In Trading UK, volatility refers to the statistical degree of variation of a traded currency pair over a specified period of time, usually measured in the form of standard deviation. So if…
HEY STOP! I thought you said this would be easy…
Uh, right. Let’s try this again… Start by having a look at this image:
In essence, volatility measures the movement of an exchange rate over a period of time. From a practical perspective, it is the amount of uncertainty or risk associated with fluctuations in the exchange rates. In general, most traders agree that the higher the volatility of a market, the greater the uncertainty.
So… high volatility is bad…?
Not necessarily. Higher volatility can mean that there are more potential short-term gains to be made by trading. Day traders are often attracted to volatile markets, where they attempt to profit by identifying short term trends. Volatile markets can actually be a lot of fun to trade.
On the other hand, high volatility means greater uncertainty, and traders do take on greater risk when trading volatile currencies.
When trading in a volatile markets, there are a couple of rules of thumb to help you limit your risk. First, by decreasing the amount of leverage used when trading, you can reduce potential loss should the trade suddenly take a turn in an undesired direction. Second, by studying recent data, you can attempt to identify volatile markets where there are clear up and down trends. Third, by limiting your trade to, for example, 10% of your balance, any losses due to volatility will not make too much of a dent in your trading account.