General definition of volatility
Volatility is inherent in any financial market. Currency volatility describes the trend in the quotes of specific currency pairs. A pair will be considered low volatility if the rate barely changes over a certain period of time, or high volatility if constant jumps are observed.
To assess the range of cost fluctuations per unit of time, technical analysis charts are used. The indicator will change depending on the selected time frame. Traders generally use the average volatility calculated as the arithmetic average of the Japanese candlestick pattern. By “candlestick” here we mean the interval between the high and low price of a currency pair during a certain time interval, for example, a trading day. These data allow predicting the behavior of the value of an asset -growth or fall- based on previous values.
Reasons for high and low volatility
Depending on the degree of price volatility, there is low and high volatility. Low is like calm in the sea: there are slight fluctuations in the value of the asset on the market, which are assessed as safe and do not affect the result of the transaction. High volatility is comparable to a storm: a decrease or increase in price occurs sharply and quickly. That is why it is often associated with the risk of loss. However, an increase in the degree of risk can promise not only failure, but also additional profit; it all depends on the correct assessment of the financial instrument.
Therefore, determining the level of volatility allows the trader to:
- weigh the risks of trading;
- develop your own trading strategy;
- choose currency pairs that are safe for investment;
- track fluctuations in rates and earn on your difference.
The key factors that affect currency volatility are:
- currency pair liquidity;
- instability of world politics;
- publication of macroeconomic statistics;
- ecological disasters.
High volatility can be caused by international conflicts, political crises, sanctions, negative economic news.
A low level of volatility is inherent in liquid assets, that is, those for which demand and supply are high. Based on Forex data for 2021, EUR/USD, USD/JPY and GBP/USD are recognized as the most liquid currency pairs. They are the most popular among traders, as they are characterized by a smaller spread and faster order execution.
When trading forex, the time of trades plays an important role. The volatility of many currencies increases during the intersection of trading sessions. The market is most active during the hours when the US and European trading sessions intersect.
Types of indicators to assess volatility
The following technical analysis tools allow you to track market changes over a given period of time:
- ATR (average true range);
- CCI (Commodity Channel Index);
- Bollidger Bands (Bollinger Lines).
These three indicators are most often included in the package of trading terminals.
ATR , translated from English, the average true range, was developed and described by J. Wells Wilder, Jr. in 1978 for the commodity market. In the future, this indicator began to be applied to financial instruments and used by Forex traders.
ATR belongs to the class of oscillators. This means that their values will fluctuate between the maximum and minimum price. The growth of the indicator is consistent with the increase in volatility, the fall – with the decrease.
The Average True Range indicator works well as an analysis aid. It tracks volatility, allows you to determine the floor and trend, but does not provide information on trend direction and best market entry points. For these purposes, Bollinger Bands and CCI are used.
Bollidger Bands combines the functions of a trend indicator, a volatility indicator, and an oscillator. Graphically, the tool is represented by three lines: in the middle there is a moving average, which characterizes the main direction of movement, the upper and lower bands are high and low levels, which limit the price chart and characterize volatility.
The distance between the upper and lower lines indicates the severity of market volatility. A wide corridor corresponds to high volatility and a narrow corridor corresponds to low volatility. The longer the price range has been in a tight corridor, the more pronounced the trend reversal will be after the breakout.
CCI is a trading channel index developed by Donald Lambert in 1980. The indicator shows the deviation of the current price from the average value over a certain period of time. Basically, it’s an oscillator.
The larger the specified deviation, the higher (if the trend is up) or lower (if the trend is down) the indicator line will move away from the zero mark. A trader receives an overbought or oversold signal when the chart curve breaks out of the -100/+100 range. A classic is a trading strategy in which a position is opened to sell an asset when the CCI rises above the +100 level, to buy, if the line falls below the -100 level.
Thus, the indicator helps determine at what times it is worth entering the market.
For a comprehensive evaluation of volatility, it is more efficient to use several indicators. Along with tracking world news from the sphere of politics and economics, technical analysis data gives the trader a clear idea of the volatility of the forex market and allows him to make the right trading decisions.
