What is Volatility in Forex Market
Volatility in the Forex market is something you can imagine like this. During one day the price of a trading pair jumps up and down. How many pips and how often price jumps up and down is how volatile it is.
When price jumps a lot and fast, and there is a large difference in price between high value and low value during that day it means that pair have higher volatility.
If volatility is higher it means that you will be able to enter into that pair with trade without any problem and you will be able to exit at any time. When there is a high number of sellers and buyers volatility will be high and traders love that.
Buyer and seller give volatility to trading pairs. If there is a seller that is willing to sell a trading pair to a buyer at any time on the market that pair will be highly volatile. This is the same in case if there is a buyer that is willing to buy a pair at any time on the market the seller will be able to sell whenever he wants.
If there is no buyer and seller, the price of the trading pair will remain in the same place. It will not move up or down because there is no demand/supply on the market to move price in any direction. If this happens you can say the pair does not have volatility and, mostly, traders will avoid trading this pair.
Volatility Meaning in Forex Trading
It is easier to understand what volatility meaning is in Forex trading if I show you a real example. So take a look in the image below.
I have explained in the part above that the volatility means when the price moves UP and DOWN very often.
If the price moves very often UP and DOWN you will see that on your chart. The chart above shows you the GBP/JPY currency pair as one of the highest volatile pairs.
How do you see the volatility on the chart?
From the left side to the right side you can see a steep line of candles that represents the price.
As you can see there are only a few candles that are next to each other(high and low of one candle is in the same height as candle next to it) which means the price did not change in one month compared to the following month.
Most candles are formed one above another. That means the price has changed each month and the price rises.
Volatility does not mean only when the price is rising UP. The price can have the same chart pointing DOWN.
Another characteristic of volatility on the chart is that the candles are very large. The candles are not small ones where the price change from maximum to minimum of each candle is few pips.
No, the difference between maximum and minimum is large which tells us the price has changed a lot.
Another thing you need to know is that the price could be volatile without moving UP or DOWN like on the image above.
Volatility Meaning When Market is Moving Sideways
It is not mandatory for the price to move upwards or downwards.
The price can move sideways and still be volatile.
Take a look at the image below.
Each candle represents one day on the market. You can see on the chart in the left upper corner where it says EURUSD Daily.
That is information that tells you which time frame I am using and what each candle represents.
Now, you can see that the market did not move only UP or only DOWN. There were some UP’s and DOWN’s, but when you take a look on the whole chart you can see the market moves sideways.
On a few candles I have extracted the pip range that shows you how the pair was volatile on that day.
The difference between maximum and minimum on that day is calculated through the number of pips.
If I take an average number of pips on those few days it will be around 70 pips.
(72.4 + 72.4 + 80 + 91.3 + 31.7) / 5 = 69.56
70 pips on each day as an average is a nice number of pips.
Candles you can see on the previous days are larger so the number of pips as an average number would be even higher.
What Number of Pips Makes Pair Volatile
As you can see in the example above we had 70 pips average on each day.
And I say that pair is a volatile pair.
But, how much would be the average number of pips when we can say that the pair is volatile?
My opinion is that any currency pair that has an average number of pips on each day more than 60 pips is a volatile pair.
Pair can be highly volatile and less volatile. Some pairs have volatility with over 100 pips daily.
Some pairs go even above that number, but those are rare and mostly exotic and minor pairs.
To get some clue about volatile pairs I will show you a chart I have made by extracting the average number of pips on several currency pairs.
Chart above shows you how each pair is volatile in different trading sessions. On the right side is the most volatile pair I have researched.
The GBP/JPY seems the most volatile pair with over 100 pips price change.
Trade Volatile Pair or Not
The question here is to determine which pair is better to trade.
Should you trade a highly volatile pair or less volatile pair.
While you are trading on the Forex market to make some money, you are looking to make a correct prediction where the price will move.
Your job is to predict the correct direction and to make as many pips as you can.
If you predict the correct direction and the price changes only a few pips per day, you will not make money.
So, the number of pips counts. You can make the conclusion that it is better to trade only highly volatile pairs.
That is correct and you should be looking for volatile pairs, but have in mind that highly volatile pairs bring more risk.
Chart above shows you a pair on a five minute chart, M5, and how the pair looks like when the market moves sideways and when there is no volatility.
You can see that the market had three candles with almost the same open and close price.
The price moved up and down only for 2-3 pips which is nothing.
On a less volatile pair where you have a move by only a few pips, you will probably lose money on that trade.
When you pay for the spread you will probably be in minus at the beginning and if the market continues to stay at the same price you will need to make a decision.
Will you get out of a non volatile currency pair and take the loss or will you stay in the trade and wait for the price to move in your direction.
The waiting period with a non-volatile market can last too long.
Volatility in Forex Market and the Risk
You will encounter someone saying that volatility is closely connected to risk. Risk is something you need to incorporate in trading strategy because you never know where the market will go. You can try to predict but you will never be 100% sure.
Risk is something normal and it is ok. But where is high volatility it does not mean that there is higher risk in trading. Any trade you take on the market, on a highly volatile or low volatile market, takes risk and you need to watch out.
Whenever you open a trade there is risk that you will be on the wrong side of the market movement and trade can be negative. Volatility is only connected in a way that risk of higher loss will be on a more volatile market.
Why? Because if volatility is high you can lose more in that trade while there are more pips that can be negative. But this can only happen if you do not set stop loss.
If you open a trade with set stop loss, you immediately accept risk in that trade but that risk is controlled.
Take a look on the image above where I have open one buy trade with standard lot size. Each pip will give me $10.00 of profit or loss.
Imagine if my trade becomes losing trade and makes a 70 pips move. I would lose $700 that day(if we are talking about daily pip range).
Notice that I did not set stop loss which means that I would lose even more if the market moves more than 70 pips that day.
To prevent a bad scenario where your trade would close with margin call you should protect your account with defining acceptable loss.
So, be smart and open a trade always with a stop loss in case if something goes wrong. This way you will protect yourself and your asset from unwanted risk.
Volatility in the Forex market is very much wanted and the Forex market is known by the volatility.
There are some currency pairs that are more volatile than others, but any type of trader can find one currency pair that moves in desired speed.
High volatile currency pairs bring more risk because more pips can be won, but also lost in a single trade.
With more pips lost the loss on a trading account is also higher. Those who can control the risk and set stop loss on each trade will have more success in trading.
Check more details about Forex and other terms you need to know to trade on the Forex.