The Forex market is continuously growing in volume every day. At present, the number of participants in this market is comparable to the population of some European countries.
Significant importance in the Forex market is given to the volatility of all currency pairs. What is volatility, how it can help traders, and how to measure it, you can learn from this article.
Definition of Volatility
Volatility is a measure of price variability for a specific asset, in this case – for a currency pair. The higher the level of volatility, the stronger the price fluctuations over a certain period of time. This has both pros and cons: the downside is the additional risks in trading, while the upside is the opportunity for traders to profit from price differences.
Volatility can be measured over various time intervals: from a few minutes to the entire trading history of a currency pair. When assessing the average volatility of currency pairs, it is important to consider several time frames simultaneously, as volatility may be high on a 15-minute chart, while on a daily chart it may be minimal.
Typically, volatility in forex is measured in pips, but any trader can convert them into percentages as in stock exchanges.
What Factors Affect Volatility?
Volatility of currency pairs is influenced by many factors. The actions of speculators have the greatest impact. Essentially, they maintain volatility on any asset. The number of speculators affects the liquidity of the instrument and the speed of its price changes. Additionally, one of the most influential factors is macroeconomic indicators: the state of the economies of the currency-issuing countries, the amount of currency in circulation, and so on. Political factors also play a role. For example, a single tweet by Donald Trump can increase the value of the dollar on the global stage. Disagreements between countries can also lead to significant fluctuations in currency value, as was the case during the recent trade wars between the United States and China.
Measuring volatility is not difficult, but analyzing the factors influencing it at the present moment is much more challenging.
How to Use Knowledge of Volatility in Trading?
With knowledge of volatility, traders can improve their trading performance. It’s quite simple to do, but for some reason, many traders either don’t know about it or don’t want to know.
Let’s say you know the average volatility of the Euro/US Dollar currency pair is 70 pips (hypothetically). Ask yourself: if at the start of trading the price suddenly jumps up by 50 pips, what is the likelihood that it will continue to rise? Is it worth entering a long position in such a situation?
The answer to this question is obvious: in such a situation, it is best to consider opening a short position rather than waiting for an increase in currency volatility. Of course, other factors should be taken into account, including political ones. However, if there are no clear prerequisites for action, it is better to refrain from making a trade.
This method is so simple that it is surprising why many traders do not take it into account, even if their trading system indicates the need to enter a trade. I believe that such a trade filtering method should be incorporated into the trading strategy of every trader.
Moreover, this method works in the opposite direction as well. For example, if the average weekly volatility of an instrument is 200 points, and the price only moved 50 points on Monday, then it can be expected to make up for 150 points during the rest of the week.
However, one should not expect a sudden jump of 1000 points unless some extraordinary events occur. In such cases, by the way, it is helpful to have well-calculated stop losses, which can also be based on the average volatility of the currency pair.
Indicators Based on Price Volatility
Many trading platforms already feature indicators built on price volatility data. While they may not significantly enhance trading effectiveness, they can still simplify the life of a novice trader on an online trading portal https://fxprimus.com/.
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ATR Indicator (Average True Range).
This indicator automatically determines the volatility of an instrument. Traders use it to set stop-loss or take-profit levels. It can also help identify entry points into a trade, as described above. While quite decent, this indicator isn’t very popular due to its limited functionality.
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CCI Indicator (Commodity Channel Index).
This indicator can signal when to buy and when to sell. It’s often used as an oscillator: buying is advisable in the oversold zone, and selling in the overbought zone. It’s based on moving averages and data on the average price and volatility of the asset.
There are several other indicators that use volatility as an auxiliary measure: Bollinger Bands, STF, HYE, and many others. Discussing them here is not particularly useful since volatility plays such a minor role in them that it can sometimes be ignored altogether on an online trading portal.
It is important to note that successful trading in the currency market requires not only the ability to analyze volatility but also confidence in making decisions based on this analysis. Traders should consider not only the current volatility but also its variability over different periods of time. Additionally, it is important to have a plan in place for both increased and decreased volatility to effectively manage risks and maximize potential profits. Lastly, continuous learning and practice in volatility analysis will help traders improve their skills and become more successful in the currency market.
