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September 6th, 2022
I hope everyone enjoyed the Labor Day break. It’s always good to take a step back and recharge your batteries, especially after Friday’s price action in the market. We’re again at a point where the market is increasing in volatility and we’re having these big intraday swings. I have a way that you can identify market volatility and will show you how you can use an indicator to adjust for volatility when creating a portfolio.
Next, we’ll get you ready for the week ahead by looking at the reports that have the greatest chance of moving the markets this week. Despite it being a shortened trading week, there are still plenty of reports and announcements that have a high probability of moving the markets, including another speech from Jerome Powell.
One way to help you identify market volatility is to look at an index ETF like the DIA, which is the Dow Industrial Average ETF, and add the average true range (ATR) indicator.
The ATR averages out the difference between the high and low of the day. Using a 10-period ATR you can see that as the DIA decreases in price, the ATR increases and vice versa. That’s because in down markets, volatility increases, and you typically see bigger differences between the high and the low of each trading day.
We can see that since the high in mid-August, the market has pulled back and the ATR is increasing. I know, ATR is a lagging indicator telling us what we’ve already seen happen in the market, but one thing that you can do is adjust trading tactics and position size based on volatility in the market and you can use the ATR to help gauge volatility. When ATR is increasing, you need to give your trades more room to move and there are some option tactics that work better in periods of high volatility.
Now, if you have a long portfolio of stocks and want to know one way you can adjust position sizing based on volatility, you can take the stock you want to add to your portfolio with the highest ATR and then compare that to the other stocks you want to add.
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