It is often said, and with reason, that the forex is the market the most volatile in the world. What is this means exactly ? This is what we see, today, in this article.
Definition of volatility
The volatility allows to measure the risk in the foreign exchange market. More specifically, it measures the amplitude of fluctuation (standard deviation), the highest and the lowest level of an asset over a given period of time. More the volatility is high, the greater the risk and vice versa.
If the forex is also popular among the financial investors, this is because during times of high volatility, trading opportunities are very interesting and therefore much more profitable. All currency pairs do have, however, not the same as volatility, so you have to choose yours based on your profile of a trader and the strategy you want to implement.
Limits of volatility
With the volatility, the major differences tend to be more important. If it gives the level of risk, this measure is not totally efficient. Indeed, to the extent that we do not know the profile of deviations from the mean, the latter may be regular or very irregular. Take, for example, the pair EUR-USD. It varies by an average of 300 pips per day but some days, it can move 600 pips and other days 0. You understand better now why you need to take the volatility with a pullback.
Another limitation, the volatility does not inform about events that have an influence very low on average because of their rarity (events, tail distribution). Back to our pair EUR-USD, and let’s imagine that she would, one day, a volatility of 1000 pips, which is rare. As the volatility does not take into account this type of event, the significant change will have very little influence. However, the risk is real.
The study of the volatility is therefore interesting when one trades in the foreign exchange market, but don’t rely on that to it. Take into account other technical indicators, this will allow you to refine your forecasts and thus improve, in the long term, your trading performance.