Volatility Ratio Meaning Calculation Signals
Volatility Ratio: Meaning, Calculation, Signals
What Is the Volatility Ratio?
The volatility ratio is used to identify price patterns and breakouts. It uses true range to understand how a security’s price is moving compared to its past volatility.
There are various versions of volatility ratios, most of which are derived from average true range (ATR).
Key Takeaways
– The volatility ratio identifies trading opportunities by measuring relative changes in an asset’s price movements.
– Technical traders use true range to determine the volatility of a stock.
– The most common volatility ratio compares today’s true range to the average true range.
Understanding Volatility Ratios
The volatility ratio helps investors track a stock’s price volatility. It is one of the technical indicators focused on volatility. Standard deviation is commonly used in following volatility, forming the basis for technical channels like Bollinger Bands.
Technical analysts use comprehensive envelope channels of various types to identify price ranges and volatility patterns that lead to trading signals. Historical volatility is another trendline used to track volatility.
The volatility ratio was developed to analyze price volatility. Different calculations can be used for volatility and volatility ratios in technical analysis. The concept of a volatility ratio was introduced by Jack Schwager in his book "Technical Analysis."
Calculating the Volatility Ratio
Schwager’s method of calculating the volatility ratio is based on true range, which was developed by Welles Wilder and has several versions. He calculates it as follows:
VR = TTR / ATR
Where:
VR = Volatility Ratio
TTR = Today’s True Range
Today’s True Range = Max – Min
Max = Today’s High, Yesterday’s Close
Min = Today’s Low, Yesterday’s Close
ATR = Average True Range of the Past N-Day Period
Other variations of the volatility ratio may include:
VR = |TTR| / ATR
Where:
TTR = Absolute Value of Max
Absolute Value of Max = TH – TL, TH – YC, YC – TL
TH = Today’s High
TL = Today’s Low
YC = Yesterday’s Close
VR = |TTR| / EMA
Where:
EMA = Exponential Moving Average of the True Range of the Past N-Day Period
Volatility Ratio Signals
Investors and traders have their own ways of interpreting the volatility ratio and detecting patterns. The ratio is usually plotted as a single line on a technical chart, either as an overlay or in a separate window.
A higher volatility ratio indicates significant price volatility on the current trading day. Volatility can signal disturbances or developments affecting the security’s price. Therefore, high volatility may lead to a new trend, positive or negative, in the security’s price. Traders use volatility and the volatility ratio along with other trading patterns to confirm investment signals.
