Financial markets are never static; they are constantly moving. To understand this, just look at the chart of a financial asset, and you’ll see that prices are either increasing, decreasing, or moving within a range. To evaluate market activity and price dynamics, an indicator called volatility is used.
Volatility refers to the range of price fluctuations of an asset over a specific period of time—daily, weekly, monthly, etc. In other words, volatility shows how much the price of a financial instrument might increase or decrease at a given time. Volatility can be measured as a percentage or in units, such as pips
It is commonly believed that the stock market is one of the most volatile markets, with price changes of different companies often measured in percentages. For example, if a stock price starts at $100 at the beginning of a trading session and increases or decreases by $10 during the day, its volatility is said to be 10%. Large companies’ stocks usually have a daily volatility of around 5 to 10%, while stocks of medium and small companies may have volatility ranging from 20% to 50% or even more than 100%.
In the forex market, the price changes of currency pairs are generally much smaller in percentage terms, which is due to the very high volume of trading. The volatility of currency pairs is usually measured in pips. For example, the JPY/USD pair, which has average volatility, typically fluctuates between 50 to 70 pips a day. In contrast, the JPY/GBP pair, which has higher volatility, fluctuates between 100 to 150 pips a day.
In other words, volatility indicates the level of market liquidity. If we observe a market with low volatility and poor movement, like a choppy market, it has low volatility.
However, if, within the same time frame, we see the formation of waves and corrections that lead to the development of a trend or the establishment of a sideways trend, this indicates high liquidity and the presence of active traders. In such a market, volatility is high.
Also, if we consider the movement of the price over similar periods—e.g., in a 1-hour chart, 1 centimeter of price movement represents 70 pips, while in another chart, 1 centimeter of price movement might represent 40 pips—this means that in the second chart, there is less liquidity and money in the market.
The higher the volatility in the market, the greater the liquidity and depth of trades, allowing for trading even on lower time frames. For example, since gold has higher volatility than silver, trading can be done on lower time frames as well.
Volatility is the average amount of fluctuation of each currency pair, stock, or commodity over a specific time period. In the forex market, volatility has a close and direct relationship with the intrinsic value of the exchange rate of that currency pair. If we assume that the supply and demand for a currency pair are equal over two different time periods, the volatility of each currency pair is determined by the intrinsic value of the exchange rate of that pair.
Volatility is a measure for assessing the level of market fluctuations within a specific time frame. In forex trading, high volatility indicates significant up and down movements of currency pairs. When a currency pair experiences large and severe fluctuations, it is said that the market volatility is high. Conversely, when a currency pair has little significant fluctuation, it is said that the market volatility is low.
Definition: Volatility represents the degree of variation of a trading price series over time. It’s typically quantified by the standard deviation of returns, which measures how much the price deviates from its average.
Historical Volatility: Measures past price movements over a specific period.
Implied Volatility: Reflects market expectations of future volatility based on options prices
Understanding and effectively managing volatility is essential for successful trading in the forex market, as it can significantly influence trade outcomes and risk levels.
Influence of Economic Factors: Economic indicators (e.g., interest rates, inflation, employment figures) and geopolitical events (e.g., political instability, natural disasters) can cause volatility.
Liquidity Impact: Higher liquidity generally means lower volatility because larger amounts of currency can be traded with less impact on the price. Lower liquidity can lead to higher volatility due to fewer trades impacting price more significantly.
Pips: In forex, volatility is often measured in pips (percentage in point). For example, if EUR/USD moves from 1.1000 to 1.1050, it has moved 50 pips
High Volatility: Traders might use strategies that benefit from large price swings, such as breakout strategies, momentum trading, or trading options.
Low Volatility: Traders might focus on range-bound strategies or scalping, which involve taking advantage of smaller price movements within a defined range.
Psychological Impact: High volatility can lead to increased stress and emotional reactions. It’s crucial for traders to have a solid plan and avoid making impulsive decisions based on short-term price movements.
Market Sessions: Different forex trading sessions (Asian, European, American) can experience varying levels of volatility. For instance, the overlap between the London and New York sessions often sees higher volatility due to increased trading activity.
