So, trading systems too must have an adaptive nature. Everything changes and so must a trading system. Firstly there is a trend and momentum component, within this is included a Fibonacci time a price pattern recognition component. Secondly there is a volatility component which signals exit and entry conditions. Volatility One crucial assumption of Black and Scholes analysis of option pricing is that the volatility of the underlying asset is known and constant.
Volatility is defined as annualised standard deviation of returns.
Forecasting of volatility is therefore paramount in trading options successfully. This trading system uses volatility cones to estimate future volatility. Volatility cones do have some drawbacks, because they involve the use of overlapping data, because of this the estimation of the variance of variance is downward biased. The trading system incorporates an adjustment factor for this .