What is Forward Volatility?
Forward volatility is the future implied volatility of a financial instrument. Since forward volatility is unknown, various techniques can be employed to determine the probability of future implied volatility. Historical volatility is a measurement of standard deviation. Historical volatility data can be analyzed in an effort to predict forward volatility. Forward volatility predictions can be a useful tool for options trading and general trading of financial instruments.
Implied volatility is in itself an indication of the future volatility of an asset. Implied volatility is calculated through the use of theoretical pricing models. The anticipated rate of price change of an asset can be interpreted as the market expectation of future volatility. Forward volatility is an estimation of the anticipated change in implied volatility.
Historical volatility can be charted. Past implied volatility can also be charted. Many traders compare historical volatility charts to past implied volatility charts. This comparison might reveal the future direction of volatility. Technical analysis of these charts might enable the trader to predict the forward volatility of any given financial instrument.
Volatility trading can be used to hedge the volatility risk of an asset position. The ability to speculate on future volatility is available through the use of option contracts as well as volatility swaps. A volatility swap is a forward contract on the future-realized volatility of an asset. A variance swap is another form of volatility swap.
Realized volatility is actually current historical volatility. Implied volatility is rarely the same as historic volatility. Forward volatility is normally considered to increase if market conditions anticipate a bearish market. Bearish markets are considered riskier markets and therefore more volatile.
Technical analysis charting might employ various indicators to determine the volatility of an asset. Standard deviation is a calculation of historical volatility. Analysis tools called Bollinger bands might indicate the volatility of an asset. Moving averages and other indicators can be used to predict the future performance of realized volatility.
Most option brokers provide charts and graphs of the historical and past implied volatility of individual assets and indexes. It's up to the trader to analyze these charts in an effort to predict forward volatility. Increased volatility might be because of economic and political events. Individual equities might have increased volatility because of earnings announcements and other company-related announcements.
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