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Volatility is an important indicator to evaluate the market activity. If the market is not volatile then you may be dealing with an illiquid situation. Illiquidity means there are more opportunities for the broker to manipulate your orders and take villain actions such as stop hunting. On the other hand if the market is very volatile then the fluctuations of the price are extreme and you could easily get whipsawed.

There are a few ways that you could find out about the volatility of the market. One common method uses ATR - Average True Range. Here I am proposing an indicator that could help you have a better understanding of volatility. I have developed a custom indicator "BB Width". It actually calculates the distance between the two upper and lower lines of the Bollinger Bands indicator and shows the distance as a line expressed in pips (the black line in the image). The indicator also includes a moving average which by default shows a 14 period simple moving average of the BB Width line. You may change the period of the moving average. The moving average (the red line in the image) is a key component to analyze the volatility.

When the black line crosses up the red line it is an indication of increased volatility. When the black line crosses down the red line it is an indication of decreased volatility. You may also consider the absolute value of the black line to measure the current volatility of the market.

When you design a trading system I suggest that you consider volatility of the market as a helpful tool to make the following key decisions:

• Entering the market: Try to find out the dependency of your system to the volatility of the market at the time of opening a new trade. You may be amazed to find out that your system opens a trade better if the market is or is not volatile. You may also ignore entering a trade when the market is not volatile when your system is sensitive to broker effects (such as stop hunting).
• Setting profit target: If the market is volatile then you may set a farther profit target to gain more.
• Setting stop loss level: If the market is volatile then you may set a farther stop loss to avoid getting whipsawed.
• Exiting the market: You may consider exiting a trade due to decreased or increased volatility. The decision depends on the system you are trading with. See the following example.

Let's assume that for some reason you have entered a trade in the opposite direction of a trend (see image) and your trade is in profit zone, you may exit that trade when the volatility drops (i.e. the price consolidates). In such cases since you have traded counter trend the decrease in volatility could be a sign that trend would resume.

Important Notes

Volatility does not define the direction of the market. It just tells you how unstable the price is. It also does not directly give you information about the liquidity of the market. Although a low volatile market could show signs of illiquidity a highly volatile market could also be illiquid. For example at the time of important news releases the market is both volatile and illiquid. One rule of thumb is to be concerned about liquidity when the volatility is extremely high or low.

Always use tools other than volatility to analyze the market and make your decisions. Volatility is usually a secondary tool to enhance your system and also boost your money management and risk management techniques. While you could build a system based on volatility it is usually not a primary factor.

Download "BB Width" Indicator

You may change the settings of BB Width to adjust it to your trade conditions (see image). If you are not familiar with changing indicators' parameters click here.

Click here to download the demo version of this indicator. You may use it on as many demo accounts for as long as you want.

Click here to purchase the commercial version of the indicator for only US$2.99. The link will redirect you to another website which is our shopping cart.

The source code of this indicator is available to my paid students only. Click here for more information about my MQL training program.

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Relevant Article: Average True Range in Pips

Relevant Glossary Term: Standard Deviation Indicator