Volatility trading guide: its causes and the most volatile markets

What is volatility – and should you trade volatile markets? Find out here, with our complete guide to volatility trading.

• What is market volatility?
• What causes market volatility?
• How is market volatility measured?
• How to trade high volatility
• Most volatile markets
• Volatility trading strategies

What is market volatility?

Market volatility is the rate at which an asset’s price increases or decreases over a period of time. It’s used to describe short-term, rapid price movements. While most financial markets experience intraday movements, volatility is defined by the speed and degree of change.

Volatility is seen as an indicator of the levels of fear on the market. When there is uncertainty, price movements can become erratic and unpredictable as even the smallest piece of news can cause outsized price movements.

What causes market volatility?

Volatility is usually caused by increased uncertainty, whether that’s market-wide, in a particular asset class or a single company’s stock. But there are plenty of factors that can unnerve markets, including:

• Politics – the decisions made by governments and political leaders on trade agreements, policy and legislation can cause strong reactions among traders and investors. As an extreme example, when Russia invaded Ukraine it sent shockwaves through markets as supply chain fears caused commodity prices to soar
• Economic data – when the economy is doing well, markets tend to react favourably. When data releases show a negative market performance or miss market expectations, it can cause volatility. Examples include jobs reports, inflation, consumer spending and GDP
• Industry news – company shares, indices or commodities can be impacted by industry-specific events, such as extreme weather conditions, strikes and supply-chain disruptions. For example, the global chip shortage caused volatility across the shares of semiconductor producers and auto manufacturers, as companies were forced to delay orders for over 6 months
• Company news – corporate actions, earnings reports and even rumours can cause volatility in share prices. The larger moves are caused by an announcement differing from the expectations, and ‘surprising’ markets

Another key driver of volatility is liquidity. If more traders and investors are willing to buy and sell an asset, it will be less likely it is that a single transaction will cause a large price move. So, less liquid markets are usually more volatile as prices can change drastically.

How is market volatility measured?

Market volatility is measured using standard deviations. This metric takes a market’s annualised returns over a given period and subtracts it from the current market price to see any variances.

Volatility is most commonly analysed using Bollinger Bands. This technical indicator is comprised of a simple moving average (SMA), with two bands placed a standard deviation above and below it. 

The level of volatility is measured by the width of the bands. The further apart they are from the SMA, the more volatile the price has been within the range. When a market experiencing comparatively low volatility, the Bollinger Bands appear closer together.

There are other indicators you can use for measuring volatility too, such as the average true range.

How to trade high volatility

To trade high volatility, you’ll need good discipline and a comprehensive risk management plan. When large swings occur, it increases the chance for bigger profits in a smaller timeframe. But it does also increase the risks, as a market can move against you just as quickly.

That’s why it’s important to understand your risk appetite before you even start to think about trading volatility. If you’re uncomfortable in high-risk scenarios, then trading volatile markets probably isn’t for you. But, if you’re interested in the potential to profit from the fast-paced changes, then the appropriate trading strategy can help you to harness the market changes.

Day traders, for example, tend to prefer high volatility because it creates more opportunities for short-term speculation.

You can trade both highly volatile markets, or volatility-based assets – such as the VIX – that track the level of uncertainty in the market.

How to trade when volatility is low

Volatility comes and goes as part of the general market cycle. Some traders take a break when volatility is low, preferring to trade when markets are at their most exciting and profitable – and risky – but there are plenty of options when things are flatter.

For more information, check out our guide to low volatility trading.

Most volatile markets

Volatility is relative. Price changes that are considered a highly volatile period for one asset class, might be fairly tame for another. Broadly speaking, some of the most volatile markets you can trade are:

1. Cryptocurrencies
2. Commodities
3. Exotic currency pairs
4. High-volatility stocks

Cryptocurrencies

Cryptocurrencies are often regarded as the most volatile market. Stellar, Ripple, Ethereum, and Bitcoin are among the most volatile cryptocurrencies. In the first two weeks of March 2022 alone, Bitcoin lost 40% of its value.

Crypto market volatility is largely driven by news and the opinions of influencers in the crypto space, such as Elon Musk. The crypto market is known for its unpredictable nature, which is what makes it exciting for some traders but daunting for others.

Commodities

Commodities are typically more volatile than currency and equity markets due to the lower levels of liquidity or trading volume than other asset classes, as well as the constant exposure to weather events and other production issues that might affect supply and demand.

Commodities are also extremely susceptible to volatility around geopolitical events due to the location of reserves being specific to different regions. Russia’s position as one of the largest exporters of oil, natural gas and basic metals meant that commodity prices increased dramatically following the country’s invasion of Ukraine.

Typically, energies are the most volatile commodities, while agriculturals tend to experience less dramatic price swings.

Most volatile commodities

Commodity	%Range (on 31 March 2022)
US Crude	7.30
Gas oil	6.75
UK Crude	5.73
Carbon Emissions	3.29
Natural gas	1.78
Coffee	1.32
Corn	1.17
Soybean	0.99
Cotton	0.70
London Wheat	0.58

Non-major currency pairs

The forex market is often called volatile, but although currency prices do change extremely rapidly, they don’t have the erratic price moves typically associated with volatility. This is because forex is the most liquid market, so price change in smaller increments due to the high volumes of traders willing to buy and sell.

Most major currencies only trade in a range of a few percent within a trading day. But, non-major currency pairs experience lower liquidity, which means the difference between intraday highs and lows tends to be wider. We see this when looking at the percentage range between different major, cross and exotic pairs.

