What is volatility?
Starting work in Forex, every trader faces such a notion as "volatility". In general, this term means "variability". This definition characterizes the essence of the main characteristics of the foreign exchange market.
Volatility of the Forex market
Volatility is changes in prices of the currency pairs. It shows the range between the minimum and maximum price of a certain period of time. Bellow we will find out, what determines the volatility, how it is measured and why it is so important to monitor the level of volatility in the foreign exchange market.
What determines volatility?
Volatility of the market is unstable. It varies according to the part of the day and the day of the week. It increases sharply after the release of emergency news and decreases before the publication of important economic data. Volatility directly depends on the number of traders in the market, the volume of orders, and overall state of the global economy.
Each currency pair has its own degree of variability depending on different ways according to the trading sessions. For example, the Japanese Yen has the greatest volatility during the work of Asian markets, and the euro’s or the British pound’s peak of activity is during the European session. On weekends, volatility of all currency pairs is significantly low, because activity of the market is minimal at this time.
Why is volatility useful for a trader?
Without taking into account volatility of the market, it is impossible to create an effective trading strategy. Degree of the price variability for currency pairs makes it possible to understand the degree of the forecasts accuracy and the probability of making a profit in the existing market conditions. High volatility makes it possible to get a bigger profit, but increases the trading risks at the same time.
Analysis of volatility allows to predict the likely price movements in the current session. For example, imagine that each day the price movements are in the range of 60 points and in the current session it has already overcome this distance. In such situation, we can say there will be a trend reversal soon, so, it is not a good idea to open deals in the direction of the current trend.
In addition, high volatility means high risks. That’s why, all beginners should avoid the situations, when the volatility of the market is high. To determine appropriate time, you need to to calculate volatility.
How to calculate volatility?
Volatility cannot be accurately forecasted. In one second, situation in Forex can change. The reason for this may be emergency news or the publication of economic data that wasn’t predicted by the most market participants. However, under normal conditions, volatility can be predicted on the basis of historical data taking into account the cyclical nature of the market movements.
Information about the levels of volatility of the concrete financial instruments at the certain periods can be found on some special services. Here, the data about the movements of prices of the currency pairs for different time periods (from 1 minute to a month) is stored and systematized. According to information about the past price movements, traders can predict their changes in the future.
The indicators of technical analysis are used to measure the current volatility of the market. The most famous tools used for this purpose are the Bollinger bands, ATR, RVI, the Chaikin volatility indicator, etc.
Volatility of the market should be always taken into account during the technical and fundamental analysis. In this way, your trading strategy will be more effective and you will avoid unnecessary risks.