How to Measure Forex Volatility

When the world descends into chaos the foreign currency markets become more volatile. Knowing how to measure Forex volatility is useful in that it gives the trader insight into the currency pair or pairs he is trading. Knowing how to measure Forex volatility goes hand in hand with basic technical analysis of market sentiment is seen in price patterns. Forex volatility can be measured in pips or as a percent. It is simply the difference between the high and the low price of one currency in relation to another. It can be stated for a day, week, month or any time frame. Pips are the smallest unit change by which a currency can be quoted. For pairs including the US dollar a pip is $0.0001 or a hundredth of a cent. When the price of the dollar versus the Euro varies by half a cent in a day the volatility is 50 pips. Measured in percent it is 0.5%. More statistically based measures use the standard deviation and more complicated measures. How to measure Forex volatility for the less mathematically inclined is to stick with pips and percents. There are charts available on the internet that will do the more serious mathematical calculations for you. In learning how to trade Forex a trader will want a basic sense of how volatile the market is and what that means for profit versus risk.

Many Forex technical strategies relate to market volatility. If a currency pair is trading in high volume technical analysis tools typically work better as they are based on statistics. During times of market upheaval, such as we are now seeing due to the unrest across North Africa and the Middle East, traders look to profit from anticipating price direction. When volatility is high many will rely upon buying options, puts and calls, because the buyer of an option only risks the price of the option, the premium. Even though his risk is low due to buying options the trader will have the right, but no obligation, to purchase or sell one currency with the other and profit should the price move as anticipated. Today many currencies are under stress due to the risk of a large upward movement in the price of oil. Typically this means that traders will move to the dollar as a safe haven currency. However, the US views inflation as more of a risk than unemployment at this point and is keeping interest rates low. If the EU or Great Britain, for example, raise their rates traders will move money into the currency with the higher rate, driving up the value of that currency and driving the dollar down. Traders will often buy futures on the Euro or dollar or options in anticipation of changes in monetary policy and continuing volatility. How to measure Forex volatility in these times is a useful skill as it can allow the trader to formulate and execute a successful Forex trading strategy no matter where the markets are going as it helps him decide on strategy, such as direct trading versus options and upon which currency pairs to trade.