Forex Volatility: What Is It & How Does It Affect Traders?
Volatility in the Forex market is all about understanding unstable conditions within currency pairs, which affects their price movements. Wild and sharp swings within a currency pair can make it risky to trade.
Thankfully, through trading CFDs on online brokerage platforms like Longhorn FX , traders can profit on both rising and falling currency pairs by going long or short. The ability to successfully spot volatility will arm traders with better information to use in their favour. By making more educated predictions on price movements, traders have the potential to make more profitable trades.
Here, we break down what Forex volatility is, how it affects trading, and reveal a few tips to bolster your trading strategy.
What does volatility mean in Forex?
In the simplest terms, volatility in Forex measures how quickly a currency pair’s value changes.
Forex is a deep market with an average global daily turnover of over $5 trillion. As Forex is tradable on a 24-hour basis during the week, high volumes of trading are happening around the clock. However, prices between currency pairs can change quickly and drastically as markets open and close across the globe.
A highly volatile currency pair will see more erratic price changes in sharper increments. Whereas lower volatility currency pairs will show prices that change more gradually over a longer stretch of time. The rule of thumb is that the more liquid an individual currency pair is, the less volatile that market is likely to be.
What causes volatility in Forex?
It’s important to keep in mind that all currency rates are affected by political, economic, and social events. This means that there are many unpredictable factors at play that can cause prices to fluctuate and become volatile at a moment’s notice.
For example, in the aftermath of the Brexit vote, the pound became extremely volatile against both the US dollar and the Euro. The usually stable pound declined sharply in value creating something of a market panic. It hasn’t been one continuous downward spiral, however. While the currency’s value hasn’t fully recovered, the pound has seen definite surges in value, especially after a withdrawal agreement was reached between the UK and the European Union.
The most level-headed way to handle volatility is to accept that all markets move up and down. Familiarising yourself with the history, trends, and deviation of Forex currency pairs will help you determine a portfolio that best suits your trading style and strategy.
The highs and lows of currency pairs
Every currency pair experiences higher or lower bouts of volatility over time. Scanning the price movements of any currency pair over a range of weeks, months, or years will instantly demonstrate this fact. There will be intervals of stability interrupted by periods of sharp movements, usually linked to economic data drops or major political events. It’s important to remember that no currency pair can be expected to enjoy low volatility conditions forever. A range of unpredictable factors may introduce greater volatility within that currency pair from time to time. It’s a traders job to take advantage of these variances in volatility to adapt their strategy accordingly.
That said, there are certain currency pairs which are typically more volatile than others. Major currency pairs linked to the US dollar, such as EUR/USD, USD/CHF, and USD/JPY, are considered to be some of the least volatile currency pairs.
Currency pairs usually considered most volatile are those linked with emerging markets, unstable economies, and low liquidity. Some are also highly volatile due to the inverse relationship between each of the currencies in the pair. For example, in AUD/JPY, the Australian dollar grows stronger as the Japanese yen falls, and vice versa. Other well-known currency pairs that regularly experience highly volatile conditions include: USD/SEK, USD/TRY, USD/BRL, and CAD/JPY.
Risk vs volatility
Highly volatile currency pairs come with a degree of uncertainty which can scare traders off. There are positives to consider too however, as volatile markets can create trading opportunities with higher yields. Naturally, with higher rewards come greater risks of bigger potential losses. So traders should strike the right balance between volatility and risk to protect their trades.
Volatility and risk are typically used as interchangeable terms, but there is a key difference between the two. A trader has no control over a market’s volatility. Prices can move drastically in any direction, at any time. Risk, on the other hand, is entirely within a trader’s grasp.
It can be tempting to follow popular Forex trading influencers or voguish trends betting on a volatile market. Yet, not every trader can afford to incur the same risks. It’s vital that you use good judgement and weigh up all the pros and cons before making any trade on a high volatility currency pair. If you decide to go ahead with making a trade, determine an appropriate position size that keeps your risk low.
One of the major benefits of trading CFDs in Forex is that you are trading on leverage. This means that even a smaller size deposit can gain you greater exposure to a currency pair, which can potentially yield bigger profits. An online broker like LonghornFX offers as much as 1:500 leverage .
No matter the market you’re trading in, you should always implement a well-thought-out risk management strategy that’s in line with your means and goals as a trader.
Tips For Trading Volatility
There’s always a degree of unpredictability when trading in the Forex market. Nevertheless, there are plenty of useful tactics that can keep you on top of any sudden currency shifts. Here are a few pointers that will serve any trader well:
- Keep abreast of current affairs and business news that are bound to impact a currency’s stability e.g. national elections, trade wars, and financial crises.
- Make use of Forex Forecast calendars, like the weekly FX Forecast posts on the LonghornFX Instagram account, to stay ahead of news affecting the economy in particular territories.
- Keep a low position size low to ensure risk remains minimal.
- Implement Stop Losses and Take Profits that operate at an affordable loss in worst-case scenarios.
- Never follow a herd mentality. Stick to your long-term trading strategy to avoid impulsive decisions and make more consistent trades.
Ultimately, a better understanding of volatility in the Forex market will help you select a portfolio of currency pairs that works best for you.
Are you looking to take advantage of volatility to make bigger profits? You can go long or sell short on 55+ currency pairs with 1:500 leverage at Longhorn FX. Benefit from 24/7 support and same-day withdrawals when opening a free account!