What Is Volatility in Currency Trading? - dummies

What Is Volatility in Currency Trading?

By Kathleen Brooks, Brian Dolan

Volatility is a statistical term referring to price fluctuations (standard deviation) relative to the average price over a specified period of time. Volatility is what makes the trading world go ’round, and without it, speculators would have a lot of time on their hands.

But not all volatility is created equal, and you need to be aware of two main types of volatility that can alter the currency playing field:

  • Market volatility: Market volatility is the overall level of price volatility in various financial markets at any given time. The VIX S&P 500 volatility index is a good overall barometer of market volatility. Market volatility typically increases during periods of uncertainty or unexpected economic data or monetary policy developments.

    If you’re trading on a short-term basis or using a model that relies on relatively low volatility (for example, mean reverting systems, moving averages, or regression channels), you need to be aware that increased volatility can quickly swamp such strategies. Better to stay on the sidelines and sit out the upheavals than jump in with a strategy unsuited to higher volatility.

  • Currency-pair volatility: Different currency pairs trade with different volatility characteristics, both in the short and long term. Before you go with a trade setup in a currency pair you’ve spotted on a chart, make sure you’re aware of the pair’s relative volatility.