Volatility on the forex market: what it is and how do you trade it?

 

In these turbulent times that the markets are navigating, forex is no exception to the rule. Volatility, which is the rate at which the price of an asset increases or decreases over a period of time, is one of the most exciting and risky features of the currency exchange market.

Below we will go over what volatility is, and how to trade with this phenomenon in the forex market. In addition, we will see in detail the City Index tools that can help you in your trading, and in what other markets you will be able to trade to mitigate the risks of this volatility.

 

What is volatility in forex?

Volatility in forex is a measure of the frequency and extent of changes in the value of a currency. A currency can be described as high volatility or low volatility depending on how much its value deviates from the average. It is a measure of the standard deviation.

While most financial markets experience intraday movements, higher volatility markets – such as forex – see a much greater speed and degree of change. In the face of greater volatility, we will find greater trading risk, but also more opportunities for traders as price movements become greater.

Volatility is seen as an indicator of fear levels in the market. When there is uncertainty, price movements can become erratic and unpredictable, as even the smallest news can cause outsized price movements.

An example of the difference between a volatile currency pair, versus a stable pair, can be seen in the fluctuation of its prices. A currency pair that fluctuates between 5 and 10 pips is less volatile than a currency pair that fluctuates between 50 and 100 pips.

Learn more about trading volatility 

 

How to trade with high volatility

Day traders tend to prefer high volatility in markets because it creates more opportunities for short-term speculation. When big changes occur, it increases the chance of making higher profits in a shorter period of time. But it also increases the risks, as a market can move against you just as quickly.

That's why it's important to understand your appetite for risk before you even start thinking about trade volatility. If you feel uncomfortable in high-risk scenarios, then trading in volatile markets is probably not for you. But, if you're interested in the potential to benefit from breakneck changes, the right trading strategy can help you take advantage of market changes.

Learn how to manage your risk with the City Index Academy

 

Is forex volatile?

The forex market is often referred to as volatile and although currency prices change extremely fast, they do not have the erratic price movements that are normally associated with volatility. This is because forex is the most liquid market, so the price changes in smaller increments due to the high volumes of traders willing to buy and sell.

Most major currencies only trade in a range of a small percentage within a trading day. However, non-major currency pairs experience less liquidity, which means that the difference between intraday highs and lows tends to be wider. We see this when we look at the percentage range between different major pairs, crossed and exotic.

Most currency volatility occurs around the release of important data, such as interest rate decisions, retail sales, inflation, employment figures, and industrial production.

 

What causes volatility in forex?

Volatility is caused by increased uncertainty, whether across the market, in a particular currency, or in the shares of a single company. In the case of the forex market, there are many factors that can affect the prices of its main currencies:

• Geopolitical factors: Decisions made by governments and political leaders about trade agreements, policies and legislation can provoke strong reactions. While a certain level of volatility in the markets is needed, a high and prolonged level of uncertainty (in the case of wars, for example) is not good for the confidence of traders and the market in general
• Trade Wars: Whether it's the US vs. China, US vs. Europe or any other region or country, trade wars can also generate volatility in the markets due to the billions or trillions of transactions involved. One way or another, the currencies involved in any trade war will be affected at some point
• Monetary Policies: Central banks around the world play an important role in managing the flow of money. They can regulate the amount of money in circulation through interest rate levels. For a forex trader, it is critical to be aware of the decisions of any relevant central bank. And whether it is 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), when publishing favourable developments, the markets tend to react favourably. The reverse happens when data releases show negative market performance or fail to meet market expectations
• Market sentiment, or liquidity: Generally, market movements are driven by the people behind them. Traders and investors generate the movement of the markets with their trades. Depending on the prevailing sentiment, positive or negative, market volatility can fluctuate. The more traders in the market are willing to buy and sell an asset, the less likely it is that a single transaction will cause a large price movement. Therefore, less liquid markets are usually more volatile, as prices can change drastically

 

Forex market volatility indicators

You can use different indicators when trading forex with volatility. With currencies of lower volatility, you can look to use support and resistance levels. These show where the forex market has risen and fallen, so they can be used to trade helping you predict market movements. You can set your stop loss to a level you are comfortable with to make sure your losses don't pile up.

With high volatility currency pairs, it is necessary to be aware of price changes, as these can be erratic. Here are some of the indicators you can use to trade them:

• Bollinger bands: Can be used to indicate whether a market is overbought or oversold, increasing the chance that prices will start moving in the opposite direction
• Average True Range (ATR): A technical indicator that is presented as a single line in a box below a market chart. When the line goes up, it means that the market is becoming more volatile. When it goes down, volatility is falling
• Relative Strength Index: An instrument to measure the magnitude of price changes, indicating again whether a currency has been overbought, or oversold, and thus can decide its position

 

How to mitigate the risk of volatility

By trading with City Index you will have access to our exclusive trading tools. These can help you make better decisions, based on your past performance, as well as how prices are moving in certain markets.

 

Performance Analytics:

With the Performance Analytics tool, you will access a 360° look at your operations, and your profile as an operator

• View an in-depth report of your trading performance
• Analyse your income statement and your profit ratio
• Review the timing of your operations
• See if you do better when going long or short
• Explore the impact of psychological factors, such as streaks

You can access Performance Analytics by logging into your platform and selecting "Performance Analytics" in the tab at the top of the platform. Or log in via the mobile app by clicking "More" and then "My History".

Learn more about Performance Analytics 

 

Market alternatives to forex volatility

Although we are living in turbulent times regarding volatility in the stock market, there are specific instruments and markets in which the most experienced traders usually pour their efforts in times of constant ups and downs.

One of the main risks observed in the market is that high inflation and rising interest rates could trigger a recession. High interest rates make it difficult to obtain credit and make existing services even more expansive, stifling economic growth.

In a recession, safe havens, such as the USD, could remain firm, in addition to defensive stocks with strong balance sheets, such as utilities, energy, and basic consumer goods.

 

USD

The US dollar is the world's reserve currency and the currency of the world's largest economy, making it a powerhouse in the foreign exchange market. Although US inflation is not stopping at the expected speed, today the US currency presents a kind of refuge from other international currencies.

On our platforms, you can trade the "DXY" index, or US dollar index. It measures the value of the U.S. dollar relative to a basket of other currencies, including the currencies of some of America's major trading partners. The dollar index rises when the US dollar gains strength compared to the other currencies in the basket and falls when the dollar weakens.

Learn more about the US Dollar Index

 

Gold and silver

Traders can gain exposure to gold through international currency exchange. Instead of buying and selling the precious metal, or speculating on its price using futures, you can trade it as a dollar-denominated currency pair; or through gold-linked pairs.

Given that gold was historically used as a currency, it is not surprising that it remains an internationally recognized part of the foreign exchange market. It trades with the currency code XAU.

In addition, with City Index you can trade gold, silver, and other metals by opening a position with CFDs.  As traditional safe-haven assets, gold and silver can help you diversify your investments and protect you from inflation.

 

Oil

Oil trading is the act of buying and selling oil for a profit, either by exchanging the physical commodity, or by speculating on its market price with CFDs. The oil market is extremely popular due to the volatility caused by changes in supply and demand.

Starting to trade on oil can be complex at first but with City Index you have the best resources available.

 

How to trade volatility with City Index

You can speculate on forex volatility with City Index in just four easy steps:

1. Open a City Index account, or log in if you’re already a customer
2. Search for the market you want to trade in our award-winning platform
3. Choose your position and size, and your stop and limit levels
4. Place the trade

Or you can try trading volatility in forex risk free by signing up for our demo trading account.