What is Volatility in Trading?

Volatility in trading is the degree of how high and low the price of a pair goes, moves or fluctuates in the market within a period.

Put simply, volatility is a measure of how quickly and dramatically an instrument’s price changes.

Let’s look at why understanding volatility is important, the spectrum of volatility, types, events that trigger it, some of the most volatile assets or pairs, and productive trading strategies:

Why is it necessary to understand volatility

Price movement is the core of trading. Without price difference(s), there is no opportunity to buy low and sell high, or vice versa. Volatility creates these opportunities.

Volatility can be profitable; it can also be loss-making. Thus, it is vital to assess market atmosphere and act accordingly.

Levels of volatility

Volatility can be high (huge/rapid price changes) or low/stable (little or slow fluctuations). High market swings is very risky but can be very profitable for skilled short-term traders. Low fluctuations, on the other hand, has minimal risk and offers less lucrative prospects.

Types

Historical: This shows you how much an asset has moved in the past. It measures how much price has departed from its average level over a particular period in the past.

Implied: Commonly used for options trading, this tool assesses future fluctuations based on market expectations.

Elements that influence volatility

Economic reports: Important economic data like non-farm payrolls, interest rate decisions, GDP releases etc. can trigger sharp or unexpected market moves.

Supply & demand: A severe imbalance between buyers and sellers can also affect volatility.

Geographical problems: Political instability or international conflicts such as trade disputes & wars can have the same impact, especially on currencies.

Market sentiment: Price fluctuations can be influenced by investor’s attitude (herd behaviour) towards target instrument.

Liquidity: In a situation where an asset has a small number of sellers and buyers, a little trade can have an unbalanced result on price values.

Some of the most fluctuating instruments/asset classes

Crypto: Cryptocurrencies are one of the most volatile assets due to their unregulated nature, speculative interest, rapid adoption and “rejection” cycles.

Forex: Exotic pairs like US dollar/Turkish lira, USD/MXN, USD/ZAR and currencies from emerging markets are mostly more volatile.

Commodities: Gold, crude oil prices are also very volatile.

Effective speculative technique(s)

Not all trading methods are functional in volatile markets. Speculation here requires suitable systems and a solid risk management plan.

For rapid price movements, short term strategies like day trading or scalping are the most ideal.

These approaches aim to take advantage of the frequent swings and require quick execution.

Also, trading breakouts can be efficient too.

FAQs

How can I manage risk during volatile market conditions?
It is recommended you use stop loss orders, reduce position size, and follow a clear risk management plan. And to be on the safe side, you should avoid trading news (if you’re not well equipped).

What are the best indicators to track market volatility?
Average True Range, Bollinger Bands, and the Volatility Index are some of the popular tools.

How does volatility affect prop firm trading rules?
High volatility can make you violate/breach your drawdown limits fast. You must be cautious and adapt your strategies to meet firm requirements.

Can volatility be predicted?
Yes, but not with absolute certainty. Economic calendars and some forex indicators can guide you in the right direction.

Is it better to avoid trading during volatile periods?
For beginners, yes.