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  • Hitting Singles With This Low Volatility Strategy 0 comments
    Jul 2, 2012 9:48 AM

    Last week, I got to go to a New York Yankees game and sit in the box behind home plate. As many of you know, I'm not much of a "sports guy," but I still enjoyed watching the game from the box.

    I saw some awesome plays. Some of them were from guys knocking it out of the park, while others were hitting singles.

    The game could technically be won by using either approach. However, I'd say more games are won by hitting singles, even though the home runs are more exciting.

    And so it is with trading. Some people love the "knock'em out of the park" trades. But in attempting to go for those, you carry more risk.

    A way to make more consistent gains is to take a "low volatility" approach and "hit singles." They aren't as impressive, but they are steadier and less risky.

    So how do we go about finding trades like this? Well, I'm going to lay out a strategy for you to sniff out these types of trades…

    You see, different pairs have different levels of volatility. For instance, right now, GBP/NZD trades about 198 pips per day. On the other hand, USD/CHF trades around 95 pips per day (about half as much as GBP/NZD).

    So, if you're trading GBP/NZD and the trade goes against you…it could go very against you. But if you're trading USD/CHF and the trade goes against you…you're likely only going to experience about half as much damage as you would if you were trading GBP/NZD.

    Therefore, the first thing is to pick a pair experiencing low volatility at the moment. The way to do that is to measure the volatility by using the Average True Range (NYSE:ATR) indicator.

    For instance, let's see what the ATR looks like on the USD/CHF daily chart below.

    Lower Volatility…More Predictable

    See larger image

    Notice on the pair above that its swings aren't wild and out of this world. The swings are more narrow, and you'll notice that the pair seems to be more predictable too. That's the type of thing you want to look for in your "hitting singles" low volatility type of trade.

    Once you've located your pair, you'll want to place the Bollinger Bands on the chart and a 50-day Simple Moving Average (NYSE:SMA).

    The Bollinger Bands note the overbought/oversold levels, and the SMA tells you whether you should be biased toward a "buy trade" or a "short trade." Let's take a look at what all of this looks like below.

    Use the SMA to Screen Which Bollinger Band Signal to Use

    See larger image

    So here's how to use the indicators above:

    If the SMA is heading higher, then only look for Bollinger Band buying signals, which is when the pair touches the lower band.

    If the SMA is heading lower, then only look to take Bollinger Band shorting signals, which is when the pair tags the upper band.

    If the SMA is flat, then you can take the next buy or short signal, whichever comes up first.

    As an example, I've noted the buy and shorting signals that occurred on the chart above as I used the SMA to give me my bias as to whether to buy or sell-short.

    Use a strategy like this and you'll be taking low-risk, "hitting singles" types of trades. The ATR tells you if you've got a pair that's low on the volatility scale. After you find the pair you want to use, you're done with the ATR and can even take it off of your chart if you wish, so that the price action will show up more clearly on your chart.

    Then just add on the Bollinger Bands and the 50-day SMA and start looking for the next signal that the SMA tells you to take.

    I hope you've enjoyed this "low volatility" strategy. You don't see many of them out there but I think this is a much-needed strategy. Also, if you're fairly risk-adverse, then this may become a staple in your trading arsenal.

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