Forex Trading A Volatile Exchange Market Of Currencies
When exchange rates fluctuate rapidly and frequently, this phenomenon is known as currency volatility on the foreign exchange market. When deciding which currencies to trade and how to do so, knowledge of forex volatility is invaluable. In this article, we will discuss what foreign exchange (FX) volatility is, how to recognize it, which currency pairs exhibit high volatility, and which strategies can be used for reliable FX volatility trading.
IN WHAT SENSE DOES VOLATILITY APPLY TO CURRENCY TRADES?
The volatility of a currency is a statistical indicator of how often and by how much its value fluctuates in the foreign exchange market. Volatility, a measure of standard deviation, can be used to characterize the degree to which a currency’s value fluctuates relative to the average. Larger price swings due to increased volatility increase both trading risk and potential reward.
For a visual representation of this concept, consider the following two charts, one depicting the Bitcoin/USD exchange rate and the other depicting the New Zealand dollar/USD exchange rate, with the orange line representing the Average True Range (ATR), a widely used indicator of volatility.
It is clear from looking at the ATR values that NZD/USD is a stable currency pair, while BTC/USD is extremely volatile.
HOW TO TAKE ADVANTAGE OF VOLATILITY IN CURRENCIES
As a result of its inherent uncertainty, currency volatility is notoriously challenging to detect and monitor.
However, there are ways to quantify volatility that can aid traders in making future predictions. For a precise evaluation, it is also important to take into account both historical and implied volatility. Volatility that has already occurred is called “historical,” while volatility that is expected in the future is called “implied” (based on the price of futures options).
Volatility over time can be viewed in charts, where the peaks and valleys in prices are readily apparent.
To gauge market expectations for currency volatility, investors can use one of four CBOE indices.
BETWEEN HIGHLY VOLATILE AND STABLE CURRENCIES IN TRADING
Foreign exchange markets are notoriously fluid, so traders should brace themselves for frequent changes in the most volatile currency pairs. There is less volatility in the more liquid currency pairs, such as the major ones, than in the less liquid pairs, such as those from emerging markets. These currency pairs are among the most unstable:
- Exchange Rate (U.S. Dollars to South African Rand)
- United States Dollar/Mexican Peso
- US dollar/Turkish lira.
Another currency pair with a history of volatility is the Australian dollar Japanese yen (AUD/JPY). See the asset’s price change, again plotted alongside ATR, in the following chart. The area inside the circle is just one place where ATR reached new heights as the AUD/JPY exchange rate dropped sharply. The following are some examples of currencies that are commonly thought to have low volatility:
EUR/USD (Euro/United States Dollar).
When trading high- and low-volatility currencies, you may want to use different indicators.
The use of support and resistance levels can be helpful for navigating the market with currencies that have lower volatility. These show where the foreign exchange market has risen and fallen, so they can be used to trade by predicting future market movements. It is possible to limit your losses to an amount that is manageable for you using a stop loss.