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Volatility in the Forex market tells you how frequently and severely the price changes for a currency pair. Using the volatility, you can assess your risks, and predict how much you can gain in each trading session.
Looking at the chart for a currency pair, if you see the price trend is moving up and down with sharp drops and inclines, it means there is high volatility associated with this pair. However, when the price line is steady or similar to a straight line, it means the traded asset has low volatility.
Some traders prefer volatile pairs in Forex like AUD/JPY or NZD/JPY because they can generate a higher return. Moreover, there are risks associated with volatile pairs in FX. Your market position might drop dramatically without any warning signs, and you can lose your money in an instant. If you feel like you are not ready for high volatility currency pairs, you can always try trading major currency pairs, stocks under 5 dollars, or penny stocks.
Therefore, you need to learn how to use volatility to your benefit, which is exactly what we are going to explain in the following guide. Here we have covered the most volatile currency pairs and strategies for trading volatile pairs in the Forex market.
Volatility refers to the market price stability or instability during a specific period of time. Ideally, volatility enables traders to make money in different financial markets. When the price of an asset increases, the trader’s market position grows in value, and vice versa.
In volatile markets, the price of an asset fluctuates severely up and down, and if the price increases sharply in one day, the trader can realize short-term gains.
In the Forex market, some currency pairs are more volatile than others, which gives traders a choice between trading more stable pairs with less price movement, or volatile ones that can maximize profits. The reason why volatile currency pairs in the Forex market enable traders to make higher returns is that they move more than 1% around the market price in a single day.
This volatility in the Forex market is defined by both the base and quote currency. For this reason, the volatility rates differ between pairs even if they share one side of the pair.
A currency pair's volatility is found by calculating the standard deviation of the market price over a specific period of time. The data is gathered from the price deviation against the average price of a currency pair, then the deviations are summed and divided by the number of periods taken.
The resulting percentage of standard deviation represents the volatility price, or how wide the price is fluctuating around the average market price.
Knowing the average volatility of financial securities helps the trader understand how risky the asset is, and what returns they can expect from the investment.
Volatility is associated with the currency’s local economic indicators, and huge divergence happens when the two currencies in the pair witness contradicting monetary policies. The pair AUD/JPY had a record daily volatility rate of 12.6% on June 24, 2016.
On that day, this pair, which had an average price of 77 AUD, witnessed a price fluctuation between 72 AUD and 81 AUD in one day, recording one of the biggest divergences ever recorded for this pair.
Another instance of huge volatility was recorded on the same day for a different currency pair. The NZD/JPY pair recorded daily volatility of 11%, with the price moving 8 NZD around the average market price.
Some currency pairs experience a higher rate of volatility than others, which is mostly the result of different economic conditions in the countries from which the currencies originate.
Usually, major currencies are less volatile than crosses or exotic pairs. Major currencies are more stable because they are connected to relatively stable economies, which do not intake sudden monetary changes.
Some Forex traders prefer highly volatile pairs, despite the associated risks. The reason for this is that these pairs are able to offer much higher returns, which some traders feel is enough to offset the risk of sudden volatility.
This cross-currency pair is one of the most volatile currency pairs out there, with average volatility of 1.12%. The reason for this is the difference in financial policies between Australia and Japan, and different economic indicators between the two countries.
The Japanese economy is characterized as having a slow and steady growth rate, in addition to a low-interest rate of around 2%. The Aussie economy lacks stability, it fluctuates with the prices of commodities, deals with agricultural lands problems, and relies heavily on its trading partners.
This diversion between the two countries' economies is what leads to this volatility in the Forex market, where the prices of the quote currency and the base currency perform differently.
The NZD/JPY is another volatile pair that moves 1.05% on average each day. We can see wide patterns of price changes across the chart due to the different trading and monetary conditions of the two economies.
Japan is a safe-haven economy, where interest and inflation rates are low. Meanwhile, the New Zealand economy relies heavily on exporting commodities - it exports meat, milk, and wool among other things. The trading balance directly affects the NZD, causing positive inflation rates.
Therefore, the different inflation rates and economic activities between the two economies cause this divergence, leading to the pair having high volatility.
This pair's volatility moves around 1.07% from the average price. It is caused by the different financial policies in these regions.
Europe is highly regarded in the global political, economic, and technological sectors, which makes the Euro relatively unstable. However, Australia seems to be stable politically, as the country is strategically and geographically far from the center of the world.
Despite being stronger, the European economy is highly affected by global events and accommodates some disagreements between the states, which makes this economy somewhat unstable. While the Australian economy is relatively stable, take into account that monetary decisions are implemented in just one state, unlike the EU where there are many member states to consider.
This volatile currency pair changes its price by 1.07% on average around the market price. This deviation comes from the fact that base and quote currencies change in different directions.
The USD is highly affected by political and economic situations around the world. For example, the presidential elections in the US, and the business ties with China can cause changes in its value. However, the Australian dollar is commodity-based, which means it relies heavily on producing and exporting natural resources like coal, iron ore, and meat.
Additionally, the Federal Reserve Bank of the US keeps the interest rates low, while the National Australia Bank pushes for higher interest rates.
This volatile pair is an interesting one for most Forex traders, with the price fluctuating on average by 1.05% around the market price.
After the GBP deteriorated in light of the Brexit referendum, the Australian economy was going through reforms that introduced new monetary and fiscal policies to the country.
However, recent developments are more interesting. The UK economy is growing at a faster rate than the Australian economy. The UK economy is projected to grow more than 6% in 2022, which is 3% more than the estimated economic growth rate of Australia for this same period.
