Volatility Breakout Trading Explained

٢٦ سبتمبر ٢٠٢١

In this post, I'll be taking you through a step by step guide on what the volatility breakout trading strategy is, and how you could incorporate it in your own trading style.

Disclaimer: This is not investment advice. This is for educational and entertainment purposes only. I am not responsible for the profits or loss generated from your investments. Trade and invest at your own risk.

The Volatility Breakout Strategy
- This strategy was designed by Larry Williams, a legendary trader.
- The premise of this strategy is based on trends; what goes up, continues to go up
- Based on this idea, the calculation and strategy is actually quite simple:

Strategy
- The Range can be calculated by subtracting the values of the daily high from the daily low; Range = High - Low
- Base Price, or Entry Price = Previous Day's Candle Close + (Range * K), with K being a constant of 0.6 to represent the noise ratio.
- If today's price exceeds the base price, you enter a position.
- The next day, you sell all your positions at the daily open price.

Example
- The diagram above demonstrates an example case
- We have an asset that had a daily range of $100.
- Calculating the base price, we get $1020.
- This means that if the price exceeds $1020 on the second day, we buy the asset and ride the momentum.
- On the third day, we sell all positions at the market open price.
- If the price of the asset reaches $1100 on the third day, that gives us 7.84% returns.
- If it retraces back to $1000 in its opening price, we have a 1.96% loss.
- This demonstrates that not only is the risk/reward ratio optimal, we have a statistical edge in our position because we're following the trend

Strengths of the Volatility Breakout Strategy
- Because we're trading purely based on volatility, and trading short term by selling all positions the next day, it helps us not to be swayed by market psychology.
- Trends are a reflection of market psychology, and as human traders, we can get swayed by our emotions of greed and fear
- However, through a systematic approach based on precise entry and exit points and strategies, we can ignore the noise from the market.
- Because the trend is our friend, unlike reversal trading strategies, we have a statistical edge in our position, and risk/reward ratio.

Conclusion
Implementing this strategy directly in today's market might not be as effective, but an understanding of how legendary traders approached the market back in the day can certainly help you understand what you need to do to methodically approach the market. Taking your emotions out of the game, and having strict rules and invalidation points are key to becoming a successful trader.

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