Explain Volatility in the Forex Market
In the context of forex, the term volatility refers to a measurement of the value fluctuation of a currency pair over a predetermined time frame. It is a critical idea for traders to comprehend because it has a big impact on how profitable their transactions are. The concept of forex volatility will be thoroughly examined in this article, along with its different subtypes.
We will also go through the many forms of volatility, such as historical volatility and implied volatility, that traders may experience on the FX market. Overall, readers will have a good understanding of forex volatility by the end of this blog and how to apply this information to make wise trading decisions.
What is Volatility in the Forex market?
The frequency and size of variations in a currency’s value are measured by volatility in the forex market. Depending on how much a currency’s value deviates from the mean, it can be classified as having high volatility or low volatility. It serves as a gauge for standard deviation.
While intraday swings occur on the majority of financial markets, higher volatility markets, like the FX market, shift significantly faster and to a greater extent. Increasing volatility on an online forex trading platform will result in higher trading risk but also more trading possibilities as price fluctuations increase.
Volatility is used to indicate the market’s level of fear. Price fluctuations can become unexpected and irregular when there is vulnerability since even the littlest piece of information can set off critical price changes.
The volatility of its pricing serves as an illustration of how a volatile currency pair and a stable pair differ from one another. A currency pair with a 5 to 10 pip range of volatility is less volatile than one with a 50 to 100 pip range.
What Causes Price Volatility?
Market volatility is typically brought on by a combination of fiscal policy changes, mood shifts, interest rate changes, and economic variables. Political issues have been a major factor lately. Any element that can affect investor behavior can increase market volatility because it frequently reflects levels of market sentiment.
Prices must drop or rise by more than 1% over a continuous period of time for a market to be deemed volatile.
Main Types of Volatility
Here, in this section, we are going to explain the several types of Forex Volatility. Let’s have a quick look:
- Implied Volatility
By analyzing option price changes, it predicts future prices. Increasing volatility is correlated with rising option prices, and vice versa. It also goes by the name future volatility.
- Relative Volatility
A measure of a currency pair’s volatility in relation to the total volatility of the forex market is called relative volatility. It is computed by dividing the currency pair’s volatility by the market’s total volatility. For traders, relative volatility can be helpful because it shows how much a particular currency pair fluctuates in relation to the rest of the market.
- Historical Volatility
It measures past price variations, often over the previous 12 months. When the price deviates further from its own average, the asset is regarded as riskier and more volatile. This style, however, typically does not offer information about the price’s future trend or direction in forex trading.
How to Predict a Volatile Market?
Average True Range: This indicator determines the actual price range that results from a 14-day moving average. The highest result of any one of the following three equations represents the true range:
- True Range = Current day’s high – current day’s low
- True Range = Current day’s high – previous day’s close
- True Range = Previous day’s close – current day´s low
Bollinger Bands: Two bands or lines that indicate the standard deviations above and below the 20-day moving average make up this volatility tracking indicator. The bands go wider as the volatility level goes up and get narrower as it goes down.
The Cboe Volatility Index (VIX): is an index that reflects how much volatility the market anticipates over the next 30 days. The degree of anticipated volatility shows the level of market uncertainty. The fear index is a common name for it.
Final Thoughts
How risky a currency pair is viewed to be at any particular time is heavily influenced by volatility in Forex market. It is crucial for traders to understand the relationship between volatility and liquidity as well as how it affects leverage, particularly in times of extreme market volatility.
Finally, it’s critical to keep in mind that there is some risk involved with forex trading. You may try to reduce this risk and improve your chances of success by controlling your exposure to volatility properly.
