What is volatility?
Forex prices can change in less than a second. To understand why it happens and how it can help or hurt their trading, any trader needs to understand the concept of volatility, why it changes and how to measure it.
Volatility is an indicator of fluctuations in the price of a trading instrument over a certain period of time. The more the price changes, the higher the volatility.
Volatility can be low or high. Note that depending on the selected timeframe, the same time period can be considered to have low or high volatility.
For example, in the screenshot of the weekly EUR/GBP chart below, you can notice high volatility of the currency pair from February to April 2020. From May 2020 to January 2021, on the contrary, there is a fading trend and low volatility.
A trend is the pronounced direction of the price of a financial asset.More information about trends you can find in the article "What is trend?"
At the same time, in the monthly chart of this instrument, the entire period from November 2014 to January 2021 can be considered a period of low volatility, since such price fluctuations are considered quite common on this timeframe.
Volatility can also be realized and implied.
Realized volatility is the statistics of changes in the price of a trading instrument over the past period of time. In other words, it's the historical change in the price of an asset.
Implied volatility is the forecast of changes in the value of an asset in the future. Traders try to predict how the price of an asset will change using various trading indicators.
What affects the volatility level?
Unfortunately, on the Forex market, stable things often become unstable, including volatility. The volatility level is highly influenced by political and economic situations in countries and regions depending on the trading instrument.
Changes in such country's indicators as the interest rate, the level of national debt and unemployment can have a large impact on the volatility of currency pairs.
An increase in inflation or a drop in a country's GDP is likely to cause an increase in the volatility of the currency pairs where the country's national currency is traded.
Less popular, or “exotic” pairs also have higher volatility due to low supply and demand and a higher spread.
Political instability, military conflicts, and major incidents can also cause a surge in the volatility of a trading instrument.
Why is volatility important to a trader?
Volatility is one of the constant parameters of Forex trading. To determine the right moment to enter the market, every trader must have an understanding of volatility and its determining factors.
Not every currency pair may be suitable for your chosen trading strategy due to high or low volatility. If a trader wants to reduce potential risks, they should not trade currency pairs with high volatility because of the significant price changes.
How do you measure volatility?
To measure the volatility of a single time period, you need to open a chart with any timeframe, hover the mouse over the period you are interested in and calculate the number of points from the highest to the lowest position of one candlestick using the pop-up window.
This candlestick shows the interval with the high and low price of a currency pair for a certain period.
To measure the dynamics of changes in the volatility of large time intervals, traders use indicators, which usually calculate the arithmetic mean of the characteristics for a sample of candlesticks. The simplest and most popular volatility indicator is the Average True Range (ATR).
Average True Range shows a high volatility value when large volumes are actively traded in the market and the price changes significantly. When the curve goes down, volatility decreases. Large financial institutions reduce their activity, and the market is calm.
There are also volatility calculators. They automatically calculate the volatility of a trading instrument according to the specified parameters and display the result in the form of charts.
Article last updated: 2022-05-11