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Volatility in the Markets good or bad?

Volatility in the Markets good or bad?

What is volatility? Characteristic of movement of a security, commodity or general market to rise or fall sharply in price within a short-term period, is referred to as having volatility. Volatility is referred to quantify the risk of the financial markets, over a period of time, generally, during a one day time period for day trading, short term swing trading or short term investing. Based on historic prices, the rise and fall of a financial instrument tends to provide potential directional patterns for market traders. Generally, historical price patterns are viewed from a set point to current day market activity, to attempt to gauge volatility.

Worldwide activity will affect market volatility. In return, traders will see the end results whether they deal in stocks, futures market or forex markets. Without volatility day traders and short term traders will have little opportunity for short term gains. Longer term investors prefer the opposite and look for investments that head generally in one direction, up or down with little volatility. Volatility should not be confused with the direction of a financial instrument.

It is found that increased volatility in a financial instrument includes increased trading volume which is a key feature that day traders and short term traders look for.

Volatility is monitored by following the VIX (CBOE Volatility Index) which tracks the S&P 500. The VIX is a widely used measurement for market risk and is frequently referred to as the ‘investor fear gauge’.  Traders additionally follow the VXN which tracks the NASDAQ 100 and the VXD tracks the Dow Jones Industrial Average.

High VIX readings generally indicate that day traders, short term traders and investors see significant risk that the market will move sharply, up or down. The highest VIX readings generally occur when day traders, short term traders and investors anticipate potentially huge moves, up or down are likely. Only when day traders, short term traders and investors perceive neither significant downside risk nor significant upside potential will the VIX reading, be low - which generally indicates uncertainty in the markets. Markets dislike uncertainty therefore; low VIX readings are not a good sign for overall market conditions.

Uncertainty in the markets may reflect ongoing worldwide conditions or questionable economic conditions. The recent concerns over the financial stability of Greece have created substantial uncertainty in the markets, resulting in a drop in the VIX index.

May 2010


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