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Currency Volatility: What is it & How to Trade It?

Currency volatility is characterized by frequent and rapid changes to exchange rates in the forex market. Understanding forex volatility can help you decide which currencies to trade and how. In this article, we explore what FX volatility is and how to identify it, reveal the high volatility currency pairs to look out for, and disclose the strategies to employ for consistent forex volatility trading.

What is Volatility in Currency Trading?

Volatility in forex trading is a measure of the frequency and extent of changes in a currency’s value. A currency might be described as having high volatility or low volatility depending on how far its value deviates from the average – volatility is a measure of standard deviation. More volatility means more trading risk, but also more opportunity for traders as the price moves are larger.

Below is a chart comparing Bitcoin/US Dollar and New Zealand Dollar/US Dollar, with the orange line for each showing the Average True Range (ATR), a common measure of volatility. As the ATR values for each asset demonstrate, NZD/USD is a stable currency pair, and BTC/USD is much more volatile.

Chart to show volatility of Bitcoin vs NZD/USD

How to Identify Currency Volatility

Currency volatility is difficult to identify and track because volatility is, by its very nature, unpredictable. But there are some methods of measuring volatility that can help traders predict what might happen.

There are also two types of volatility that need to be addressed for an accurate measure – historical volatility and implied volatility. Historical volatility has already happened, and implied volatility is a measure of traders’ expectations for the future (based on the price of futures options).

You can view historical volatility in charts, where you can clearly see spikes and troughs in prices. For implied volatility, traders can use the four CBOE indices that measure the market’s expectations in relation to currency volatility.

Trading High Volatility Currencies vs Stable Currencies

With some of the most volatile currency pairs, traders should expect frequent fluctuations. Major currency pairs tend to be more stable than emerging market currency pairs; the more liquid currency pairs tend to have less volatility. Some of the most volatile currency pairs are:

  • USD/ZAR (United States Dollar/South African Rand)
  • USD/RUB (United States Dollar/Russian Ruble)
  • USD/BRL (United States Dollar/Brazilian Real)
  • USD/TRY (United States Dollar/Turkish Lira).

AUD/JPY Volatility

AUD/JPY is another pair that has historically been considered volatile. The below chart shows the asset’s price movement, again alongside ATR. The circled portion is just one example of where ATR hit new heights as the AUD/JPY rate fell rapidly.

Chart to show AUDJPY volatility and Average True Range

Examples of currencies traditionally seen as having low volatility are:

You might use different indicators when trading high and low volatility currencies. For lower volatility currencies, you can look to use support and resistance levels. These show where the forex market has moved up and pulled back again, so they can be used to trade by helping you predict the market’s movements. You can set your stop loss at a level you are comfortable with to ensure your losses don’t mount up.

This may be more difficult to do with volatile currencies as their price changes can be erratic. These are some of the indicators you can use to trade them:

  • Bollinger Bands: These can be used to indicate if a market is overbought or oversold, increasing the chance of prices beginning to move in the opposite direction
  • Average True Range: This is used as a measure of volatility, and it can be applied to trade exit methods with a trailing stop to limit losses
  • Relative Strength Index: You can use this to measure the magnitude of price changes, again indicating whether a currency has been overbought or oversold so you can decide on your position.

Knowing the Difference Between Volatility and Risk

There are some distinct differences between volatility and risk. Volatility is out of your control, whereas risk is not; with the latter, you can decide exactly how much you are willing and able to manage. However, the relationship between the two is strong. Trading volatile currencies always carries risk because prices could move sharply in any direction, at any time. This large swing can magnify losses as well as gains.

One common pattern that emerges in forex trading involves a degree of herd mentality – traders decide to take a chance on a volatile market, largely influenced by the fact that other traders are taking the same action. In the e