Volatility - what is it? Option volatility

2024 Author: Henry Conors | [email protected]. Last modified: 2024-02-12 02:55

Becoming a successful trader is not easy, and therefore more than one year of experience is needed to get a stable income from currency speculation. The development of financial markets is an introduction to macroeconomics, the study of technical analysis and work on oneself. However, the most important thing is to create a trading strategy that will not work 100% if the trader does not know how to analyze and use volatility.

What is volatility

When you master trading, you are looking for answers to many questions, among which there is always a basic one: "What is volatility?" It determines the number of points that the price has passed in a certain time. For example, during the day, the EUR/USD quote can rise or fall by 80-100 points - this is the size of its volatility. Being in the market, you should not be surprised by such movements: a change in this currency pair by 140 points is a change in the price of the euro against the dollar by only 1%.

The fluctuation range of the analyzed financial instrument is volatility, the definition of which is important for successful trading. If this indicator is high, then the trader shouldunderstand that the probability of making a profit increases in accordance with the risk. The reverse situation is when there is a flat on the chart, and the volatility is only 5-15 points. In such conditions, it is comfortable for scalpers to work. With medium and high volatility, it is convenient to draw trend lines and make forecasts for the price movement of financial instruments.

What affects volatility

Price volatility changes for several reasons:

• Activity of market participants. Sharp price swings occur when buyers and sellers fight for a deal. Thus, an uptrend or a downtrend is formed, depending on who wins this fight.
• Output of macroeconomic statistics. The economic calendar contains the most important economic events of all developed countries: the release of data on production, the labor market, changes in the interest rate. The difference between real and predicted figures causes a violent reaction from traders, which justifies the increasing volatility.
• Trading session. Most transactions are concluded in the morning when the London Stock Exchange is open - during this period, the maximum volatility of most financial instruments is observed. During the American trading session, traders are less active if there is no macroeconomic news. During the Asian and Pacific sessions, volatility rises on currency pairs in which the Japanese yen, Australian and New Zealand dollars are present.
• The general state of the economy. All countriescooperate with each other, which leads to their influence on each other. For example, when investing in the Australian dollar, you need to consider that it is very susceptible to negative changes in the Chinese economy, since these two countries are close partners. A drought can lead to a fall in the New Zealand dollar, since the economy of this state is based on the sale of agricultural products. Thus, the volatility of the currency is determined by fundamental methods that cover everything: the results of negotiations between heads of state, minutes of meetings of central banks, a crisis in any industry, natural disasters, and more.

Volatility Characteristics

To build a successful trading strategy, it is worth understanding the concept of "volatility" in detail. What is it, what characteristics does it have. First, it is characterized by constancy - most often, volatility does not change over a long period, until a really significant economic event occurs. So, analyzing the calendar of outgoing statistics, we can assume that the price fluctuations of the EUR/USD pair will not change their range until the release of Nonfarm payrolls.

Secondly, volatility is cyclical - sharp fluctuations are replaced by minor price changes, after which again there are sharp jumps due to certain fundamental factors. Thirdly, the volatility of an option or a currency pair often tends towards the mean. For example, if it is typical for the USD/JPY pair to pass 80points, then it will return to this value every time after reaching new extremes.

Volatility value

Understanding volatility - what and how to use it in your trading, a trader can increase his chances of making a profit, as he will be more careful in choosing the entry point into the market. Volatility helps to calculate the level of risk of the planned transaction, since it is necessary to see the approximate boundaries for the current price movement. This gives a clear understanding of where the protective order should be, and where the position will be closed with a profit.

A trader should be aware that the most volatile financial instruments provide more opportunities to earn, however, the risks in such transactions also increase significantly. It is better for beginners to choose “calm” currency pairs in order to learn how to analyze volatility changes, filter out market noise and false signals, after which they can already make their trading tactics more aggressive.

How to calculate volatility yourself

The calculation of volatility is very simple, let's look at an example. An intraday trader needs to know how many pips the price can move in an hour and a day. To do this, he needs to analyze the history of the behavior of the financial instrument in question. To simplify the procedure, he opens the weekly chart and calculates the difference between the High and Low values of the last closed candle. He needs to divide this value by 5 to determine the number of points that the price has overcome in one day. To find the hourly volatility, the value is divided by 120 (524).

If a trader notes this statistic, he will soon be able to see some regularity in volatility changes, determine the standard average range of price movement for the financial instrument used, which will greatly facilitate his work and help improve his trading strategy.

Volatility indicators

Indicators for determining the strength of volatility are standard and are available in the trading terminal. The simplest option is exponential moving averages. The further the line is from the candles, the stronger the volatility of this currency pair. Moving averages compete with Bollinger Bands. This volatility indicator consists of several lines that converge when the indicator is low and diverge when the range of price fluctuations increases.

The third option for calculating volatility is ATR, which uses the price difference (current high and low) to build its image. The larger this number, the greater the volatility. The ATR chart does not illustrate a trend, but an increase or decrease in the rate of price change. Each of these indicators can be customized according to your needs, so that the analyzed data is the most accurate.

Using volatility

To profit from financial markets, it is important to use volatility changes wisely. Its increase increases not only the potentialprofit, but also risks. It is best for beginners to choose currency pairs whose charts do not illustrate sharp jumps that clearly knock inexperienced traders out of the market. To properly use volatility, you need to know the following:

• If there is a flat on the chart, and the range of price fluctuations remains unchanged for a long time, then we should expect that volatility will increase sharply soon. Carefully review the economic calendar to place pending orders in a timely manner.
• The trading system should take into account changes in the behavior of the financial instrument - "Stop loss" should be placed outside the noise zone and taking into account the possible increase in volatility - this will eliminate the likelihood that you will simply be "knocked out" of the market. For example, when trading EUR against USD, carefully choose the level at which a protective order will be placed - in the range of 80 points. If the price during the London or American session rose or fell by a given number of points, then on that day it is no longer worth opening a position. Also remember that the potential profit must be at least 2 times the losses.
• When volatility is high, reduce the volume of opened transactions - do not risk your capital unreasonably.

By adjusting your trading strategy based on the information you receive, you will be able to weed out most of the false signals and find really good market entry points. Asking the question: "Volatility - what is it?", youshould not be satisfied with a mere definition of the term. The ability to analyze and apply it in your trading is the key to increasing income from working in financial markets.