Most volatile FX pairs

Currency pair	Type	Volatility (month to 21 September 2023)
USD/RUB	Exotic	2.57%
EUR/TRY	Exotic	2.27%
EUR/RUB	Exotic	2.10%
GBP/TRY	Exotic	1.58%
TRY/JPY	Exotic	1.55%
AUD/JPY	Cross	0.74%
GBP/JPY	Cross	0.73%
EUR/AUD	Cross	0.72%
CAD/JPY	Cross	0.71%
AUD/GBP	Cross	0.69%
AUD/USD	Major	0.91%
NZD/USD	Major	0.87%
GBP/USD	Major	0.72%
USD/JPY	Major	0.66%
EUR/USD	Major	0.64%

Most FX volatility occurs around major data releases, such as interest rate decisions, retail sales, inflation, employment figures and industrial production.

High-volatility stocks

For the most part, volatility isn’t something that investors pay attention to when it comes to choosing stocks. The shorter-term fluctuations of the market are of little concern to someone who’s going to hold shares for years. But, for short-term traders – like swing and day traders – volatility is the cornerstone of their strategy.

Most stocks experience a degree of volatility around key events – such as earnings – but remain relatively stable over time when compared to the likes of cryptos or currencies. Blue-chip stocks and bellwethers of the economy typically experience the least amount of volatility, while more speculative and ‘trending’ stocks see larger intra-day changes. We just have to look at meme stocks like GameStop and AMC to see that equities can be volatile under the right circumstances.

To find high-volatility stocks, most traders use the ‘beta’ metric, which looks at how a stock moves compared to a benchmark – normally the S&P 500, which has a beta of 1.0. Stocks that have a beta higher than 1.0 are more volatile than the market average. However, it is a lagging indicator as it’s based on historical data.

Most volatile stocks

Looking at the constituents of the S&P 500 High Beta Index – which measures the performance of the 100 companies that are the most sensitive to changes in market returns – we can see that some of the most volatile stocks (as of September 2023) are:

1. Nvidia
2. Caesars Entertainment
3. Generac Holdings
4. On Semiconductor
5. Carnival
6. Monolithic Power Systems
7. Align Technology
8. AMD
9. Zebra Technologies
10. Tesla

When we compare the rate of change of these companies to blue-chip stocks – such as Alphabet, Apple and Microsoft – or bellwether companies – such as Barclays, Vodafone and GlaxoSmithKline – we can see the rate of change is much greater for high beta stocks.

Company	Volatility (month to 21 September 2023)
Nvidia	3.8%
Caesars Entertainment	3.1%
Generac	3%
On Semiconductor	3.1%
Carnival	3.3%
Alphabet	1.9%
Apple	1.9%
Vodafone	1.7%
Microsoft	1.7%
GSK	1.6%

 

Least volatile markets

All markets experience volatility to some degree, but the markets with fewer price swings are bonds, T-bills and cash in savings. Safe havens, like gold and silver, are often regarded as hedges against market instability, but as commodities they can also experience price swings.

It’s important to be aware of the context of your trades, and understand the past performance is no guarantee of future price movements.

Volatility trading strategies

1. Trading volatility with the VIX

The CBOE Volatility Index – more commonly known as the VIX or fear index, tracks the market’s expectations of changes to the S&P 500 in real time. It’s used to measure – and take a position on – the traders’ anticipated volatility. 

The VIX is expressed as a percentage, which fluctuates like any other oscillator. Readings below 12 indicate a low volatility environment, between 12 and 20 indicates normal levels of volatility, and any readings above 20 are seen as a signal of high volatility.

Taking a position on the VIX can give a direct exposure to market sentiment and provide insights into key turning points in the market. When the VIX is high, it’s usually a sign that the market is about to have a bullish run, and when the VIX is low, it’s taken as a bullish indicator.

Learn more about trading the VIX

2. News trading

Another popular option for volatility trading is to try and capitalise on the market movements surrounding major news releases. As we’ve seen, this can be when volatility is at its highest.

Generally, news traders will try to predict where a key economic announcement – like a change in interest rates, GDP figures or NFP – will land, and how that will play out across the markets. Then, they’ll take a position accordingly.

However, you have to take into account that the markets usually take anticipated news into account well before it is released. So, many news traders will wait for the release and then trade the fallout. Even this is risky, though, as markets can often move in unsurprising ways immediately after a release.

3. Options trading

Options can be a popular choice for volatile markets, as several options strategies enable you to profit from volatility, whichever way the market moves. You can, for example, buy a call and a put at the same time – meaning that as long as the market moves significantly in one direction, you’ll profit.

Options trading is complex and usually favoured by advanced traders. So if you’re just starting out, this might not be the best strategy for you.

Learn more about volatility and options.

Trading leveraged products in a volatile market

When you trade volatile markets using leveraged products, your potential for profit or loss is greater. For example, an unleveraged position on Apple would see a $1 profit or loss for every point the market moves. But a leveraged position, say of 10:1, would mean that same point move would equal a $10 profit or loss.

In periods of volatility, the market can move by large amounts, which could see your gains magnified. But your losses could stack up too. This is why you should always manage your leveraged trades with take-profit orders and stop-losses, these allow you to set predetermined exit levels that will execute automatically at a certain level of profit or loss.

Start trading volatility with City Index

Build your volatility trading strategy in a risk-free environment with a City Index demo account.

Or, if you’re ready to start trading live markets, follow these simple steps to open your first position:

1. Open an account, or log in if you’re already a customer 
   
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2. Search for the asset you want to trade in our award-winning platform
3. Choose your position and size, and your stop and limit levels
4. Place the trade