The Impact of Volatility on the Forex Market

It is no secret that the Forex market is one of the most volatile spaces to invest, due to its liquidity of more than 5 trillion dollars a day. However...

The Impact of Volatility on the Forex Market

It is no secret that the Forex market is one of the most volatile spaces to invest, due to its liquidity of more than 5 trillion dollars a day. However, to have volatility in our favor, it is important to highlight that it can be a double-edged sword when trading. As with leverage, if we have huge Forex volatility in an asset and it works in our favor, then the gains can become exponential. However, if the cards play against us, likewise the losses would be huge and we can easily drain our trading account. In this article, we are going to delve into several concepts that need to be taken into account to make proper trading and thus be able to measure the impact of volatility on Forex.

What is asset volatility

The volatility of the markets has to do with the variation of a price with respect to its average, in statistical terms, simply put, volatility is related to the speed at which an asset moves, be it a currency pair, such as a stock, and it is expressed in pips (in the case of Forex) or in percentage. There are indicators such as the CBOE volatility index or the VIX that account for the general picture in which assets are moving. They are measures of appetite or risk aversion in financial markets. But, and what generates this volatility in the financial markets?

Who or what causes volatility in financial markets

There is a mistaken conception of traders regarding the origin of volatility in Trading and that is that it has to do with the broker, when the reality is totally different. In fact, we have had situations such as the decision of negative interest rates of the Swiss National Bank, which brought with it a huge wave of volatility that shook the markets abruptly. This hurt many brokers who did not have this central bank decision planned, and some even declared themselves "insolvent" in a matter of seconds. For example, Alpari or Excel Markets - suffered losses of 20% in seconds.

Therefore, it is important to highlight that trading volatility is generated by the strength of supply and demand that is at the moment, based on the general sentiment of the large investors who move to the Forex market, which is our case at LVM Trade - a broker interprets this volatility in Forex through the charts shown, which are generated by the different liquidity providers to which the broker is subscribed. We aim to always bring the safest and most proficient trading options to our clients.

In the case of ECN brokers, the volatility of the market is determined by the supply and demand generated among the traders that participate through the "electronic communications network" or ECN. Market volatility in Straight Through Process (STP) brokers is similar to that of ECN brokers, with the difference that supply and demand depends on the Bid and Ask prices offered by liquidity providers in the moment the operation is executed. Meanwhile, the market volatility seen in the supply and demand of a broker Market Maker is at the mercy of the last word of the broker operators, who will determine the prices when receiving an order from a client, which it gives rise to a conflict of interest.

The volatility of the forex market does not determine your probability of profit or loss in a certain currency pair. Volatility in Forex is increased because there is a game in play 24 hours a day, 5 days a week, where bears and bulls are actively trying to determine the path of a short, medium or long-term trading instrument.

In conclusion, the volatility of the market determines the range in which we can take advantage of opportunities to trade and it will depend on us and our strategy to make the operation successful or not.

We can benefit from volatility in Forex if we have an operating strategy that is in line with market dynamics, at times when movements are abrupt, and therefore, decisions must be made quickly. For example, it helps a lot to have a robot (or expert advisor) that operates in times of high volatility and we will talk about this later in our next LVM educational post.

Our conclusion:

  • Trading volatility is the speed with which the market moves
  • Not determined or generated by the broker
  • It is a constant supply and demand fight
  • There may be macroeconomic factors that influence Forex volatility
  • You always have to trade volatility in