Volatility Cycles

Every Tuesday Chuck releases a new Trader Tip video on YouTube. This week we will discuss how if we understand volatility, it's going to allow us to have an improved understanding of market environments. Volatility also helps you to normalize your trading indicators across different timeframes, different environments and different products. & so much more! Watch the episode for more information on Volatility Cycles and how to use the knowledge to become an elite trader.

You can read the episode transcript below or watch the video that follows.
If you have any questions, please reach out to us. We look forward to being a continued part of your trading education!

Today we're going to talk about volatility cycles. Volatility is something that many traders don't even look at, or even consider in their trading, but volatility can have a massive impact on the success of your trades. Let's just start off and talk about why does volatility matter?

If we understand volatility, it's going to allow us to have an improved understanding of market environments, you're being able to identify volatility regimes. In other words, if we understand the volatility regime, about the environment, we're going to be able to make better decisions, both in putting our trades on and in managing them. Because through the lifecycle of a trade, the volatility environments will actually transition and go to different environments. Each of them, which has its own best way to manage.

The other thing Aabout volatility is volatility helps you to normalize your trading indicators across different timeframes, different environments and different products. One of the things with me is that I trade everything virtually the same, the method of how I trade is highly fractal. So I could intraday trade SNPs, the same way that I treat Bitcoin, the same way that I swing trade the euro, versus the same way I trade Exxon Mobil on a monthly timeframe. You can literally take the label off the chart, and I don't even care I don't even know what it is. The reason I'm able to do that is because I normalize everything with volatility.

The other thing is that, with volatility, it gives us more options to be able to achieve our objectives. Because of this, when we trade direction, it's like trading with a blunt instrument. It's like trading with a sledgehammer. "We BUY! We SELL! We BUY! We SELL!" It's very blunt. But when we trade, when we understand volatility environments, it opens up it creates so many different environments that we can take advantage of. It allows us to be much more specific in our objectives, and when that's the case, then we can use options in different options structures, to instead of being a sledgehammer it can be a scalpel, where we can be very tactical, very precise with what we want to do.

When we're able to do that, that gives us the potential to be much more profitable in achieving our objectives than trading underlying alone. This is something I show all the time in my workshops. There's so many options structures that can do amazingly better than just trading underlying, with less risk and much less margin. This week, we're starting a Red Pill Challenge, actually tomorrow, and if you go through the Red Pill Challenge,, you'll see all kinds of examples of how you can use an options trade to have a better return, less risk, and lower margin, all the same trade, but to do that, we have to understand our objectives. If we understand our objectives, options, kick the shit out of trading underlying.

Okay, so how should we think about volatility in our trading? One of the things I like to do is highlight how a retail trader thinks which is most often wrong, versus how a professional trader thinks. In this case, we're going to talk about volatility. Most retail traders don't even understand volatility. But those who do understand volatility often trade it completely the wrong way. The average retail trader's volatility approaches to sell volatility when it's cheap. To create the certainty and easy money, to be able to make $200 a day. "I just want to replace my paycheck if I could just make $1,000 a week in trading options that I could not have a job or I could replace my Social Security check," or whatever it is, and that's how they think about it. They try and find the trades that will give them that $1000, $1000, $1000 Every week, every day sort of thing. Then BAM it blows up on them and they lose 50 grand and they're like "what happened?!" Because they're selling volatility when it's cheap, and ironically, they will love to sell volatility when it's cheap, and they're scared to death would sell it to sell when it's expensive. Fearful.

If you go through and you look at a lot of the option educators, what are they training you to do? They're training you to sell options to sell strangles, to put on Iron butterflies, iron condors, all strategies that create theta, that make you feel good. Because they have the, what I call the recency bias, it's been making money every day for the last two weeks. just, you'll make money for the next two weeks. The problem is that you're selling cheap volatility, and you're getting addicted to the theta, to the time decay that just pays you every day, pays you $200 Today, $200 dollars tomorrow, $200 the next day, and then like I said, all of a sudden youlose 20 grand a day.

Okay, so how does a professional trader think about volatility? Well, professional traders manage risk by using various options structures that best optimize for the environment. If the volatility environment is high, volatility is expensive, they're going to sell it, but they're going to sell it in a smart, calculated way. If volatilities cheap, they're going to buy it, but they're going to buy it in a way that they don't just bleed out while they wait for it to work. It'll be very intelligent through the structures they use to set up these trades, and professional traders are going to buy cheap volatility, and they're going to sell expensive volatility, and they're going to realize that the best trades can be made when volatility is high. Everyone else is scared to act. Some of the best trades I've ever had were selling really high volatility and having massive winners in a day or two or week.

