged”. A relatively small market movement will have a proportionately larger impact on the funds you have deposited or will have to deposit: this may work against you as well as for you. You may sustain a total loss of initial margin funds and any additional funds deposited with the clearing firm to maintain your position. If the market moves against your position or margin levels are increased, you may be called upon to pay substantial additional funds on short notice to maintain your position. If you fail to comply with a request for additional funds within the time prescribed, your position may be liquidated at a loss and you will be liable for any resulting deficit.

The risk of trading can be substantial and each investor and/or trader must consider whether this is a suitable investment. You should use risk capital, and not capital required for other purposes, such as retirement savings, student loans, mortgages or education. Past performance, whether actual or indicated by simulated historical tests of indicators, is not indicative of future results.

Disclosure: Interactive Brokers

Information posted on IBKR Traders’ Academy that is provided by third-parties and not by Interactive Brokers does NOT constitute a recommendation by Interactive Brokers that you should contract for the services of that third party. Third-party participants who contribute to IBKR Traders’ Academy are independent of Interactive Brokers and Interactive Brokers does not make any representations or warranties concerning the services offered, their past or future performance, or the accuracy of the information provided by the third party. Past performance is no guarantee of future results.

This material is from MarketLife and is being posted with permission from MarketLife. The views expressed in this material are solely those of the author and/or MarketLife and IBKR is not endorsing or recommending any investment or trading discussed in the material. This material is not and should not be construed as an offer to sell or the solicitation of an offer to buy any security. To the extent that this material discusses general market activity, industry or sector trends or other broad based economic or political conditions, it should not be construed as research or investment advice. To the extent that it includes references to specific securities, commodities, currencies, or other instruments, those references do not constitute a recommendation to buy, sell or hold such security. This material does not and is not intended to take into account the particular financial conditions, investment objectives or requirements of individual customers. Before acting on this material, you should consider whether it is suitable for your particular circumstances and, as necessary, seek professional advice.

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