What are volatility indices? Should you trade them?

What are volatility indices? Should you trade them?

We tend to stick with what we know and what we are familiar with in our comfort zone. Trading is no exception. If you have been trading forex options, you probably have a few favorite currency pairs. The chances are, you have not traded any market indices and you may not even have heard of volatility indices.

So what exactly are volatility indices?

Generally, market indices consist of a “basket” of items that give you a measure of the strength, sentiment and volatility of the market. For stock market indices such as the S&P500, you have the stocks of 500 of the top US public companies. Then you have the CBOE (Chicago Board Options Exchange) Volatility Index, also known as VIX, which measures the volatility of the S&P500 Index options. So the VIX is derived from the underlying S&P500 Index.

Don’t worry if this has gone over your head. These are not the volatility indices that we will be trading. This is just to give you a conceptual overview of what volatility indices are. You just need to know that indices are based on aggregating the attributes of a number of items, (does the Retail Price Index ring a bell?) and that volatility indices are generally derived from some other underlying assets for the purpose of reflecting their volatility.

We traders like volatility. Volatility means that prices are moving. And money is made from fast moving markets, more precisely, big and frequent price movements.

Now that you know what volatility indices are, let’s introduce you to the ones that you will be trading with the BonusTrade app.

Proprietary Volatility Indices

The BonusTrade app is built on Binary.com‘s options trading platform. Binary.com is a pioneer and market leader in options trading. They have their own proprietary synthetic volatility indices which emulate real-world market volatility. These indices are based on “a cryptographically secure random number generator audited for fairness by an independent third party.”

There are 2 types of these synthetic volatility indices, the Continuous Indices and the Daily Reset Indices. As their names suggest, the Continuous Indices never stop, they are literally ongoing 24/7/365. Whereas the Daily Reset Indices reset each day at midnight GMT.

Binary.com list of synthetic indices

There are 5 “flavors” of Volatility Indices as can be seen from the above list. If we measure market volatility on a scale from 1 to 100 with 100 being maximum volatility, that is indeed what the various volatility index numbers mean, with the Volatility 100 Index being the most volatile and the Volatility 10 Index being the least. In fact, the Volatility 10 Index has just 10% of the volatility of the Volatility 100 Index.

The Daily Reset Indices are slightly different, they replicate markets with a bullish and bearish trend respectively with a constant volatility. The Bull Market and Bear Market indices reset at 0:00 GMT daily.

Pheww, hope that wasn’t too overwhelming. The main takeaway is that these synthetic indices mimic real market volatility. And more importantly, volatility indices never stop so you can trade 24/7 even when the forex markets are closed!

Why we like Volatility Indices

If you have traded forex currency pairs for any length of time, you might have noticed that there’s varying amount of market action at various times of the day, and of the week for that matter. Some days the markets are sluggish and are not moving much. Other days the markets go crazy, particular if there are some impactful and unexpected economic news. The time of day is a big factor as to whether the markets are moving and shaking. But you don’t always have time to trade when the markets are at its most active and interesting. Enter the volatility indices.

Of the 7 flavors of volatility indices you have to choose from, you will invariably find one that is trending well enough to trade with at virtually any time of day. Remember the Golden Rule of trading?

– The trend is your friend!

You are always much better off trading when the market is trending, i.e. making a predictably consistent move in one direction.

And as mentioned already, if you want to trade in the after-market hours and during the weekend, there’s always the volatility indices!

Last but not least, we like volatility indices because the prices really move and tend to make more interesting chart patterns for trading!

Here’s a typical volatility index tick chart:

Volatility 10 Index tick chart

And here’s a “boxy” USDCHF chart for about the same time frame:

USDCHF tick chart

Volatility Index trading tips

Tip #1

Whether you are trading forex currency pairs or not, when you are tick trading, remember that the outcome is a binary event. You either win or you lose. That means if the price ends up being the same as your starting price, it is not a draw, you don’t get your money back, you lose – because the price has not gone up or down! This is very frustrating indeed if it happens to you. This can happen more often than you realize especially if you are trading boxy formations like the USDCHF tick chart above! It goes up, it goes down, it doesn’t go anywhere and ends up at the same place! Beware, GBPUSD is particularly prone to that too, so it’s not a good asset for tick trading. On the other hand, volatility indices tend to work well for tick trading.

Tip #2

When trading volatility indices, start with the Volatility 10 Index and stick with the lower number indices as a general rule. They are typically a bit less volatile and therefore, a bit more predictable.

Perhaps you like the sound of trading volatility indices better now? You should definitely try them. They are a lot of fun to trade. Download the BonusTrade app now and see for yourself. You get a free demo account with $10,000 virtual money right off the bat. No sign up necessary.

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