In our Matrix Money Machine workshop, we teach this volatility expectation model, and I'm gonna give you a brief summary over here, and two of the three components that are really important for you to understand we teach the third in the workshop. The first is all of you need to have a technical framework. If You need to have some way. "I'm a fundamentalist" Well, get some kind of technical framework. Fundamentals are great, but fundamentals are a recipe for getting yourself in a lot of trouble thinking that you know what's going on and getting clobbered. One my favorite quotes is from John Maynard Keynes. His quote was, "the market can remain irrational longer than you can remain solvent."

What a technical framework does is it takes our ideas, and it makes it tactical, and then we also want to understand the current volatility environment, just what we talked about, is volatility cheap or expensive, and then the third is the future expected volatility patterns, which you can actually predict what volatility is going to do in the future. The first two we're going to cover here today, but when we have these three components, we have a model where we can create both in trade expectation and in volatility expectation, and when we put it together we got something awesome.

Component 1: Framework.

We must have a framework that generates the following inputs: We need to have an entry price. We need to have a Stop price or a price that we're wrong. We need to have a target price, and we need to have a time expectation or a path of how long it will take to get stopped out or be wrong, and how long it will take if we're right, go to our target. This creates the expectation a lot of people like "I'm bullish, I'm buying and its going up", but that's not enough. At the heart of what we're doing is understanding our reward to risk ratios and the path of how that reward to risk ratio gets fulfilled. If we understand this, then options open up this huge world of outperformance, but if we don't understand these four things, kinda lost. You say well, "I don't know. I don't know my target." Figure it out. Study. Having a solid target for your trades is absolutely one of the best things you could come up with, and if you don't know, guess what? I know somebody who can help you. I can teach you how to identify targets.

The second component is understanding the current volatility environment. There's a couple principles behind volatility behavior you want to understand. One is that volatility is mean reverting, and there's two ways that the market reverts to the mean. Most people think of reversion to the mean as the second one here, which is that basically price goes back to the mean, it goes back to where it came from. That's how most people think about mean reversion, but there's a second way happening that people don't often think about, which is that the mean will actually catch up. What will happen is the market will take off, price will move sideways as volatility digest itself and the mean will catch up. When a mean catches up, the mean will then push again, but volatility is constantly reverting. The second aspect is volatility regimes, we need to understand the volatility level. Is volatility low, is volatility normal, or is volatilty high? Low, normal or high, that seems obvious, but what's key is understanding that regime will tell you how to manage your position.

You manage your positions much differently in a low volatility regime than you do in a normal volatility regime versus you do in a high volatility regime. This is one of the things that trips traders up because they don't think about volatility at all, they just manage your trades, but the volatility environments are changing, and as they change, your behavior has to change, or your trades will not work, or you will screw them up. You won't get the money in them that is in them,. You'll massively under perform, miss manage the trades. If you want to improve your capture rate, the amount of profit you make per trade, you need to understand the volatility regime. You need to understand it's going to revert and you need to understand what level it's reverting from.

I'm giving you a lot to think about there. The last two Facebook Lives, I talked about the rubberband effect, which is what happens in high volatility, where at high volatility, gets to stretched, mean reverts, it snaps back. Okay, it snaps back, and then we also talked about volatility contraction leads to volatility expansion. This is what happens when volatility is too low. Volatility gets too low, it's going to expand. We have two environments, we discussed those Facebook Lives: high volatility environment, snap back to the rubber band, just like this, and low volatility contraction going to volatility expansion, this is where you go from being very contracted to where it starts to expand, stretch. Okay, you can go back and watch those, and you can consider everything we talked about here. Just look, you're never going to be the trader you're capable of being unless you understand volatility.

I don't care if you never trade an option your whole life, I think you should. But if you never do, you still need to understand volatility, because you're going to be a superior position manager, if you do. We have a red pill challenge starting tomorrow. That's something you've never done, we're actually offering it for free. This time, for free, free, free, free, free. Sign up if you've wanted to learn about options, and you just want to learn how to trade better. There's some amazing stuff in this free course. Check it out.

You can sign up for the FREE 10 Day Red Pill Challenge that Starts May 25th 2022 here: 
https://enter.tradingmatrix.com/offers/vBZDLFND/checkout

We also have our Matrix Money Machine workshop, starting on June 13. Look into that as we talk about all this stuff of how to interpret and utilize volatility in your trading. Stay tuned every Tuesday for additional webinars such as this where I will teach you different ways to think about trading that will help you get your performance to an elite level. Great stuff every week for free. Follow us on YouTube. Check us out on Facebook. I do a Facebook Live every single day at the Trading Matrix Facebook page. Check us out there and let me help you get where you want to go. Have a great week. I'll see you next Tuesday.