The forex market may seem like it’s forever in a state of unfathomable chaos. But once you try to make sense of it you will start to realize that there are patterns and reasons for its frenzy. And in our humble attempt to discern the forex market we will be discussing currency volatility.
Volatility is the measure of the rate and extent of a market’s price change. A currency’s volatility depends upon how much its price deviates from the average. If the upswing or downswing of a forex pair is quite high, it is said to have high volatility. If the price movement is relatively low, it is said to have low volatility.
The volatility of a currency pair is influenced by a great number of factors, including its liquidity. It refers to how many traders are active in the market and how easy it is to buy or sell a pair. As you know, the forex market is one of the most liquid financial markets owing to its 24 hours open to trade nature. When the market has high liquidity or a lot of traders are active, the volatility is relatively low. Similarly, when the liquidity is low the prices fluctuate rapidly. As the forex market is governed by political, economic, and social factors there is always a possibility of sudden volatility.
There are mainly two types of volatility that traders must be aware of; Implied and Historical. Implied volatility is the expected future volatility of the currency pair, whereas historical volatility is the experienced volatility of the same. Bollinger bands, Average True Indicator, technical charts, Momentum indicators are some of the tools that traders can employ to identify and measure volatility in the currency market.
Now we know what volatility is and how to identify it – but is it good or bad for traders? Well, it depends on what kind of trader you are. For short-term investors like swing and day traders, volatility is extremely crucial as they depend on hourly or daily price movements to make a possible profit.
While long-term traders mostly employ a buy-and-hold strategy, where they open a position and hold it for an extended period of time. And a high volatile market might extremely stress-inducing for them. Even then the rapid price movements could provide them the opportunity to buy low and the possibility to make high returns in the future.
But despite the shore of possibilities that volatility provides, it can prove extremely fatal for traders with inadequate risk management measures. Swift price movements against one’s own position is not something any trader wishes to encounter in the market, nevertheless, we must be always prepared for such an occasion. Position sizing, stop-loss orders, and take profit orders are just a few of the means to curb the risk involved in volatility.
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