Volatility is something that traders need to consider, because trading when volatility is high or low has its own risks. Which is the best?
Many traders complain on forums because they have not yet received satisfactory trading profits. There are many factors behind why traders can experience losses when trading. One of them is choosing the wrong momentum, because it cannot adjust to high or low volatility.
Based on their volatility, currencies can be divided into three types, namely high, stable, and low volatility currencies. Well, before trading forex traders should be able to see this. In this discussion, the author will highlight the differences in trading when volatility is high vs. low. Which is the best for forex traders?
What is Currency Volatility?
Volatility is the rise and fall of forex prices in the financial market. If a currency is categorized as having high volatility, it means that prices go up and down quickly, resulting in a very large difference between the lowest price and the highest price at a time. On the other hand, currencies that are categorized as having low volatility rarely experience price spikes, so the difference between the lowest and highest prices is not that far away.
Changes in volatility in currency pairs can occur due to market sentiment due to certain news, important fundamental news releases, or the actions of speculators who enter in large numbers when trading volume is thin or liquidity is declining.
How to Measure Volatility in Currency Pairs
Volatility is one of the vital parts of the forex trading system because it describes the fluctuations in the price movement of a particular currency pair. By knowing the type of currency with high or low volatility, traders can prepare the best trading strategy.
Generally, trading during high volatility is not recommended, especially for novice traders because it is too risky. Likewise, trading when volatility is too low, it is feared that it will prevent traders from getting the desired profit target.
But the question is, how do you know if a currency has high or low volatility? There are several ways that are commonly used by professional forex traders, namely by using technical indicators or following news releases.
1. Using Bollinger Bands Indicator
There are many choices of technical indicators that can be chosen based on their respective functions or uses. One of the most common indicators used by forex traders to measure volatility is Bollinger Bands. In order to get more accurate results, usually Bollinger Bands are combined with other indicators such as the Moving Average (MA). For more details, please see the sample image below.
The Bollinger Bands indicator has an upper and lower channel. When both narrow, the volatility of the currency decreases. Meanwhile, when the channels widen again, that is when there is an increase in volatility. To look for entry moments, you can pay attention to rejections on the upper and lower channels, such as in the area marked with a yellow circle on the chart above. Traders can place a Sell entry from any of these positions, with a stop loss placed above the swing high.
2. Following Fundamental News Releases
As mentioned above, one of the price drivers in the forex market is the release of fundamental news. Fundamental news also needs to be listened to, because trading only using technical analysis will certainly not be enough. So, it is best to balance between technical and fundamental analysis so that traders can get an idea of the market conditions and the most appropriate moment to open a position.
To be aware of extreme changes in volatility, some examples of fundamental news that forex traders must listen to include interest rate announcements, elections, speeches of important figures, and others. If you are very new to fundamental analysis, one way you can do it is to learn fundamental news terms first.
Currency Pairs With Their Volatility
Before trading, forex traders can do some research on the volatility of currency pairs. Reporting from fxssi[dot]com, the following is volatility data for several major, cross, and exotic pairs.
The table shows that the currency pairs with the least volatility are exotic pairs. With the average daily volatility reaching around 300 points per day, the comparison between one pair to another is extreme; if high can rise between 200 to 600 points, if low only ranged from 30 to 60 points.
Meanwhile, the major and cross pairs are not much different on average. However, the spread of volatility in major pairs is relatively more even than in cross pairs. Only GBP/USD is the only major pair that has a significant volatility gap among the major pairs.
Volatility can be expressed as a number of pips, for example: 200 pips a day, or an absolute figure of $0.3000, or also a percentage change in forex prices at the beginning of a period, such as 8.2% in a year. Below is an example of a daily currency pair price movement chart in pips.
Trading Strategy When Volatility Is Low
Market volatility that tends to be low usually makes the market move ranging (sideways). Well, when the forex market is experiencing a sideways trend, there are several strategies that can be used. However, traders need to take advantage of signals as early as possible in order to get the best profit and need to anticipate false reversals. Well, some trading strategies when volatility is low or sideways are as follows:
- First, take advantage of Price Action or candlestick patterns that form long-tail Pin Bars, Bullish/Bearish Engulfing, Morning Stars, and Evening Stars. These patterns are reversal candlestick patterns that indicate the occurrence of Rejection at the Resistance or Support level.
- Second, traders can avoid sideways markets and save energy in anticipation. Determine the support resistance level, then wait for a confirmed breakout signal between the support or resistance levels.
Trading Strategy When Volatility is High
As mentioned above, high volatility also carries greater risk. However, that doesn't mean you can't trade. You can still trade when the market is experiencing high volatility.
Some tips that can be used if you want to trade in high-volatility currencies are: widen take profit, reduce lots, lower leverage, etc. You can find more details in tips for safe trading when volatility is high.
So, Which is Best For Traders?
After knowing the character of the price volatility of a currency pair, how can we react to it? Every trader has their own preference between trading when volatility is high or low.
But keep in mind, both have their own risks. Volatility is often viewed negatively because it expresses uncertainty and risk. For novice traders it is not recommended to trade during high volatility. However, low volatility is also not recommended because there are usually no profit opportunities to look forward to. Beginner traders are highly recommended to look for trading momentum during stable volatility in order to be able to reduce the risk of loss and immediately get a profit target.
In this case, choose a major pair that can generally provide stable daily volatility, and be aware of high-impact fundamental news releases so as not to get caught trading in extreme volatility. You can also use Bollinger Bands to prepare a technical trading strategy.
To minimize risk in trading when volatility is high, low, or stable, you must also have good risk management. Please refer to this collection of forex management articles as your learning reference.
