Futures Market Volatility: What to Look for and How to Measure It

Highly volatile futures markets can be characterized by dramatic swings in price action and spikes in trading volume. When two indicators of volatility react to unexpected ‘market moving’ news simultaneously, this could potentially mean market sentiment is changing.

Below are two potential indications of a volatile market:

  1. Sudden Drop in Price Action – A futures contract’s market price decreases significantly below the current level. Ex. The value of the S&P 500 Index (ES) decreases suddenly due to a market reaction of an unemployment report number that is above market estimates.
  2. Spike in Volume – The amount of a financial instrument’s futures contract being traded suddenly increases significantly. Ex. Due to an announcement by the Organization of the Petroleum Exporting Countries (OPEC) deciding to cut future production of oil, a significant number of futures traders suddenly seek to sell their WTI Crude Oil (CL) futures contract positions.

Highly volatile futures markets can also be identified by measuring trader sentiment. During volatile market conditions, futures contracts start ‘changing hands’. This could potentially be the result of traders seeking to either protect their positions or take advantage of a decrease in current market prices.

Below is an example of how volatility can be measured:

  1. Spike in the Volatility Index (VIX) – The number of traders seeking protection or a hedge for their positions suddenly increases significantly. o Ex. Due to a significant number of ‘brick and morter’ retail companies announcing earnings below market estimates in the same week, a large number of traders are suddenly seeking protection for their S&P 500 Index related positions.

The below of the S&P 500 Index (ES), trading volume of the ES and Volatility Index (VIX) is an example of a drop in price action and a spike in trading volume along with a measure of a spike in volatility:

Emini S&P and VIX Chart

Remember past performance is not indicative of future results and you should always trade within your risk tolerance levels.

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