Volatility is a measure of how much a price fluctuates over a specific time period.
Volatility in forex trading measures the magnitude of a currency pair’s ups and downswings.
When the price of a currency bounces drastically up and down, it is considered to have high volatility.
Low volatility refers to a currency pair that does not vary as much.
Before entering a trade, it is critical to understand how volatile a currency pair is.
Volatility should always be considered while determining position size and stop loss level.
KEY LESSONS
- Emotional investing (greed or fear) is the primary reason why so many people buy at market tops and sell at market bottoms.
- One reason investors may make bad judgments based on emotion is underestimating the risks involved with investments.
- Investors frequently shift capital away from riskier stocks and toward lower-risk interest-rate instruments during periods of market volatility and rising interest rates.
- Dollar-cost averaging and diversity are two strategies that investors can use to make steady, non-emotional judgments.
- Staying the course through short-term volatility is frequently the key to long-term investment success.
What causes forex volatility?
Increased uncertainty causes volatility, whether throughout the market, in a specific currency, or in the shares of a single company. There are numerous factors that can influence the pricing of the forex market’s major currencies:
Geopolitical factors:
Government and political leaders’ decisions on trade deals, policy, and legislation can elicit significant reactions. While some market volatility is necessary, a high and extended level of uncertainty (as in the case of wars, for example) is detrimental to trader confidence and the market in general.
Trade Wars:
Trade wars, whether between the United States and China, the United States and Europe, or any other area or country, can cause market volatility due to the billions or trillions of markets at stake. The currencies involved in any trade war will be affected in some way at some point.
Monetary Policies:
Central banks play a vital role in managing the flow of money around the world. They can control the amount of money in circulation by adjusting interest rates. It is vital for a forex trader to be aware of any relevant central bank’s choices.
When the US Federal Reserve, the European Central Bank (ECB), the Bank of England (BoE), the Bank of Japan (BoJ), the Bank of Canada (BoC), or the Reserve Bank of Australia (ARB) publish beneficial developments, markets tend to respond positively. When data releases reflect poor market performance or fail to meet market expectations, the opposite occurs.
Market sentiment, or liquidity:
Market fluctuations are generally driven by the individuals behind them. Traders and investors drive market movement through their deals. Market volatility can fluctuate depending on whether the prevailing emotion is positive or negative. The more traders eager to buy and sell an item in the market, the less likely it is that a single transaction will create a major price change. As a result, less liquid markets are typically more volatile, as prices can fluctuate dramatically.
Trading Tips For Forex Volatility
You can utilize some particular forex volatility trading methods and advice. These will assist you in making the most of your trades, but more significantly, they will assist you in minimizing risk so that you can protect yourself from large losses. Volatile markets are always risky, so having a strategy in place and sticking to it is one of the most critical things you can do.
Tips for trading forex volatility:
- Trade using charts and indicators
- Trade around news and events
- Use stop losses
- Keep position size low
- Adhere to your forex trading strategy
- Keep a trading journal
Trade Using Charts and Indicators
As previously discussed, there are several technical indicators you can use to predict market emotion and future price direction. While not conclusive, employing charts and indicators will assist you in developing your strategy and determining when to trade.
Trade around news and events
Following news and current events can alert you to events that may have an economic impact and change currency value. Currency volatility frequently coincides with political or economic upheaval, therefore the DailyFX economic calendar can be used to keep a broad awareness of news releases. Trading around news events is one strategy to avoid volatile market circumstances.
Use stop losses
Stop losses are usually an excellent approach to reduce risk when trading, and this is especially crucial when trading volatile currencies. Stop losses ensure that any lost transactions are accounted for in advance, and you may choose a degree of loss that is reasonable in the worst-case situation. This is especially crucial if you are trading with leverage, as your losses could be enormous, with you losing considerably more than you deposit.
Keep position size low
There is the possibility of large profits in volatile forex markets, but there is also the possibility of large losses. Any volatility trader would do well to keep their position size small. It is recommended that you risk no more than 5% of your account on open trades. This will give your position more wiggle room without losing your funds too quickly.
Adhere to your forex trading strategy
Maintain a trading strategy and stick to it. Following your trading plan to the letter can assist you in managing the swings of volatile markets.
Using the recommendations in this article and sticking to your trading plan can help you manage volatile markets and trade more regularly.
Keep a trading journal
Keeping a trading journal to keep track of your deals is a great habit to get into. It’s especially useful when trading volatile forex markets because it allows you to review your deals and assess what worked and what you could have done differently. A well-kept trading journal will help you become a better trader by allowing you to constantly evaluate, reflect, and improve.
Conclusion
When trading the financial markets, one of the most crucial things to understand is volatility. It’s also a term that investors may use without fully knowing what it entails or how volatile markets work. You now understand how volatility works and how to trade it successfully after reading this post!