The volatility rupture trading strategy

When it comes to achieving and maintaining trading success, having a rule-based method of trading is vitally important. Many new traders mistakenly believe that market professionals simply follow the market and act on impulse. However, experienced market pros will tell you that having a system or strategy is the basis of their trading success.

Having a system simply means identifying a setup that you use and developing a set of trading rules around that setup. By approaching the market with a clear strategy in mind, you have a much better chance of long-term success.

However, given the wide range of technical tools and analytical approaches in the market, it can be hard for new traders to identify a good strategy or system to use. With this in mind, we're going to explore one of the most popular and effective trading approaches, namely the Volatility Breakout System. Before we look at the volatility breakout strategy, let's quickly make sure you know the main terms.

What is volatility?

First of all, volatility simply refers to the amount of movement in the market. In a very volatile market, prices move a lot. You can easily spot a volatile market by looking at a chart. If you see a large number of swings and large price movements, it's volatile. If the market volatility is low, it means there is not much movement. Again, you can spot a non-volatile market quite easily on a chart, as the price action will be very contained and restrained.

Before discussing the different volatility breakout strategies, it is very important to keep in mind that all markets experience different degrees of volatility. If we take the EUR/USD as an example, at times the market will be volatile and see many large moves, while at other times the market will experience reduced volatility and show very few moves.

In the chart above, you can see periods where the price makes big moves, called volatile market periods. At other times, however, you may find that the volatility decreases and the price stops making big moves. We usually call these two periods a trend (increased volatility) or a range (reduced volatility).

If you look at any price chart of any instrument or market, you will see that the price goes through periods of high volatility and periods of low volatility. This is precisely what creates the opportunity when implementing a volatility breakout method.

Volatility Breakout Trading Using Support and Resistance

The objective of volatility breakout trading is to capture price when volatility increases. In fact, it's about capturing the market when it goes from range mode to trend mode. This type of volatility breakout system can be traded over any time frame and in any market. There are several approaches that we can use and even some tools and indicators that can help us. Let's take a closer look at the volatility breakout strategy.

In the chart above, you can see an example of the most basic type of volatility breakout trade. To start with, in the lower left corner, we can see that the price is trending up with a lot of volatility in the market. However, in the middle of the chart, you can see the price moving into a range as the volatility wears off.

Once we see a break in price like this, we can go ahead and draw our support and resistance lines, marking the corrective high and low of this market break. This gives us our range. All you have to do then is watch the price action and look for the price to break the range and continue its way up.

Volatility breakout trading with the trend

It is important to note that for the best results, we want to take the volatility breakout trade only if the price breaks out of the range. Since the price was in an uptrend before the range started, we know that we are more likely to capture volatility if the price rises and the trend continues. If the price breaks below the range, it would be a contrarian trade and we would not seek to trade it with this system.