The measure of the extent of the changes in the value of a currency is what constitutes volatility.
So, depending with far it fluctuates from the average, a currency can be termed to have high volatility or low volatility.
More rapid changes within a very short period of time show that the market or more volatile and vice vasa.
When a trading instrument experiences change in price, it exhibits volatility.
In which case, it’s is not just the price that is experiencing the change but the trade instruments as well.
This is therefore volatility trading.
So, we can say that volatility trading happens where there is no definite prediction of the direction of the trade.
Characteristics of Volatility Trading
A volatile market can exhibit the following characteristics:
1. Very rapid high and low movements within a particular range
2. A trend with deep retraces after hundreds of pips (price interest point). A pip in forex trading is the price that moves in a given exchange rate. It measures the amount of change in the exchange rate for a currency pair.
3. It is possible for a volatile market to run for many pips in one given direction without retracing back.
How to Determine Volatility Trading
Volatility is very unpredictable by every nature.
This makes it very hard to tack and determine the trend.
However, to be able to determine volatility, traders use the types of volatility to make future predictions.
Types of Volatility Trading
1. Historical volatility
2. Implied volatility
3. Market volatility-refers to the overall level of price volatility in the market at a particular period of time.
4. Currency-pair volatility-this is volatility exuded by different pairs of currency pairs in both long and short term.
Historical volatility is one that has already taken place or the current price action.
While implied volatility is one that is anticipated to take place in future.
Historical volatility charts furnish the trader with information on the clear trends of past highs and lows of the prices.
A forex trader can then use the index in line with market expectations in relation to currency volatility.
It is important to understand that the higher the volatility the higher the risk. Trading volatility can swing prices in one direction magnifying the losses or the profits depending on the direction.
How to Measure Volatility Trading
Volatility is measured using standard deviation in financial analysis.
To measure volatility then one will have the highest price change over a particular period of time, terming this as a gross move.
You then capture the lowest price change and subtract from the previous highest price change.
In the forex market, volatility is measured using the VIX index.
This is a CBOE volatility index created by the Chicago Board of Exchange for the sole purpose of tracking market volatility.
Factors That Influence Volatility Trading
The volatility of financial markets can be influenced by the following factors;
political factors, national and international economic factors, earnings and financial market reports, news reports and policies of central banks.
For instance, there is likely to be an erratic market reaction if a central bank lowers its interest rates.
Is Volatility Trading Important?
Actually, the question should be;
as a trader would you consider volatility as an opportunity or as a risk?
When you hear about market volatility do you see a door for a huge profit or do you see uncertainty?
When properly executed, volatility trading should offer huge profit opportunity though the big movement.
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