According to Google.com, the definition of volatility is: Liability to change rapidly and unpredictably, especially for the worse. Example :”the succession of new rulers contributed to the volatility of the situation” According to Investopedia.com however, the trading definition of volatility is much less negative: Volatility is a statistical measure of the dispersion of returns for a given security or market index. They add in that the higher the volatility for a given security, the riskier the security, but that is more geared toward someone who is a buy only investor or trader in the stock market. While it’s true that higher volatility or “vol” mean larger price swings, there is a filter you can use as a short-term trader when trading the S&P equivalent on Nadex. That filter is the VIX.
The VIX has been in the headlines lately after closing at a 24 year low, then rising 42% in one day on Wednesday. The Volatility Index or “VIX does not move or trade with regularity so price action is not reliable but the negative correlation of the change on the day to the S&P 500 is high. Very simply stated, negative correlation means that if one goes up, the other goes down. From 2000 through 2013 the negative correlation of the VIX to the S&P 500 on a point basis ranged from 76% to 88.5%. According to Morningstar, so far in 2017 there is a nearly 90% chance (or 90% correlation) that markets fall if volatility rises. If there is a rise in volatility over the period of a week, there is only a 14% chance that the S&P 500 will be positive over the same period. Typically, the S&P rises in 57% of weeks. This is useful information when the S&P is near plus or minus in terms of change on the day and you are looking at either exiting a trade or entering a short-term trade trade late in the day, whether spread or binary. How far has the VIX moved this week? Is it positive or negative? The psychology of it is very powerful.
While the VIX doesn’t replace price action methods and cannot be used as on indicator alone, it’s important to know the relationship and can be a deciding factor on what you do when in a particular trade. High volatility does’t have to be a bad thing especially when trading in the limited risk environment that Nadex provides. In fact, when vol spikes in the S&P as it did on Wednesday, it’s a great opportunity to short a binary option or spread, knowing the high negative correlation. So now you know.