We can go into a lot of definitions and technical jargon to explain "volatility." The fact is that anyone who has traded in the market has either been the beneficiary or victim of "volatility." Trading and taking positions in periods of high volatility can extract a cost that oftentimes is unexpected. When prices are on the move, the market makers increase the spread between the bid and ask price. On the other hand when there are periods of low volatility these spreads may only be a penny (vs. 5-10 cents). Therefore, periods of low volatility can be opportunities to take positions that will be "goosed" by the increased volatility. The Bollinger Bands demonstrate volatility by showing the "second" level of standard deviation from the norm. The Bollinger Bands capture 95% if the price action, and should the price go beyond that, it is more than likely that a new direction has been established.
Click on the Following Charts to Enlarge the View
SPY 3.8.10 - One Day, 15 min. - There was an expansion of volatility yesterday as the market moved up. Today was a "Sideways" day, and you can see that the Bollinger Bands contracted. In fact, even though I had a position from yesterday which went up, the value went down due to volatility. The present contraction of the Bollinger Bands is actually an opportunity the benefit from an eventual expansion of volatility. All contractions are followed by expansion and all expansions are followed by contractions. It is the job and art of the trader to anticipate these moments of changes in volatility as well as market direction.
Click on Chart to Enlarge
SPY 5 Day, 15 min. - This 5 Day chart demonstrates the gap up on Friday and the Bollinger Band expansion. During this period of time the "spreads" between bid and ask on any issue broadened. It is often felt that a contraction of volatility and subsequent narrow Bollinger Bands is "boring." To the contrary, this may be a great opportunity to take a position (up or down) and when it occurs (if you are right on direction), you will benefit by expansion of volatility.
There is a Strategy called "Sleeping Tiger" explained by Toni Turner that shows how to take advantage of this situation. It is one of her favorite trades. You can find that is the Sidebar on the Blog.
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