If you are an old player in the currency trading market then it won’t be a wonder that this market is highly volatile. The main reason behind this is that the Forex market gets highly influenced by supply and demand and other economic factors. This volatile trait of the currency market makes it more liquid and enables its participants in more trading opportunities. Traders enjoy the facility of trading with minimalistic investment and since all works are done online, many non-professional traders often try out their lucks to win some good deals in this market.
What is the first thing that comes to your mind when you hear about volatility? It must be the occurrence of changes. Well, it’s practically the same in trading too. Here volatility is used to denote the changes in price movement that takes place in a certain period. This period can be a single minute, day, weeks, or even months. Based on the types of traders, it is essential to choose what type of volatility you want to work with. If you are an HFT trader, then you have to keep records of the changes that take place in fractions of a second. On the other hand, in day trading, a trader doesn’t need to monitor the volatility much as trading begins and closes on the same day.
But, why is it important to measure volatility? Well, it plays an important role to build a developed portfolio for the traders. So, if you are a serious trader, you should be able to measure the volatility in Forex.
Types of volatility
Surprising right? We know. Many of you might not be aware but volatility can be divided into two types.
The first one is historical volatility where the changes already took place in the past. The second one is referred to as implied volatility where traders speculate how the market may look like shortly. To get a better explanation, you can ask the professional traders who are involved in futures trading for more than 3 years. They always study the historic price movement as it helps them to get the best price while taking the trades.
Now you may ask what the use of historical volatility is when it already happened in the past. Good for you that we have the answer. Historical volatility is important to understand the market clearly. A market with higher volatility means investors are attracted to invest in that market. When the volatility remains the same for days, it shows that the supply and demand are pretty constant and at any time the trend may break out. That’s why understanding the historical volatility helps traders to know about the implied volatility. While we are at it, the importance of implied volatility is not lessened. It helps you to find out potential entry points for the traders to invest their money in a trade. These types of volatilities show the changes in the movement of currency pairs in a price chart.
To measure volatility, we need to consider the Bollinger bands indicator where the movement of a 2 standard deviation band is shown above and below twenty days. You can change the defaults in standard deviation bands according to your preference and distribution.
There are two levels in Bollinger bands; the high and the low. The implied volatility can be considered moving upward when it hits the Bollinger band high and considered lower when it hits the Bollinger band low. The higher the Bollinger band is, the richer the implied volatility. And, the lower the Bollinger band, the cheaper is the implied velocity. Analyzing these traits helps traders to come up with strategies based on volatility.
When you are trading, you must measure the implied volatility because it not only helps one to predict the market but also helps t6o evaluate your futures, options, and securities. In many cases, implied volatility is the speculation of how much the market might move. Nonetheless, this is highly important if you plan to look for more serious opportunities in trading.