Volatility breakout
Volatility breakout is an entry technique introduced in “New Concepts in Technical Trading Systems” by John Welles Wilder.
Volatility breakout is a sudden strong move in prices which is usually measured by average true range (ATR). We can define volatility breakout ATR multiplied by a constant. Let’s say, ETH close price yesterday was $1,100 while ATR for last 14 days was 145. And let’s suppose we defined volatility breakout ATR times 2. If ETH price reaches $1,290 (1,100 + 2 * 145) or falls to $810 (1,100 – 2 * 145), we’d call it a volatility breakout. In the former case of an upside volatility breakout, we would buy ETH; in the latter case, we’d short it because of a downside volatility breakout. If ETH trades in the range of $810 - $1,1290, we wouldn’t trade it.
What makes volatility breakout a good entry setup? When there is a dramatic price movement, you want to be on the breakout side of the market. A strong upside (downside) price move is likely to be followed by further increases (decreases) in price. Volatility breakout also can signal the end of the current trend, and even the beginning of a new opposite trend. If the market is trending upwards and there’s a solid downside volatility breakout, it can portend that the uptrend is near its end. Since you don’t want trade against the volatility breakout, you can exit your long position if you have one.
What about exits? When should we exit trades we entered on volatility breakout? Since volatility breakout can lead to really solid price action, I think it makes sense not to set profit target. We’ll always exit the open positions with stop loss. For stop loss we can choose among multiple options, such as moving average crossover, channel breakout or volatility breakout.
Moving average crossover means that we exit the trade when a short-term moving average crosses a long-term moving average from the top. Channel breakout indicates when the price makes N-day high or N-day low. If we have bought a coin and its price makes, say, 10-day low, we can deduce that there’s a strong downward move; so, we will exit our long position. We can also set our stop loss with volatility breakout itself. If we have a long position, and we see a downward volatility breakout, this can be a signal to close the trade. We can also select time stop if we wish to. This means that we hold our position during the predefined time period, say, 7 days. After 7 days we close the position whatever the result.
