Market volatility

What it is

Volatility is the size of price movement over a period, regardless of direction. A pair that moves 40 pips in an average day is more volatile than one that moves 20, and the same pair is more volatile in some weeks than others. It is measured in several ways: the average true range, which is the average of each day's high-to-low span, is the one most retail platforms show; standard deviation of returns is what the academic and options markets use; and the implied volatility priced into currency options is the market's forecast of it.

When it rises

Volatility follows a daily rhythm and a calendar. Within the day, it rises when London opens, peaks in the overlap with New York and falls away in the Asian session for the European and American pairs, with the reverse for the yen and the Australian dollar. Across the week, it clusters around scheduled data: central bank decisions, employment and inflation releases, and the speeches around them, which the economic calendar lists. And it arrives unscheduled with political shocks, market crises and central bank surprises, when it can rise many times over in minutes.

Volatility also clusters. A volatile day is more likely to be followed by another than by a calm one, which is why a shock tends to be followed by a week of wide ranges rather than a return to normal the next morning.

What it does to a trade

Higher volatility widens spreads, because liquidity providers protect themselves by quoting wider, and it increases slippage, because prices move further between an order and its fill. A stop placed for a calm market is hit by ordinary movement in a volatile one, and a stop that is hit in a fast market fills further away. The leverage caps in Europe and Australia were set on the basis of each instrument's volatility, which is why gold and indices carry lower leverage than the major pairs and cryptocurrencies lower still.

Adjusting to it

The adjustment is mechanical if position sizing is done by risk. A wider stop, set from the current average true range rather than a fixed number of pips, gives a smaller position for the same risk, so a volatile market is traded in smaller size automatically. Beyond that, the sensible responses are to avoid market orders in the minutes around a release, to know when the release is, to be wary of holding a position sized for a calm week through a scheduled event, and to remember that a broker can raise margin requirements before an event it expects to be volatile, which can trigger a close-out in an account that was comfortable the day before.