What Is Volatility?
Volatility is the degree of change in a currency’s price over a specific period of time. Volatility can be measured using the standard deviation from the average price or by using the daily percentage change. In some cases, volatility can indicate a high level of uncertainty in the market, making it difficult to trade. However, it can also provide opportunities for quick profits if you can identify the correct direction of the market.
What causes volatility?
In the forex market, volatility is a measure of the variation of returns for an asset over a specific period of time. It falls under the influence of political, economic, and natural events (either temporary or long-term.)
When central banks make announcements on interest rates or monetary policy, it can cause significant volatility in the market. E.g., When the US Federal Reserve announces a change in interest rates, it can cause the US dollar to experience large price movements.
Similarly, high-impact economic reports, such as non-farm payroll data, GDP reports, or inflation data, can also cause significant volatility in the forex market. These reports are closely watched by traders and analysts and can provide important insights into the health of an economy. E.g., a jobs report or GDP release can cause a currency pair to experience a sudden and significant price movement.
Political events, such as elections or unexpected policy changes, can also cause volatility in the market. For example, when the United Kingdom voted to leave the European Union in 2016, it caused the British pound to experience a significant drop in value.
But far more unexpected than political and economic events, are natural disasters (hurricanes, earthquakes, or else). They can also impact the forex market by disrupting supply chains or causing significant damage to infrastructure. This can impact the value of currencies that are closely tied to industries that are affected by the disaster.
How to calculate and manage volatility?
Volatility is a crucial factor that affects the prices of currencies and the potential for gains or losses. Higher volatility can lead to larger price swings, which can create opportunities for traders to make profits, but can also increase the risks of trading.
To measure volatility and identify potential trading opportunities, you can use the Average True Range (ATR), Bollinger Bands, and the Relative Strength Index (RSI). Read more about them in our Learn section.
It is vital to manage risk when trading in a volatile market. You should use stop-loss orders, choose reasonable position sizes, and avoid over-leveraging your trades. A solid understanding of technical analysis and market fundamentals, as well as a well-defined trading plan, is also important to navigate the challenges and potential opportunities presented by volatility in the forex market.
After all, in times of market volatility, the emotional urge to sell and exit positions prematurely can be strong. Learn how to manage your emotions in our article. The key secret to controlling your emotions is staying updated: Read the news regularly during high volatility and act accordingly!
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