Chapter 4
Capitalizing on the Cyclical Nature of Volatility
Baccarat is a game whereby the croupier gathers in money with a flexible sculling oar, then rakes it home. If I could have borrowed his oar I would have stayed.
—Mark Twain
The single most important tool in developing positive expectancy trading models is the cyclical nature of volatility. Particular emphasis will be on incorporating volatility indicators so as to make both trend-following and countertrend models more robust.
THE ONLY CONSTANT
I'm sure you've heard it said that the trend is your friend. And it is true; the trend is your friend … until it ends. Unfortunately, its end is never announced on the front page of financial media publications, so we can never count on a trend's continuation. Another commonly repeated phrase regarding market behavior is that assets trade in a range around 70 percent of the time. While this is also true, it too is not nearly as helpful as traders would hope because breakouts from trading ranges are unpredictable and violent. In summary, traders can never count on a bear trend, bull trend, or even a trendless market. Instead the only constant in every market, at all times, is change. At first glance, this truth of the ever-changing nature of market behavior might seem to be a worthless fact. Instead, I have found it to be the core concept behind many robust positive expectancy trading models. No, we cannot count on a trend, or on trendless action, but we always know that sideways ...
