Adapting to the Surging Average True Range in Silver

May 2, 2011: 10:01 AM CST

All measures of volatility have increased significantly over the last few months in silver, which have both thrilled traders and caused them to adjust their trading tactics as a result.

Let’s zero-in on the recent changes in the Average True Range – ATR – and find out what that means for traders adjusting to the new volatility highs in Silver.

The chart above shows the Weekly ATR indicator hitting a new high at $3.19 per ounce.

What that means is that if you average the last fourteen trading days, one could expect the price of silver to move up or down $3.19 in the course of the week.

At roughly $45.00 per ounce, that $3.19 represents a 7% move in the metal in a given week, which is far more volatile than most traders can stand.

You can see the prior values in the indicator and how weekly volatility – as measured by the ATR – has steadily been increasing over the years.

The Daily ATR hit similar highs:

Though I’m showing the @SI – Silver Futures Chart – the picture in SLV is similar.

The Weekly ATR in SLV is $2.71 while the Daily ATR value is $1.74.

I draw your attention to this indicator because silver was down as much as 10% in the overnight session on Sunday – which probably panicked traders who were not expecting such a large move was possible – it is.

That brings me to my main point – when volatility significantly increases, it tends to draw traders into the action to make quick profits from the higher volatility… but with increased volatility comes increased risk.

To minimize the risk from a suddenly higher volatility market, traders can employ a number of strategies, including:

1.  Reducing Position Size

2.  Substituting Options instead of Full Positions (SLV options for example)

3.  Increasing Stop-Loss Parameters

4.  Reduce Your Trading Frequency During this Period

I know it’s fun to watch your account grow significantly from being positioned with a big size on the right side of a breakout market – but breakout rallies like this can turn sour overnight and trap traders, wiping out significant profits.

I understand that discussing “Risk” is not popular in a red-hot market, but focusing on risk can keep you in the trading game and prevent career-ending losses in a single trade (or series of back-to-back bad trades).

As volatility increases, you should account for it – either by reducing position size to cut back on outright risk or increasing stop-loss parameters from what seems normal in the past to what is normal in the present.

A $1.00 stop in silver would have been appropriate almost anywhere from 2002 to 2006, but as volatility (weekly and daily range) has steadily been increasing, so has the need to use a wider stop that’s outside the noise or expected volatility.

Of course, you can always jump into the options market – both as outright plays (long calls or long puts depending on what you expect) or complex hedges on open positions.

Perhaps the least popular tactic would be to “go trade elsewhere” until the volatility returns to somewhat normal levels.

Notice in mid-2006 and late 2008 how the ATR (volatility) spiked and then leveled off (flatlined) for a year or more after the spike-up in volatility occurred.

Believe it or not, we’ll see a similar leveling-off in volatility in the future and you’ll probably find silver easier to trade in that period.

Not only are there dozens of other futures contracts to trade, but there are hundreds of ETFs and thousands of stocks.  While they might not offer the instant overnight riches that silver seems to entice, these other markets may offer safer, risk-controlled plays.

Ultimately it’s up to us to adapt to sudden and significant changes in volatility, and now would be a good time to do so if you have not adapted already.

Corey Rosenbloom, CMT
Afraid to Trade.com

Follow Corey on Twitter:  http://twitter.com/afraidtotrade

Corey’s new book The Complete Trading Course (Wiley Finance) is now available!

5 Comments

5 Responses to “Adapting to the Surging Average True Range in Silver”

  1. chaunceyherbie Says:

    Hi Corey, Great info. I use the ATR for daily and hourly PnF charts. Look at the difference now in the traditional PnF and the ATR PnF Charts. Normally, the ATR makes for good determination criteria for supply demand SR levels. But of late, the traditional gives better focus.

    Here is my updated linear regression chart and analysis.

    The collapse last night and massive gaps are characteristic of parabolic moves ending. Where do we go from here? There sure are a lot of people in the muscial chairs game without a chair right now. It has been rumored hedge funds have helped create and have been riding this parabolic wave. I suspect they will do everything in the power to push it back up while they scale out of speculative positions. They are the quants and will attempt to apply their magic. My $0.02 only.
    Good luck everyone. Have a great week. CH

    http://screencast.com/t/5cfrhl

  2. Guest Says:

    Your graph shows ATR in dollars. Is it any surprise that when the price goes up, ATR (in dollars) goes up?!?!?!? Give this man a pat at the bat for stating the completely obvious!

  3. Corey Rosenbloom, CMT Says:

    In actuality, that is more of a longer-term trend and yes that's obvious.

    However, what I'm discussing is sudden spikes in volatility like those of mid-2006, late 2008, and the present.

    It's actually the opposite in terms of spikes – volatility spikes tend to occur on sharp declines in price, as was the case in late 2008 when Silver plunged 50% from $20 to $10 and the weekly ATR surged from $1.00 to $2.00.

    It's not that the ATR is rising steadily along with price – it's these sudden spikes that throw traders for a loop because the normal range is suddenly disturbed and abnormal.

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