What is volatility and how to use it in trading
Exchange rate volatility is the dynamics of price changes over a fixed period. If during the same time the price change in comparison with the same previous period has increased, then the volatility of the exchange rate has increased. In other words, volatility is the average range of price movement between its highs and lows over a fixed period. For example, if the oil price fluctuated between $ 48 and $ 49 yesterday within 24 hours, then this could be called slight volatility. If today in 24 hours the price changed in the range of $ 45 and $ 55, then the volatility has increased.
Volatility of the exchange rate and its properties
Rate volatility properties:
- Consistency. Most of the time, the course moves in the range of its mean. If the average daily volatility is 50 pips, this range is likely to continue the next day. In other words, the probability that the trend will move in one direction or the other for more than 50 points is small.
- Cyclicity. The wave theory is built on it. It is believed that the price, having reached one of its extremes, will turn towards the other. Thus, a channel will be formed, the boundaries of which are easier to predict than the chaotic price movement within it.
- The tendency of the price to the average value. This property is used to build channel “bounce” strategies with setting targets in the middle of the channel. The volatility of the rate allows you to build a range by determining the level of stops outside of it.
An example of manual volatility calculation. You need to calculate volatility on a daily chart for 10 days:
- We calculate the daily volatility range for each candle. On the daily timeframe, there are 10. For each candlestick, subtract the minimum from the maximum (D = High – Low).
- We calculate the average daily volatility range – the arithmetic mean. D (cf.) = (D1 + D2 +… + D10) / 10.
For the development of trading systems, exchange rate volatility is of fundamental importance. That is, strategies are practically not built on it directly, but ignoring its presence would be an unforgivable mistake. It could be compared to stormy weather: when everything is calm at sea, all people are in the water. But as soon as the stormy wind rises, the strategy of the majority changes radically. Someone immediately runs after a surfboard in order to catch a high wave and get maximum pleasure, while someone hides in a tent. Volatility is the same. Someone seizes the moment and makes money on the fast moment of price changes in a narrow time range, while someone is afraid of breaking stops and leaves the market altogether.
Tools for calculating rate volatility:
- Indicators… There are several main ones. The simplest and most famous of them is ATR, which is one of the basic all trading platforms. The second option is the Chaikin indicator. There are also modifications of indicators that allow you to measure the ratio of volatilities of different periods, etc.
- Calculators… For example, on the Investing website.
Volatility indicators do not show the direction of the price or the strength of the trend; they cannot be used to determine divergence. They serve rather for placing stops, take-profits, pending orders, as well as assessing the “windy weather”. In manual strategies, they are used only by scalpers and “fundamentalists”, but almost everyone has indicators of rate volatility in trading advisors in the risk management block.
Exchange rate volatility information can be used in different ways. For example, if the average daily volatility according to the calculator is 90 points, and at the current moment the indicator shows 40 points (less than 50%), most likely the market is flat. The figure of 50% is arbitrary, but statistics say that half of the range is most often taken abroad. Another option is to place orders. It is unlikely that the price will go beyond the average daily volatility.
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