In addition, the UK has recovered from the Brexit shock and is more likely to stabilize its economy in the coming years. On the other side of the pair, Australia is facing export issues with its main trading partner, China, as China is banning the import of specific commodities from Australia.
The volatility of exotic pairs is usually high and makes them riskier to trade since they include currencies that are not commonly traded, such as the Uruguayan peso, South African rand, Swedish króna, etc.
These currencies have less liquidity in the market, which makes it harder to buy and sell them. Additionally, they have less trading volume and higher spreads, which makes it a costly choice for traders.
The exotic pairs may be paired with one common currency such as EUR/TRY, USD/HKD, and NZD/SGD.
Some traders prefer trading exotic pairs because they have high volatility rates, which means that they can return higher gains. However, they are riskier because they include economies that are unstable and inconsistent.
Trading volatile pairs might not require a special strategy. However, you need to eliminate trading strategies that put your market position at risk. Volatile currency pairs can move up and down fast, and you want to keep both your eyes on the market to make sure you don't miss a beat.
Therefore, long-term buy-and-hold strategies are not really recommended for volatile currency pairs. It is recommended to get the advantage of the quick price changes, and gain as much as possible using these short-term strategies:
Entering and leaving the market at the Forex market trading hours is a good idea when trading volatile assets. A day trading strategy in Forex entails keeping your market position active only during the trading day, without holding any positions overnight.
During the night, a trader is more likely to be far from his desk, which is quite risky because volatile currency pairs can move suddenly and severely, and any winning position can turn and start trending in the opposite direction.
Volatility in the Forex market peaks when the UK and the US markets overlap, causing currency pairs associated with the USD and the GBP to fluctuate strongly.
Trading when the market price catches momentum enables traders to maximize their potential gains. During swing trading, a Forex trader executes a buy order when the market price moves upwards, then closes the position and sells it when the price trend changes its direction.
Swing trading in Forex can be used with volatile pairs because volatile currencies’ prices are more likely to change and fluctuate several times a day, which enables swing traders to enter the market according to the direction that the price is trending in.
Scalping in Forex is used by many traders. It entails entering and leaving the market after a short time, several times a day. Scalping relies on the volatility of the currency pairs because the trade does not stay open for very long, traders using this strategy try to maximize their gains in every single entry
Additionally, when the currency pair is highly volatile, the scalper can gain enough pips to offset the spread or the trading cost imposed by the broker. Therefore, scalping is probably the most recommended trading strategy for currency pairs with high volatility.
Trading volatile currencies mean that prices can fluctuate heavily in a short period of time, and the market trend can change its direction a few times in one day. Therefore, the stop-loss option in Forex helps traders to avoid excessive losses.
When you set a stop-loss order, the market position will automatically close if the market price dropped to a certain level, which creates a safety cushion against dramatic price changes.
Currencies are associated with central banks' policies and regulations. Any change in the local economy can highly affect the value of the national currency, and eventually its price against other currencies.
Liquidity plays a huge role in the volatility of the currency pairs, which is what distinguishes the major currency pairs in the market from the rest. When there is a huge number of traders buying and selling a specific currency, and a lot of money is poured into trade, it means that this currency is widely available in the market for new traders while seeing only tiny fluctuations in price.
The high availability (liquidity) of a currency leads to stabilized prices and low volatility. However, when the asset is less liquid, and limited in the market, it becomes more volatile because its value fluctuates after any small change in the economy.
Another factor that determines volatility in the Forex market is global news and events. Trading wars, regional disputes, inflation, and interest rates can all lead to changes in the economy, which influences the value of the local currency.
For example, an increased inflation rate might motivate the national bank to print more currency and pump it into the economy, which leads to a fall in the value of the currency.
When a country faces high inflation rates, traders may develop a negative sentiment about its economic growth, and decide to start selling that currency. Eventually, when more traders are selling the currency, it loses value and its price falls against other major currencies in the Forex market.
These are unpredictable events that cause huge changes in the economic map, leading to severe price changes, and giving traders only minutes to save their capital. These events can cause even the most stable assets to become extremely variable, and lose their value compared to other assets.
These Black Swan events are unpredictable and extremely rare, usually have a wide reach effect on economies, and are more likely to redefine some economic factors in several countries.
For example, the Brexit referendum caused the British pound to lose its value tremendously against other major currencies. When the UK announced its departure from the EU, traders had negative estimates about the growth prospects of the UK economy and started selling off their holding of British pounds.
Traders started to sell the GBP into the market, and when the supply increased the price of the British pound decreased against other major currencies.
Other Black Swan events such as the Covid-19 pandemic, the US Presidential election disputes, and the US-China trade wars, had a global impact on several markets, causing some immense declines in the global economy.
EUR/USD is the most traded currency pair, which makes it the most liquid asset on the Forex market. The high liquidity associated with the EUR/USD pair makes it less volatile and safer to trade with. The price changes in this pair are very tiny, with low daily volatility of 0.50% on average, which makes it safe and easy to open a market position on this pair.
First, the average market price is determined, then the daily price deviation from the average is calculated. Once this is done, total price deviations are then divided by the number of periods recorded to have the average price deviations from the average price.
This calculation tells the volatility price or the range at which the market price is changing. Note that you need to determine the timeline to calculate the volatility.
EUR/USD, EUR/CHF, and USD/CHF are the safest currency pairs to trade with as they have the lowest volatility. These currencies are associated with the strongest and most stable economies around the world, which motivates many traders to buy and sell market positions of these pairs, greatly increasing their liquidity.