732 Part VI: Measuring and Trading Volatility 
al volatility was lower, then when you make the volatility prediction for tomorrow, 
you'll probably want to adjust it downward, using the experience of the real world, 
where you see volatility declining. This also incorporates the common-sense notion 
that volatility tends to remain the same; that is, tomorrow's volatility is likely to be 
much like today's. Of course, that's a little bit like saying tomorrow's weather is likely 
to be the same as today's (which it is, two-thirds of the time, according to statistics). 
It's just that when a tornado hits, you have to realize that your forecast could be wrong. 
The same thing applies to GAR CH volatility projections. They can be wrong, too. 
So, GARCH does not do a perfect job of estimating and forecasting volatility. In 
fact, it might not even be superior, from a strategist's viewpoint, to using the simple 
minimum/maximum techniques outlined in the previous section. It is really best 
geared to predicting short-term volatility and is favored most heavily by dealers in 
currency options who must adjust their markets constantly. For longer-term volatility 
projections, which is what a position trader of volatility is interested in, GARCH may 
not be all that useful. However, it is considered state-of-the-art as far as volatility pre­
dicting goes, so it has a following among theoretically oriented traders and analysts. 
MOVING AVERAGES 
Some traders try to use moving averages of daily composite implied volatility read­
ings, or use a smoothing of recent past historical volatility readings to make volatility 
estimates. As mentioned in the chapter on mathematical applications, once the com­
posite daily implied volatility has been computed, it was recommended that a 
smoothing effect be obtained by taking a moving average of the 20 or 30 days' 
implied volatilities. In fact, an exponential moving average was recommended, 
because it does not require one to keep accessing the last 20 or 30 days' worth of data 
in order to compute the moving average. Rather, the most recent exponential mov­
ing average is all that's needed in order to compute the next one. 
IMPLIED VOLATILITY 
Implied volatility has been mentioned many times already, but we want to expand on 
its concept before getting deeper into its measure and uses later in this section. 
Implied volatility pertains only to options, although one can aggregate the implied 
volatilities of the various options trading on a particular underlying instrument to 
produce a single number, which is often referred to as the implied volatility of the 
underlying.