One high-probability method used by traders to trade the forex market is to look for significant increases in volatility. The essential idea behind this trading methodology is that periods of high volatility often follow periods of low volatility, or consolidation. In cases where high volatility follows low volatility in this manner, the result is often a one-directional move, which can offer a significant potential for profit. Besides the use of support and resistance levels, many traders use two important indicators to aid in identifying potential volatility breakout opportunities in the forex market. Changes in these two indicators signal contractions and expansions in volatility, which can be used to gauge tradable volatility shifts. Following are excerpts from my book, Essentials of Foreign Exchange Trading (John Wiley & Sons, 2009) regarding these two indicators:

“Average True Range (ATR) is an average measure of recent volatility. It is calculated as a moving average of a given past period of price ranges. When the ATR has a high reading, recent volatility has been high. When a low reading is given, recent volatility has been low. ATR is used by technical currency traders to determine the recent level of trading activity and volatility for a given currency pair. ATR can also be used for setting logical stop-losses and price targets based upon volatility, among other uses.”

“Bollinger Bands consist of a simple moving average (SMA) with two additional lines, one that is a certain number of standard deviations above the SMA and the other that is the same number of standard deviations below the SMA. By default, Bollinger Bands are usually set at a 20-period SMA with 2 standard deviations above and below the moving average. But these settings can be readily changed to suit the trading environment. The primary purpose of the Bollinger Bands indicator is to measure a currency pair’s volatility around the mean. The Bands are often used to give indications of impending volatility increases (when the bands tighten).”

- Excerpted from Essentials of Foreign Exchange Trading (John Wiley & Sons, 2009) by James Chen, CTA, CMT. Please click here for more information on this book.

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