This article will help you understand what forex volatility is, how to measure it, and how to use it in trading to increase your profits.
The Meaning of Volatility in Forex
Volatility in finances means the frequency and strength of price change. An asset is said to be highly volatile if its price fluctuates a lot within a given time period. Contrary, they say there is little volatility if the asset price doesn’t change throughout time. The picture below illustrates the highly volatile EUR/AUD currency pair.
In general, the forex market is highly volatile, and currency pairs fluctuate more than stocks, real estate, etc. However, not all forex pairs are equally volatile.
The volatility of a currency pair is based on the volatility of its base and quoted currencies. If either of them is susceptible to some events that take place at the time of trading, the currency pair is likely to fluctuate a lot.
The Most Volatile Currency Pairs
The most volatile forex instruments are exotic currency pairs. Exotics are currency pairs that include one or two currencies of emerging markets, e.g., USD/MXN, USD/ZAR, USD/TRY, etc. They are characterized by low trading volume and are extremely risky to trade due to their high volatility. Since there are fewer market participants buying and selling them, it is much easier for buyers and sellers to push quotes up and down.
Minor and major pairs are less volatile compared to exotics. Their volatility depends on many factors. The following currency pairs have shown the most volatility in 2022:
- AUD/JPY (average volatility – 1.12%);
- AUD/USD (average volatility – 1.07%);
- EUR/AUD (average volatility – 1.07%);
- NZD/JPY (average volatility – 1.05%);
- GBP/AUD (average volatility – 1.05%);
- GBP/NZD (average volatility – 1.05%).
The Least Volatile Currency Pairs
Now let’s look at the least volatile forex pairs. One of the reasons for their low volatility is a positive correlation between two currencies that often leads to less volatility. Let’s take USD/CHF as an example. Both referred to as safe-haven currencies, the US dollar and the Swiss franc tend to move in the same direction against other currencies upon the same market conditions. This is the reason why USD/CHF is one of the least volatile currency pairs. You can see other currency pairs with low volatility below.
- EUR/CHF (average volatility – 0.3%);
- EUR/USD (average volatility – 0.4%);
- AUD/CHF (average volatility – 0.5%);
- EUR/CAD (average volatility – 0.7%).
The Measure of Volatility
As has been noted above, volatility is a measure concerned with a specified time period. Hence, we can talk about daily, weekly, monthly, or annual volatility. A forex pair is considered volatile if it moves up or down by more than 0.7% over a sustained time period.
To calculate the historical volatility of an asset, traders refer to the average true range (ATR) indicator. It is a common indicator you can apply in the MT4/MT5 trading platform. In the example below, you can find a chart with the ATR indicator for the EUR/AUD currency pair.
High Volatility vs. Low Volatility Pairs
There is no ultimate answer to the question of whether one should trade currency pairs with high or low volatility. Most traders are looking to speculate on frequent price moves, thus concentrating on the most active trading hours when the market is volatile. However, there are trading strategies that do not involve relying on frequent price fluctuations. An example of such a strategy is carry trade. Historically, the most suitable currency pairs for this strategy were AUD/JPY and NZD/JPY. Although these FX pairs are rather volatile, carry traders do not follow their daily fluctuations.
Exotic currencies are extremely volatile. However, it’s the last type of asset novice traders should refer to. Despite their extreme volatility, which may be considered an advantage over other currency pairs, exotics have a few significant drawbacks that include low trading volume and larger spreads. Having that said, we conclude that high volatility does not always mean profitable trades.
How to Trade Currency Pair Volatility
There are a few trading approaches that allow speculating on highly volatile securities successfully. The most common of them are day trading, scalping, price action, swing trading, etc. Each of these strategies can be implemented, given the market is volatile.
The primary difference between high and low volatility pairs is that volatile pairs normally gain/lose more pips over a certain time period, thus they are riskier to trade. Moreover, frequent price moves are more likely to result in slippage. Trading pairs with low volatility may sound less risky but is an obstacle in the way to large profits.
Knowing the level of volatility in a currency pair helps traders set reasonable stop-loss and take-profit levels. It is important that they can measure volatility and understand what kind of events may lead to big volatility changes. The two crucial factors that can make a currency pair fluctuate more than usual are:
- Big news occasionally affects the market out of the blue and makes the market extremely volatile. Whether it’s Brexit or a new coronavirus strain outburst, it can’t help but affect the quotes.
- Data releases tend to drive activity in the market and consequently increase volatility. Following up the Weekly calendar can help you predict some volatility bursts. Subscribe to our daily newsletters to stay tuned on important market news.
As a rule, the more volatile an asset is, the riskier it is. However, there is no reward without risk, neither in forex nor in any other market. The most volatile currency pairs are "exotics," although few traders choose to trade them because of their unpredictability and high risks. Less but still volatile are AUD/JPY, AUD/USD, EUR/AUD, NZD/JPY, GBP/AUD, GBP/NZD. The least volatile currency pairs are EUR/CHF, EUR/USD, AUD/CHF, USD/CHF, EUR/CAD, etc. To analyze forex volatility, refer to the average true range (ATR) indicator.
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