Volatility Ratio Indicator

The Volatility Ratio indicator helps traders examine unpredictable market conditions and project possible upcoming trend directions. It also determines the strength/weakness of potential price breakouts.

Volatility is an investment term that refers to periods of choppy or sharp price movements in a market or security. Traders frequently associate volatility with price declines, but volatility can cause unexpected price increases.

To learn how to treat an irregularly volatile market, you need to prepare yourself to focus on your long-term trading objectives by adopting the mentality that accepts volatility as a necessary component of trading.

This guide explains how the Volatility Ratio indicator relieves you from the complexity of market sentiment analysis by predicting the possible directions of upcoming price spikes.

What is the Volatility Ratio Indicator?

The Volatility Ratio is a technical MT4 indicator developed to measure the price volatility levels. Besides, it changes its color to signal whether it is a bullish or bearish sentiment that is driving the market.

Strong price breakouts are usually associated with rising volatility. In ranging markets, traders seek volatility confirmations before considering a breakout as a trade entry opportunity. This is because a breakout in a low volatile market may not generate an on-trend price movement as expected. Instead, the price might create a false breakout, leading to adverse trading conditions.

Volatility Ratio Indicator Chart Setup
Volatility Ratio Indicator Chart Setup

The volatility ratio is displayed in a separate window in MT4. A value greater than one indicates volatility, while a value less than one reveals a lack of volatility. For a better understanding, the indicator changes the color of its signal line to portray the current volatility level. It becomes medium sea green during highly volatile markets and turns red to signal low volatility.

You can add horizontal levels at +1 and -1 levels to signify whether the price has hit the expected volatility level or consolidated for a while.

Volatility Ratio Trading Strategy

Buy Signal

  • The price breaks a trendline or horizontal resistance.
  • The volatility ratio indicator level turns green, signaling a highly volatile market.
  • Hold longs until the signal line turns red and the price rebounds for a bearish move.
Volatility Ratio Indicator Buy Signal
Volatility Ratio Indicator Buy Signal

Sell Signal

  • The price breaks below a trendline or horizontal support.
  • The volatility ratio level turns green, indicating high market volatility.
  • Hold shorts until the indicator level becomes red and the price swings for an upside movement.
Volatility Ratio Indicator Sell Signal
Volatility Ratio Indicator Sell Signal

Volatility Ratio Indicator Pros/Cons

Pros

  • Predicts possible direction of upcoming price breakouts during market consolidations.
  • Determines trend strength/weakness.
  • Assists with trade-exit decisions.
  • Suits trend-following trading strategies.
  • Works on multi-timeframes.
  • Beginner-friendly MT4 indicator.

Cons

  • It is unable to pinpoint when a trend started or ended.

Conclusion

Technical traders consider the volatility ratio indicator a useful market sentiment analysis tool. It doesn’t generate a straightforward trend signal but helps to predict an upcoming market bias. Besides, you can apply the indicator to examine the strength of a price breakout. Technically, volatility ratio signals work best when combined with price level and trend indicators. Alternatively, you may use automatic pivot points and trendline indicators for a better scenario of the price action changes.