In the Forex market, volatility has two sides; on one hand, it can help traders maximize their profits through short-term trades; on the other hand, when volatility rises, it makes the market uncertain and unstable.
When traders are relying on market trends to make trades, they don’t want an increase in volatility, as that would move the price position. Therefore, this article will thoroughly discuss all the aspects of Forex market volatilty and its impacts on traders.
What is Forex Trading?
Forex trading is when a trader buys a currency and sells a different one, and the exchange range fluctuates according to the demand and supply. The trade for currencies takes place in the foreign exchange market that is open from Monday to Friday.
The Foreign exchange market is open 24 hours a day. All currencies are traded over the counter (OTC), which means there are no physical exchanges, and a worldwide network of financial institutions and banks oversee the operations. As a result, the vast majority of trading in the market is between institutional traders.
Indicators of Volatility in the Forex Market
If traders want to take advantage of market volatility, then they should study indicators. We have discussed some popular indicators below:
Bollinger Bands
Bollinger Bands is a type of measurement and contains two standard deviations:
- About 95 % above
- Below the moving average of twenty days
When distance of the two bands widens, it shows that the volatility for a certain currency has increased in the market. When the distance is smaller between the two bands, there is low volatility in the market.
Bollinger Bangers can help traders assess the market volatility and use candle’s proximity for one of the two bands. When a candle is touching the Bollinger Banger, or near it, there is a strong chance of retracement.
Average True Range (ATR)
ATR uses 3 types of calculations. To find out the ATR value, you will need to:
- Subtract low of the current day from high of the current day
- Then you will need to subtract the close of the previous day from the high of the current day
- Lastly, subtract the low of the current day from the close of the previous day
When you do these calculations, you will end up with three values. The biggest of the three values will be considered the ATR for a currency pairing. The larger the ATR value, the bigger the volatility of the currency pairing in the Forex market.
However, while traders use the ATR, it is not perfect and has its flaws. The ATR value cannot determine the potential path of a price movement and can only speculate the move. ATR is also considered an indicator that lags, as it is not quick to identify trading opportunities.
Keltner Channel
The Keltner Channel assesses the price movements of a currency pairing and is relative to upwards and downwards movements. Thus, Keltner Channel is similar to Bollinger Bangers, but you need a different approach when using this indicator to assess the market volatility.
Bollinger Banger represents a pair of standard deviations above the moving average of twenty days, the Keltner Channel is narrower, and the range is determined by drawing a band that is twice the size of ATR on both sides of the EMA (exponential moving average).
Traders should look for price trends that either break above Keltner Channel or below it.
Parabolic Stop and Reverse (PSAR)
A PSAR is a type of pattern that creates a ‘parabolic’ curve on the Forex market chart. The dots of the curve appear either above the trend of the price or below it. Traders can identify these dots and take advantage of the trading opportunities they present.
If the dots move above the price trend, the trading activity is moving upwards, whereas when the dots move below the price trend, it means a shift is taking place. Thus, this indicator helps traders make sense of market volatility.
Liquidity and Volatility in the Forex Market
Volatility depends on several factors, and liquidity is one of those factors. In other words, volatility is a broad concept, and in the Forex market, a currency’s volatility depends on what the sellers and buyers offer in exchange.
On the other hand, liquidity is considered a driver, as it keeps a difference between the asking and the bidding price. However, its liquidity cannot bring down the volatility of a currency, but a lack of liquidity will decrease the volatility in the market.
How to Choose the Best Forex Trading Strategy?
There isn’t a permanent winning formula; there are several key factors that need to be considered. Some strategies will do wonders for traders, while others won’t. Traders should be comfortable with the strategies they design, and they should be sustainable.
The Risks of Forex Trading
Forex traders require leverage, and traders will also use margin, so there are risks involved. Currency prices fluctuate but not by a huge margin, so traders often need leverage to execute a trade. If the trader makes a winning bet, the leverage can help maximize the profits.
However, the leverage can also increase the losses. If the value of a specific currency falls significantly, traders that rely on leverage open themselves up to margin calls, which can force them to sell off their securities. Other than losses, transaction costs can also reduce the profit.
Forex Trading Frequently Asked Questions (FAQ)
- Who owns Forex, and where is it located?
Forex does not have a particular owner; it is an interbank market, which means transactions occur between a seller and a buyer. Therefore, as long as the current banking system exists, Forex will exist as a specific government or country that does not run it.
- Working Hours of Forex?
Forex opens at 22:00 GMT on Sunday (Australian trading session opens) and closes on Friday 22:00 GMT (US trading session closes)
- How Much Money is Needed to Start Forex?
Some traders start trading with just a dollar; however, the starting amount varies from 100 to 100,000 dollars.
- Best Strategy for Forex?
No one strategy is better than the other one; traders must develop new strategies all the time. Some Forex strategies are only beneficial in the short term.
- Can I Lose more than What I Invest in Forex?
Not really; the broker will not let the trader face huge losses and will not allow the loss to be greater than the amount in the trading account.
Conclusion
This article discussed what volatility is and how traders can use volatility indicators to cash in on trade opportunities. We also shed light on the difference between liquidity and volatility. Volatility is an important concept, so if you are trading in Forex or planning to trade, make sure you are well aware of all the market aspects.