How to Use Market Volatility in Your Favour When Trading FX
Education - AxiTrader Team | 15 Feb 2019
Warren Buffett was once quoted as saying: “Look at market fluctuations (volatility) as your friend rather than your enemy.”
While he was talking about markets in general, Buffett who is also known as the Sage of Omaha, could well be talking about volatility in the forex markets.
Volatility (market fluctuations) can indeed be your friend when trading the global forex market. But you have to know how to harness it and make it work in your favour.
But what is volatility?
In simple terms volatility refers to the price fluctuations of assets. It measures the difference between the opening and closing prices over a certain period of time.
For example, a currency pair that is fluctuating between 5-10 pips is less volatile than an FX pair that fluctuates between 50-100 pips.
If you look closely you can see that some currencies and currency pairs are more volatile than others. You must have heard of the term ‘safe haven’ which refers to some currencies like the Japanese Yen, the Swiss Franc and the US dollar (to a certain degree).
On the other hand, emerging market currencies such as the Turkish Lira, Mexican Peso, Indian Rupee and Thai Baht are considered more volatile than the safe haven currencies.
So, depending on your trading style, strategy and trading preferences, you can always find a currency pair that will suit your trading technique.
Why is volatility important in the markets?
Quoting Warren Buffett again, he said: “All time is uncertain. It was uncertain back in 2007, we just didn't know it was uncertain.”
The fact is uncertainty, volatility, fluctuations or whatever you call the range of price movement – they are all intrinsic parts of trading the markets.
No volatility means there are no price movements. And without price movement it will be impossible to have any trading activity.
The thing to keep in mind is that a certain level of volatility is needed for markets to operate efficiently. The challenge for traders though is when volatility becomes too high.
As an FX trader, you need to be aware of which currencies are more volatile than others and when volatility is rising.
What causes volatility?
Given the nature of the current global markets – interconnected trades, seamless flow of information and communication and the prevalence of social media and digital technology – market pundits agree that market volatility is very much in every trader’s mind these days more than in any other period of time.
And why not? Let’s look at some of the factors that cause volatility that can affect your FX trading.
- Geopolitical factors – Wars (military invasion), uprisings, riots and other forms of civil unrest count as one of the major causes of volatility. This is because while a certain level of volatility is needed in the markets, a prolonged and high level of uncertainty (in case of wars and uprisings) is not good for traders’ sentiment and the market in general.
- Trade wars – Whether it’s the US vs China, US vs Europe or any other region or country, trade wars can also spur volatility in the markets due to the billions or trillions of transactions involved. One way or another, the currencies involved in any trade war will be affected at some stage.
- Monetary policies – Central banks across the globe play an important role in managing the flow of money. They can regulate the amount of money in circulation via interest rate levels. It’s no wonder that every FX trader is keeping an eye on central bank decisions – whether it is the US Federal Reserve, the European Central Bank (ECB), Bank of England (BoE), Bank of Japan (BoJ), Bank of Canada (BoC) or the Australian Reserve Bank (ARB).
- Trader/Market sentiment – It is a fact that market movements are driven by the people behind them. Traders and investors around the world make markets move. And depending on the prevailing sentiment – positive or negative – market volatility can fluctuate.
Knowing the inherent nature of volatility and the factors behind it, how can you use it in your favour? How can you harness volatility in your FX trading?
If you heed Warren Buffett’s word and look at market volatility as your friend rather than an enemy, there must be ways to make it work for you and your trading success.
Here are a few possible ways to use volatility in your favour:
- Use stop loss orders – if you set a stop loss level for every FX trade you take, you are giving yourself an extra protection for any market volatility.
- Monitor the economic calendar – if you know the major economic events and decisions that can possibly move the markets, you will be in a better position to anticipate volatility, at least to a certain extent. Remember that volatility is part and parcel of the markets, the challenge for you as a trader is how you react to that volatility when it comes. Some traders prefer to stay on the sidelines when there are high-impact events that may push volatility higher. But there are also some traders who want to take advantage of the price movements around those major events. No matter what is your preference, it pays to monitor and keep track of key events that can impact your trading.
- Limit your leverage – you must be aware by now that leverage can be a double-edged sword. It can magnify your wins as well as your losses. By limiting the amount of leverage you use for your FX trades, you are already putting some risk management in place.
In conclusion, knowing that volatility is what makes trading the global markets possible, it is in your best interest to use and harness it in your favour. Knowing the factors behind them and how you can use them to your trading gives you an edge as an FX trader.
The information provided here has been produced by third parties and does not reflect the opinion of AxiTrader. AxiTrader has reproduced the information without alteration or verification and does not represent that this material is accurate, current, or complete and it should not be relied upon as such. The Information is not to be construed as a recommendation; or an offer to buy or sell; or the solicitation of an offer to buy or sell any security, financial product, or instrument; or to participate in any trading strategy. Readers should seek their own advice. Reproduction or redistribution of this information is not permitted.
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