Becoming a successful trader is very difficult, and therefore, to obtain a stable income from currency speculation requires more than one year of experience. The development of financial markets is an introduction to macroeconomics, the study of technical analysis and work on oneself. However, the most important thing is to create a trading strategy that will not work 100% if the trader is not able to analyze and use volatility.
What is volatility?
When mastering trading, you are looking for answers to many questions, among which there is always a basic one: "What is volatility?" It determines the number of points that the price has passed in a certain time. For example, a EUR / USD quote may rise or fall by 80-100 points per day - this is the size of its volatility. When you are in the market, you should not be surprised at such movements: a change of this currency pair by 140 points is a change in the price of the euro against the dollar by only 1%.
The range of fluctuations of the analyzed financial instrument is volatility, the determination of which is important for successful trading. If this indicator is high, then the trader should understand that the probability of making a profit increases in accordance with the risk. The reverse situation is when a flat is observed on the chart, and the volatility is only 5-15 points. In such conditions, scalpers are comfortable to work with. With medium and high volatility, it is convenient to draw trend lines and make forecasts of price movements of financial instruments.
What affects volatility
Price volatility changes for several reasons:
- The activity of market participants. Sharp price fluctuations occur when buyers and sellers fight for a deal. Thus, an upward or downward trend is formed depending on who wins this fight.
- The output of macroeconomic statistics. The economic calendar contains the most important economic events of all developed countries: output of data on production, labor market, interest rate changes. The difference between real and forecast indicators causes a stormy reaction of traders, which justifies the increasing volatility.
- Trading session. Most transactions are concluded in the first half of the day, when the London Stock Exchange is open - during this period the maximum volatility of most financial instruments is observed. In the American trading session, traders are less active if there is no macroeconomic news. During the Asian and Pacific sessions, volatility rises in currency pairs in which the Japanese yen, the Australian and New Zealand dollars are present.
- General state of the economy. All countries cooperate with each other, which leads to their influence on each other. For example, when investing in the Australian dollar, you need to consider that it is very susceptible to negative changes in the Chinese economy, as these two countries are close partners. A drought can lead to a fall in the New Zealand dollar , since the economy of this state is based on the sale of agricultural products. Thus, currency volatility is determined by fundamental methods that cover everything: the results of negotiations between heads of countries, minutes of meetings of central banks, a crisis in an industry, natural disasters, and more.
Volatility characteristics
To build a successful trading strategy, it is worthwhile to thoroughly understand the concept of "volatility". This is what it is, what characteristic features it has. First, constancy is inherent in it - most often volatility does not change for a long period until a really significant economic event occurs. So, analyzing the calendar of outgoing statistics, we can assume that the price fluctuations of the EUR / USD pair will not change their range until the release of Nonfarm payrolls.
Secondly, volatility is cyclical - sharp fluctuations are replaced by insignificant changes in prices, after which sharp jumps again arise due to certain fundamental factors. Thirdly, the volatility of an option or currency pair often tends to average. For example, if it is typical for the pair USD / JPY to pass 80 points per day, then it will return to this value every time after reaching new extremes.
Value of volatility
Understanding that volatility is what and how to use it in your trading, a trader can increase his chances of making a profit, as he will be more careful in choosing a market entry point. Volatility helps to calculate the risk level of a planned transaction, since it is necessary to see approximate boundaries for the current price movement. This gives a clear understanding of where the protective order should be and where the position will be closed at a profit.
A trader should be aware that the most volatile financial instruments provide more opportunities to earn money, however, the risks in such transactions also increase significantly. It is better for beginners to choose “calm” currency pairs in order to learn how to analyze changes in volatility, filter out market noise and false signals, after which it is already possible to make your trading tactics more aggressive.
How to calculate volatility on your own
The calculation of volatility is very simple, consider it with an example. A intraday trader should know how many points the price can go in an hour and a day. To do this, he needs to analyze the history of the behavior of the financial instrument in question. To simplify the procedure, he opens a weekly chart and considers the difference between the High and Low values of the last closed candle. He needs to divide this value by 5 to determine the number of points that the price overcame in one day. To find out the hourly volatility, the value is divided by 120 (5 * 24).
If a trader notes these statistics, then soon he will be able to see some pattern in the changes in volatility, determine the standard average range of price movements for the financial instrument used, which will greatly facilitate his work and help improve the trading strategy.
Volatility indicators
Indicators for determining the strength of volatility are standard and are in the trading terminal. The simplest option is exponential moving averages. The farther the line is from the candles, the stronger the volatility of a given currency pair. The moving average competition is Bollinger Bands. This volatility indicator is a series of lines converging, if the indicator is low, and diverging with increasing range of price fluctuations.
The third option for calculating volatility is ATR, which uses the price difference (current maximum and minimum) to build its image. The higher this number, the greater the volatility. The ATR chart does not illustrate a trend, but an increase or decrease in the rate of price change. Each of these indicators can be customized based on their own considerations so that the analyzed data is the most accurate.
Using volatility
To profit from financial markets, it is important to correctly use the changes in volatility. Its increase increases not only potential profit, but also risks. For beginners, it is best to choose currency pairs whose charts do not illustrate sharp jumps that uniquely knock inexperienced traders out of the market. To correctly use volatility, you need to know the following:
- If a flat is observed on the chart, and the price fluctuation range remains unchanged for a long time, then it is expected that volatility will increase sharply in the near future. Carefully review the economic calendar to place pending orders in a timely manner .
- The trading system should take into account changes in the behavior of the financial instrument - Stop Loss should be placed outside the noise zone and taking into account a possible increase in volatility - this will eliminate the likelihood that you will simply be “knocked out” of the market. For example, when trading EUR against USD, carefully choose the level at which the protective order will be located - in the range of 80 points. If the price during the London or American session increased or fell by a given number of points, then this day you should not open a position. Also remember that the potential profit should be at least 2 times the loss.
- With high volatility, reduce the volume of open transactions - do not risk your capital unreasonably.
By adjusting your trading strategy based on the information received, you can filter out most of the false signals and find really good entry points to the market. Asking the question: “Volatility is what?”, You should not be satisfied with the mere definition of a given term. The ability to analyze and apply it in your trade is the key to increasing income from working in the financial markets.