Volatility compression: the quiet before an expansion

[Shadow Trader]

Markets alternate between quiet and active periods. When ranges shrink to unusually narrow levels, an expansion often follows. Traders refer to this as compression.

Measuring it is straightforward. Compare the current average true range or band width with its average over the last few days. A reading well below normal marks a compressed state.

The difficulty is direction. Compression does not say which way the breakout will go, and false breaks are common. Many traders wait for a decisive close beyond the range, with a rise in tick volume as confirmation.

Compression can also persist for a long time, especially in summer or around holidays. Entering too early means sitting through a lot of chop.

The test is to log compression events over a few months and record what happened in the following hour: how large the expansion was, and how often the first break held.

That provides a base rate for planning trades around compressions.

How do you measure compression, and what has the data shown about what comes next?