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How To Trade Volatility The Right Way


My goal is to bring new trading strategies to the table every month. Last month, I brought you details about building a trading robot with Excel and Interactive Brokers and this month I’m back with another excellent strategy from Peter Titus called The Big Volatility Short.

Volatility Trading – 5 Things You Must Know

Over the last few years, a lot of investors have been getting into volatility trading. This is a highly profitable area if you know what you’re doing but unfortunately, many traders are making big mistakes with the way they structure their volatility trades.

A lot of traders have fallen victim to a greed-like mentality with this trade and they are failing to manage their volatility risk responsibly.

When the next big volatility event comes, these trading systems are likely to blow up spectacularly and investors will be nursing sore losses.

So let’s take a look at five things you must know if you want to execute the volatility trade:

1. Volatility Never Lasts Forever

Bring up any long term chart of the stock market and there is one thing that should be glaringly obvious. Over a long enough time span, the market always goes up. Even a ten year old child could make this observation.

There are bear markets and periods of volatility but high volatility always drops, given enough time.

Think about this for a moment and you’ll realise that this pattern has worked every single time in the history of the stock market. Is there anything else that comes close to this kind of perfect track record?

2. You Need Consistency And Patience

The key to making money from volatility trading is to simply take advantage of this pattern consistently and to bet against volatility when it’s high.

If we wait long enough and manage our risk properly, we should be able to make money on every single trade we make. That’s because we will know that high volatility will eventually fall. This alone makes volatility trading very different to stock trading.

If we bet on a stock, we never know what it’s long term direction will be with any certainty. If we get the direction wrong, we’ll lose money. Volatility trading is different. We always know the long term direction is down.

In contrast, if we are not patient enough with our trades we can lose a lot of money when an unexpected volatility event occurs.

3. You Can Use ETF Decay To Your Advantage

If we try to play rising volatility, we’ll be wrong some of the time. Worse yet, we’ll be losing money to time decay if we use options.

If we buy a volatility ETF (such as VXX), we’ll lose money over time to ETF decay. Graph any volatility ETF over a long time span and you’ll see that they’re all plagued by hideous decay, 30% per year or more.

How to trade volatility the right way - volatility trading

If we bet against volatility, on the other hand, we’ll have this long term decay pattern working with us instead of against us. That gives us a trade setup with two extremely powerful factors working in our favour: falling volatility AND ETF decay.

What causes this ETF decay? It’s kind of complicated but it’s all to do with how these products are structured and how they are rebalanced daily.

4. There Are Three Types Of Volatility Strategies

Depending on the type of trader you are there are three different ways to trade volatility, all with various advantages and disadvantages. But all of them are profitable and worthy of consideration.

These strategies are all covered in detail in this course but essentially, they all adhere to the same three principles that can be summarised as follows:

  1. Identify when volatility is high according to the market environment
  2. Short the correct ETF at the right moment to capture declining volatility and time decay
  3. Manage the trade as it progresses to maximise return and minimise risk

It’s been my experience that some volatility traders are unable to execute any of these steps correctly.

Trading volatility requires some patience as volatility events do not occur every week. Impatient traders get themselves into hot water by shorting volatility after only the smallest upticks in the VIX.

More experienced traders are able to get step one and step two right but they often fail when it comes to step three, managing the trade.

Unfortunately, managing the trade is a crucial component of volatility trading that could make the difference between a boatload of profits or a blown account.

What can happen if volatility trading goes wrong
What can happen if you get the volatility trade wrong. from josh.sg

5. You Should Know The Type Of Market You’re In

Finally, before you place your volatility trade, it’s important to know if you’re facing a recession, or just a short term pullback in a bull market.

A short term pullback is usually over in a few weeks. If a recession unfolds, you’ll want to wait for higher VIX levels before placing your trade and you can expect to be in the trade much longer.

How much longer depends on the situation. Fortunately, you won’t need a full market recovery for volatility to drop. Once the market settles down, your trade will become profitable.

This is one of the more challenging aspects of the volatility trade but there are several steps we can take to overcome the risks.

Volatility Trades Made An 80% Return In 2016

2016 was a great year for this strategy, with four volatility events occurring and over 80% returns coming just from this strategy alone. Not every year will be as good as 2016 but it is these type of returns that make the volatility trade one of the best around.

The Best Trade On Wall Street

If done properly, volatility trades can be great for your portfolio. On this volatility course, you’ll learn how you can feasibly make 20-30% across your entire account in a single trade, while staying as safe as possible. It’s this type of return that makes waiting for the right volatility trading setup worth the wait.

If volatility keeps going higher after you enter your trade, you’ll learn how you can plan your trade setup to use this to your advantage and make even greater profits.

You’ll also learn all the details about the three types of strategy, what levels can be used to take profits, as well as what levels to look for when entering the trade.

As well as all this, Peter will be posting all of his trades inside the course along with analysis of the market as events unfold. As a student, you’ll be able to access this for the life of the course. That is another reason why I think this is such a great course and why I have included it in my Marwood Research program.

So, be sure to check out the course and here’s to hoping for another great volatility year in 2017!

Note: The Big Volatility Short is currently available at a special launch price of only $47 which will end midnight 31st March.

Comments (2)

Thanks for the great article JB! This is a trading strategy I’ve often thought about, but never really acted upon. It’s really helpful to get your take, and the course certainly looks interesting.

Thanks for sharing!

No problem Jay, volatility is a great trade and there are different ways to play it. Cheers

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