Understanding volatility

Volatility

Currency volatility refers to the constantly changing exchange rates between different currency pairs. These changes allow for currencies to be exchanged at different prices, resulting in profits or losses for the trader.

While inherently unpredictable, volatility is influenced by everything from inflation levels and interest rates to tourism and geopolitical stability to a country’s balance of payments and monetary policy.

Leveraging Volatility

Volatility allows a trader to purchase one currency and sell it a week later for more money given the differing exchange rate. Higher volatility increases the “spread” available to trade on. For example, a volatility rating of 10 on the DailyFX Volatility Index means exchange rates are expected to remain relatively stable while a rating of 30 means the rates will likely fluctuate wildly.

Predicting Volatilty

The key to profiting from FX trading is correctly predicting changes in exchange rates. Many of these changes are event-driven and can be traced to political elections, wars, commodity price changes, release of new economic data, changing alliances, increases in tourism, or the signing of new trade deals. FX traders must stay on top of events around the globe in order to predict these changes and trade the currencies related to the outcome.

For example, the Russian Ruble lost over 50% of it’s value compared with the dollar in early 2014 following volatility from political and economic upheaval. Sanctions over the Ukraine crisis, a crash in the price of oil, decreased tourism to Russia, and an exodus of international corporations preceded the Ruble’s collapse. FX traders who predicted these events and trends would have known to convert their Rubles to Dollars to preserve their value.

As an FX trader, it is your job to predict the next global event or trend to increase volatility, whether it’s the outcome of an election, the collapse of an alliance or trade deal, or simply domestic economic hardship. Pick the right outcome and currency and the resulting volatility can see your money potentially multiply!

Read on to learn the basics of analysing trading charts.