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Prior to understanding why market volatility might be here to stay for the foreseeable future, the concept must be defined and understood on a basic level. When it comes to the forex trading market, volatility is the measurement of the frequency and extent of the positive and negative changes and swings in a particular currency’s value.
For example, if the Australian Dollar deviated from its average quite frequently and the deviations were substantial, it would be known to be a highly volatile currency. On the contrary if the Japanese Yen’s deviations from average were quite minimal and very rare – the currency would be known to have low volatility.
Volatility in the Forex market might not be all so bad, the more volatile the currency, the easier for traders to make big gains as price moves are likely to be larger. However, at the same time, such volatility can hold trading risk.
Difference between Volatility and Risk
Many forex traders make the mistake and join the concepts of volatility and risk at the hip. When in reality, they are different, and understand that much can take a trader a long way to being successful in the currency market game.
Market volatility, currency fluctuations, price gains and losses are all elements of Forex Trading that traders cannot control. However, risk is within a traders control. An individual can choose how much to invest, how much risk to expose themselves to and whether they are able to manage risk in general.
It is accurate that trading volatile currencies carries a large amount of risk, but traders need to be aware that it is ultimately up to them how much of their investment portfolio is made up of volatile currencies, and as a consequence the amount of risk they deal with.
Dealing with Volatility
When it comes to responding to volatility, many will say there is no one size fits all methodology. One of the more important mindsets to adopt is the ability to mould the volatility to your trading strategy and your current ‘life stage of investing.’
Those in their twilight years, will most likely be risk averse, and would prefer to trade with currencies that offer lower volatility, as opposed to those who are younger and a hungrier for a bit more ‘bang for buck.’
As COVID-19 continues to bring uncertainty on a global scale, many countries are struggling to keep up with the health requirements and the dire economic outlook. This uncertainty brings the understanding that market volatility is here to stay as covered by CNN.
Historical Volatility v Implied Volatility
One of the ways to understand volatility in a more wholistic manner, is by understanding the difference between historical volatility and implied volatility.
Implied volatility is when a trader is able to look at options presented to them and ascertain what the implications of those options are. This does not employ historical charts or information, and is majorly based on the ability of the option provided to succeed in the future market.
Historical volatility measures and determines the price fluctuations of a currency over time, and ascertains where a currency is tracking based on its past performance.
During these tumultuous times, its evident that market volatility is prevalent and will be an important facet of the trading markets in the short term. It is up to the trader to ascertain how much risk they are able to manage and have the foresight to use fluctuations to their advantage as opposed to conceding major losses on investments.
Disclaimer: Currency trading is a leveraged product which means that with an eligible FX broker you can amplify your deposit up to 500 times. This leverage means there is a real possibility of losing your money so it’s important to understand the risks involved and consider options such a practice account. For more information view the South African section of CompareForexBrokers.