Measuring volatility in the Forex market enables traders to know the overall turbulence associated with a particular currency pair so as to identify the most profitable trade opportunities. An increase in the volatility of a currency pair in the foreign exchange market is usually due to major changes taking place in the economy of the country the currency represents.
Here are three indicators for measuring the volatility of a currency pair.
Video: How to Measure Volatility in the Forex Market
1. The Average True Range (ATR)
The Average True Range or ATR in general calculates the range of a session in pips and then establishes the average of that range over a particular number of sessions.
For example, if the ATR is set to 15 on a daily chart, it would give the average trading range for the previous 15 days. As such, this indicator gives the present reading on the volatility of a particular currency pair.
When the indicator is falling, it signifies that the volatility of the pair is reducing, and when it is rising, it signifies that the volatility of the pair is increasing.
It is important to note that this volatility forex indicator does not offer an inference for the direction of price trend; however, it basically gauges the level of price volatility, from high – low for the day.
2. Bollinger Bands
Bollinger bands are an exceptional indicator at showing volatility. In general, these bands are two lines drawn two standard deviations above and below a moving average for a K amount of time (with K representing any figure you choose).
For example, if it is set at 30, there would be a 30 Simple Moving Average and two lines in which one line would be drawn +3 standard deviations above it and another line -3 standard deviations below it.
The bands are very dynamic in nature and they automatically contract when volatility is low and widen when volatility is high.
3. Moving Averages
Another crucial volatility forex indicator — and arguably one of the oldest — is the moving average.
In general, moving averages are lines drawn on charts to give the average price at a given point over a definite period of time such as minutes, hours, days, or weeks. For example, if a 30 Simple moving average is plotted on a daily chart; it would give the average movement of the market for the past 30 days.
There are different kinds of averages, however. The major types most used by traders are: Moving Average Convergence Divergence (MACD), Exponential Moving Average (EMA) and Simple Moving Average (SMA).
To learn more (a lot more) about moving averages check out this blog post.
All of these averages perform similar functions and because of that, all of the averages turn out to be pretty much similar. The function they perform is to eliminate or minimize the noise that is related to the day-to-day price movements and the alluring forex trends along with whatever is plotted on the charts.