What is Market Volatility and Why You Need to Consider it in Your Trading

Market volatility can sometimes be too much for traders to handle but while some prefer to stay clear of choppy waters, others will say that a smooth sea never made a good sailor.

Market volatility in forex, if played right, can lead to an incredibly satisfying way of trading.

So, while some will toss around the term ‘volatility’ without fully understanding it, we highly recommend you dig into the subject as it will certainly give you a better understanding of the market and, in the process, make you a better trader.

So, how exactly does one handle market volatility?

The first important thing to understand here is that volatility, uncertainty, risk, and fluctuations are 100% intrinsic elements when it comes to trading the markets as they need to operate in an efficient manner.

The second point to make is that some currencies are incredibly more volatile than others during a period in which volatility is increasing.

What causes volatility in the forex market?

In essence, it comes down to the 4 elements. The main perpetrators are:

1. Monetary policies

All around the world, central banks play a crucial role in managing the money flow.

Central banks can regulate the amount of money that is in circulation through interest rate levels.

Accordingly, regardless of their source (European Central Bank, the US Federal Reserve, Bank of Japan, Bank of England, and so forth…), forex traders will always keep an eye out for central bank decisions and policies.

2. Geopolitical factors

As you’ve probably seen in your news feed, there are many ongoing conflicts across the globe that, to no one’s surprise, play a role in what concerns volatility in the markets.

Whether its war, riots, or other denominations of civil unrest, these events will cause volatility as they heighten uncertainty and, by extension, affect another major element of trading: the trader and market sentiment.

3. Traders and market sentiment

Every market move is driven by whoever is behind it.

As such, both volatility and the market fluctuations that it causes can also be seen as a “fight” to determine if the prevailing sentiment is either positive or negative.

If traders and investors are the ones making the market move, in times of uncertainty, you’ll certainly be met with choppiness in your trading sessions.

4. Trade wars

Trade wars are known to spur volatility given the transactions they involve.

This correlation to inflation is incredibly straightforward as the currencies which get pulled into a trade war are bound to be affected.

As you can see all these 4 elements are deeply intertwined so to embrace volatility is to embrace a somewhat holistic view of the market where all elements are moving parts and influence one another.

How to handle market volatility in forex?

A good place, to begin with, is to look out for the most volatile currency pairs and to see how they move and what causes such behavior.

Here are 2 simple examples:

1. AUD/JPY:

Usually seen as a risk barometer, this currency pair’s volatility Volatility In terms of trading, volatility refers to the amount of change in the rate of an index or asset, such as forex, commodities, stocks, over a given time period. Trading volatility can be a means of describing an instrument’s fluctuation. For example, a highly volatile stock equates to large fluctuations in price, whereas a low volatile stock equates to tepid fluctuations in price. Overall, volatility is an important statistical indicator used by many parties, including financial traders, analysts, In terms of trading, volatility refers to the amount of change in the rate of an index or asset, such as forex, commodities, stocks, over a given time period. Trading volatility can be a means of describing an instrument’s fluctuation. For example, a highly volatile stock equates to large fluctuations in price, whereas a low volatile stock equates to tepid fluctuations in price. Overall, volatility is an important statistical indicator used by many parties, including financial traders, analysts, Read this Term usually is seen by this rule of thumb: it tends to rise when traders feel optimistic and seek risk. Inversely, it will fall as more traders become risk-averse. This happens as the JPY is seen as a safe haven, whereas the AUD is considered by many to be a risk-on currency (it sees demand as risk appetite Risk Appetite Risk appetite is a term used by investors in financial markets, describing the behavior by traders to actively seek out exposure to uncertainty or risk with the hope of higher payoffs. The term contrasts with risk aversion, which is defined as a trader's preference to limit their exposure to uncertainty or risk. Risk appetite is a very trait of investors especially in times of prosperity, who seek to flock towards investments with an unknown payoff or outcome. These traders will opt for less sa Risk appetite is a term used by investors in financial markets, describing the behavior by traders to actively seek out exposure to uncertainty or risk with the hope of higher payoffs. The term contrasts with risk aversion, which is defined as a trader's preference to limit their exposure to uncertainty or risk. Risk appetite is a very trait of investors especially in times of prosperity, who seek to flock towards investments with an unknown payoff or outcome. These traders will opt for less sa Read this Term increases).

2. GBP/CAD

Much like the AUD, the CAD is also seen as a risk-on currency that draws its movements from the influence of the oil price. Accordingly, as oil prices fall, the CAD usually sees pressure. As for the GBP, it is considered by many to be the most volatile currency among the major ones.

Following a careful study of the currency pair of your choice and its behavior, you should devise a plan to use volatility to your advantage and harness it in your trading.

Accordingly, to anticipate volatility, you should keep a very close eye on the economic calendar and become fully aware of any potential major economic event or important decision which might be able to move the markets.

Moreover, we cannot stress this enough: use stop loss orders. If you’re up against volatility it would be unwise to not give yourself the extra layer of protection.

Another point to consider in terms of risk management is limiting your leverage as it is known to be a double-edged sword, meaning it will enhance both your wins and your losses.

Lastly, technical analysis will always be a trader’s best friend when it comes to navigating volatility so you should at least be familiar with the concept of Bollinger Bands and the Average True Range.

Wrapping up: Market volatility in the forex market

Much like stock market volatility, in what concerns the forex market many traders will prefer to wait it out.

But sitting on the sidelines isn’t always the best course of action and it is certainly possible to take advantage of volatile markets and price movements that surround major events, thus leading to elegant and sophisticated new ways of approaching the trading market.

So, have you begun trading volatile markets yet?