Predicting volatility beats guessing price direction

Many traders are taught that predicting price direction is the goal of investing. But according to an analyst on X, this is fundamentally wrong. The truly predictable part of markets is not whether the price goes up or down, but how large the next move will be: volatility.

In short:

• Volatility clusters in market regimes and can be predicted by up to 81% using the GARCH model
• Large hedge funds focus on volatility forecasts rather than price directions
• A trader who is correct 48% of the time but incorporates volatility into position sizing beats someone who is correct 62% of the time while ignoring it

Volatility as a market regime

Robert Engle won the Nobel Prize in Economics by demonstrating that volatility is not random, but occurs in clusters. Large investment firms such as Citadel and D.E. Shaw have used this insight for years, yet retail investors hear almost nothing about it.

The model behind this is called GARCH and appears on page four of virtually every econometrics textbook. Implementing it requires only sixty lines of Python code. The core idea: today’s volatility predicts tomorrow’s volatility with more than 70% accuracy.

Winning with formulas, not guesses

Large investment desks do not ask the question “is it going up or down?” They ask: “will the next move be big or small?”

This difference is crucial. A trader who guesses the right direction in only 48% of cases, but adjusts his position size to the volatility regime, consistently earns more than someone who is right 62% of the time but blindly places equal weight on every trade. In the long run, the former wins every time.

Ten years of historical S&P 500 (SPY) data clearly show this pattern: when volatility is low, it remains low in the next trading session in 74% of cases. After a volatility spike, elevated volatility persists the next day in 81% of cases.

Free tools no one tells you about

The mathematics is free. The data is free. The software to carry this out is free. Yet many traders learn to focus on candlestick patterns instead of analysing the distribution of price movements.

The result: most retail traders are constantly using the wrong position size for the current market conditions, which dramatically undermines their returns.