A volatility firewall is a risk management system or protocol component designed to automatically restrict or halt trading activity for a specific asset when its price movements exceed predefined volatility thresholds within a given timeframe. Its purpose is to prevent cascading liquidations, mitigate extreme market dislocations, and provide a circuit breaker during periods of intense market stress.
Mechanism
The mechanism continuously monitors an asset’s price, calculating its realized or implied volatility against configurable parameters such as percentage price change, trading volume spikes, or deviation from an exponential moving average. When these thresholds are breached, the firewall automatically triggers actions like pausing trading, increasing margin requirements, widening bid-ask spreads, or temporarily rejecting new orders, effectively creating a buffer against uncontrolled price swings.
Methodology
The strategic approach to deploying a volatility firewall is a systemic stability measure,
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