Does forex trading favor volatility?
When we think of volatility, we usually associate it with unpredictability and confusion. Indeed, the word inherently carries this negative connotation. However, in forex trading, volatility can actually be a good thing. If all markets suddenly flat-lined on the chart, everybody would stop trading. Putting it simply, it’s pointless to trade when the price isn’t moving as there isn’t any opportunity for profit. Consequently, the more a market moves, the higher the profit potential but your risk exposure rises as well.
From the above statement, we can infer that the most popular or liquid instruments are the more volatile ones but that isn’t exactly the case. Even though liquidity does play its part in how volatile or not a market can be – it’s not the sole factor that drives the rates. While it’s true that higher liquidity translates to lower volatility, the markets are also quite vulnerable to financial, political, cultural news and events. Keeping track of these events can help traders identify better opportunities for profit in online trading.
The highly liquid currency pairs like the EUR/USD and GBP/USD are inherently less volatile than the so-called exotic ones, for example, but they too can sometimes be susceptible to bouts of volatility under certain conditions. However, even if volatility presents opportunities for traders, you should note that it also enhances risk which can negatively affect any forex trading activity.
During high-impact events, trading forex becomes a dangerous endeavor due to price gaps, thin liquidity, increased margin requirements, widening spreads and also the fact that technical indicators can go haywire giving out false signals. This is especially true when an announcement or event takes place during the weekend or at the end of a trading session – a time where access to the market is limited. When traders log back into their account again, they will find that the market made considerable movements when they were away and there is a big gap in pricing.
Therefore, if you’re trading forex and sometimes keep positions open over different trading sessions, it’s important to consider how the market will behave during this time. In fact, many traders developed their strategy around anticipating these weekend price gaps.
In general, hunting big price swings or movements to maximize short-term profits is quite a viable strategy and there are several tools that you can incorporate in your trading arsenal to help you find them. These, of course, are mostly the technical indicators that can identify breakouts and reversals like the RSI oscillator, Bollinger Bands and Moving Average Convergence/Divergence (MACD).
However, keeping up with the news is the most surefire way of identifying when a currency pair or other financial instrument is going to start behaving erratically. Taking note of all the economic indicators that drive a country’s economy and by association, its currency rates are called fundamental analysis. Politics and financial institution announcements regarding monetary policies and economic developments are critical for any strategy that focuses on the fundamentals.
Admittedly, there is an overwhelming amount of news to consider so rather than sift through hundreds of news articles and forums for tips, you can just use a live economic calendar that focuses on forex trading. An economic calendar acts as your personal market analyst. It filters out all the redundant information and categorizes news and events by their impact on the market. With just a quick glance, you can know exactly when the event will take place and how impactful it may be, and you can act accordingly.
If you are looking for inherently volatile markets, you should start looking into emerging economies and their local currencies including the South African Rand, South Korean Won and the Brazilian Real. These markets are highly affected by financial news and can swing wildly in either direction with no warning. However, if you think forex trading is just about finding the fast-moving markets and riding the trend – you need to reconsider. Erratic price movements can easily risk your invested capital and move way past your stop-loss orders. Thin liquidity also means that you will probably have a hard time closing out your positions at the specified price range and coupled with imprudent use of leverage, you are liable to risk much more than your invested capital.
The more risk-averse investors would likely aim to avoid trading completely due to the unpredictable nature of the market during these volatile periods. As long as your account is well-capitalized, and you follow a good risk management strategy to protect your investment in case the market moves against you – trading forex when volatility arises can prove to have great benefits in terms of income potential. Just make sure that the risk doesn’t exceed the reward. You should always be aiming to maximize profits when your assessment is correct and minimize losses if you aren’t. Now, if you can succeed in sustaining a consistently profitable strategy while trading during these erratic market-movements is a different story altogether.