There are several volatility indicators available for stock traders and analysts to use. Some of the most commonly used ones include the volatility index (VIX), the average true range (ATR) indicator and Bollinger Bands.
The volatility index tracks an extensive range of put and call options on the S&P 500 Index and aims to act as a predictor of market volatility for at least the next 30 days forward. Because large institutions account for the bulk of trading in S&P Index options, their trading in the options market is used by other traders to help them get a reading of likely market volatility in the days ahead. The VIX shows a reading between 18 and 35 the vast majority of the time, but it has gone as low as 10 and as high as 85. VIX values higher than 30 indicate increased volatility, while values below 20 are indicative of extremely low volatility.
Average True Range
The ATR indicator, developed by J. Welles Wilder Jr., calculates what Wilder called "true range" and then creates the ATR as a 14-day exponential moving average (EMA) of the true range. The true range is found by using the following three equations:
True range = Current day's high minus the current day's low
True range = Current day's high minus the previous day's close
True range = Previous day's close minus the current day's low
The ATR is then created as an EMA of the highest value found when the three equations are solved. A larger ATR indicates higher volatility.
Bollinger Bands measure two standard deviations above and below the 20-day average and plot lines representing these levels on a chart, along with a line between the two bands that shows the 20-day moving average. Widening of the bands shows increased market volatility, and narrowing of the bands shows decreased volatility.
Volatility in the stock market goes through cycles of high and low. Analysts watch the direction of market movement when there is a sharp increase in volatility as a possible indication of a future market trend.