When trading currencies or any other kind of asset, you often run into the term volatility. Volatility is one of the core terms in trading because it is a severe factor in choosing the asset to trade in the first place.
What is volatility
“Volatility is the degree of variation of a trading price series over time, as measured by the standard deviation of logarithmic returns” (sourced by Wikipedia). Simply put, volatility represents the tendency of changing the price of a given asset. It shows if the price is changing rapidly, frequently, and significantly, or not.
Volatility is a complex indicator calculated using variance and standard deviation. However, as a trader, you don’t necessarily need to calculate the volatility of each asset before you start trading it.
Volatility in trading
In general, volatility in trading is used to evaluate the risks of each particular currency or asset that a trader is about to invest in. If the currency tends big swings in its rate, that means the currency has high volatility. The bigger are the swings in any direction, the higher is the volatility.
Most of the currencies in the Forex Exotic segment are put there because of their high volatility. They tend to be quite unstable and experience a severe price swing. The same goes for oil trading: the oil market is known to be very volatile and is used to big daily moves both sides. That's why BRENT and WTI require a slightly different approach in trading – read more about it in the article “How to be successful on the oil market”.
Historical volatility and Implied volatility
Implied volatility is more about the future. As it is seen from the name of it, it helps traders to predict how volatile will be the market in some nearby future. However, the implied volatility is not an accurately calculated measure and should be interpreted no more than as an approximate forecast.
Historical volatility or statistical volatility, on the other hand, is based on the previous data and assets’ swings over a particular period. This one, unlike the implied volatility, is more reliable. If the historical volatility is going up, it means the asset is more active than it usually is. Vice versa, if the historical volatility is eliminating, the asset is going back to its stable level.
High volatility: good or bad?
High volatility attracts investors because of its potential big profit. Since the profit from trading a currency pair lies in the difference between the buy and sell price, it's logical to assume that the bigger the gap, the bigger the profit. When opened and closed at the right time, the highly volatile currency pair order can be really profitable – read about TOP 3 currency pairs that could’ve made you rich.
However, remember – high volatility also bears higher risks! Be extremely cautious when investing in highly volatile assets, and always use the risk management instruments to avoid the losses you can't afford.