How to Use Volatility to Make Trading Decisions

In the last post to this site, the author of the excellent blog, HeadlineCharts, made a comment regarding the Bollinger Bands of the XAU monthly chart. I was going to respond to that comment, but instead decided to write an entire post on the subject, since it was such a good point.

The premise behind this upcoming chart is that periods of low volatility precede explosive moves. On the other hand, periods of high volatility tend to come at times where the market is tired, and needs to take a breather for a while.

The following chart is a monthly chart of the XAU:



The indicator at the very top of the chart is an indicator that you likely have never seen before. I call it a compound indicator, since it is in fact an indicator on an indicator. It is taking the stochastic of the %B indicator.

This indicator dances to a completely different drum than most others since it is based on volatility and not price. However, it can be read just like stochastics can. This indicator currently is on a buy signal.

The indicator at the bottom represents the Bollinger Band width. By clicking on the above image, you will see that this indicator tends to fluctuate between 20 on the low end and 100 on the high end. Moves down to the 20 area tend to be good long term buying opportunities.

I remain extremely bullish on gold stocks right now. I'm just hoping that they relieve some of their short term overbought condition before moving higher again. But, again, the long term picture is more bullish now than it has been for a long time.