Volatility Bands: The Skinny
Essential Links
Volatility Bands
Also Known as Vol Barrier Bands
Ever wonder where a daily move in the markets should or shouldn’t go using probabilities? I built the Vol Bands to take emotion out of the could, should, etc…and boiled down to just MATH
What Vol Bands tell us:
the Probabilistic closing price range of the market based on the current Volatility Regime
what is possible statistically on an intra-day basis (high to low of day move or vice versa) - not close to high or low.
alert of possible trend change or entering different Volatility regime (ill show you later in detail)
Calculus behind the Vol Bands:
Data from 1985 to present. I calculate current volatility environment using approximately 6-8 special vol features depending on a few parameters. Boom I have today’s Vol regime. I then go back through the 1985 to present data or almost 40 years. It finds the past environments most like Today’s Vol Regime.
It spits me out the probabilistic Daily Closing move expected for the S&P 500 (SPX). those are imposed as the Upper Barrier and Lower Barriers you see on the charts and prices given.
It also deciphers the probalistic intra-day move for the day based on those same features. This is the High to low or low to high move for the day. Not prior closing to a low or closing to a high.
Ever look back on an intra-day move and say I never could have seen that coming?
Enter the Vol Bands. They give clues as to what is probabilistically possible. Say that again, Probabilistically possible…
In higher volatility environments with wider ranges than usual, you’d be shocked at how many times an early morning weakness, or gap down to the Daily lower barrier band level or even lower is completely erased by the end of day. And even crazier the lower barrier and higher barrier band are hit on the same day!
Same could be said for moves up that get fully reversed…having the vol bands helps frame your mind to the probable potential, so you are never surprised or caught off guard!
= Advantage for day traders looking to capitalize on value or inflection points.
Another benefit: potential early warning to a regime shift
ever wonder how some traders are quick to adapt or see potential things happen before they manifest. These bands can be helpful to an early volatility regime change or shift.
Check out below, orange highlighted arrows. Those where all daily SPX closes outside or Below the lower Vol band.
What does this tell us? Well the tape or SPX is moving further than it statistically should, not once, but a few times in a short window of time. Basically the market is more volatile than the regime it SHOULD be in. Again advantage to those who recognize it early for downside clues.
The SPX was moving in daily % terms outside what Volatility was pricing. Ie options where mispriced for what was happening. Huge advantage in knowing that!
2-fold advantage:
1) long based investors etc, got early signs to hedge for cheap! Market wasn’t pricing in as big of a move as happened and was warned by jumping the lower vol bands.
2) short traders just the opposite, downside plays where cheap to what was actually happening and could manifest…
big advantage to either!
Another benefit intra day: helps decipher a range bound day vs expansion type trend day
By utilizing the Daily close upper and lower Vol bands, if plotted on an intra-day chart, a very easy visual to see where move extremes fail or expand.
Ie a trend up day trading up to the daily % limit, many times price will kiss the level, slightly over take it, and act as a magnet somewhat. Days when vol is underpriced you can see price not fail or run into resistance at the daily and can use it as a indication its a trend up day that can continue.
Shark line moves: price goes outside the daily bands…trades for a bit…sucks buyers in on a big up day, or sellers in on a deep down day….—> then reverses and comes back inside the daily limit. Can be a great indication potential of a strong reversal day to be used to your advantage. I affectionately refer to these Shark line moves as Suckouts…TA speak bull or bear traps…and on and on…
Simply put, you will be amazed at the help these Vol bands will bring to any type of trader if plotted each day and familiarized oneself with them…
put em in your trading Briefcase….
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