What Causes Volatility?

Let’s revise what Volatility means in the forex market before moving on to the causes.

Volatility is a measure of how easily prices fluctuate in a market. It is inversely proportional to liquidity. So when liquidity is high, the market is less volatile and when there’s low liquidity there’s high volatility. When it’s said that USD is the most liquid currency, it also means that it is the least volatile and so more traders want to use it, which in turn would add to its liquidity further decreasing volatility.

  1. So in short,

    Highvolatility = unstable

    Lowvolatility = stable

    If one knows what causes volatility in the market, they can use those indicators to inform their trading decisions.

    Let’s look at some of these.

    Data reports

Whenever new data is released, the market will most likely have a reaction to it. There will be indecision and confusion, a previous trend might be disrupted or reversed as traders act based on their analysis of that data

  1. Economies are built of a plethora of components but there are three that affect them the most drastically; employment, consumerism, and business. On top of these three main areas there are a lot of smaller but equally important factors to take into consideration, such as GDP, Trade Balance etc.

    Some reports that you, as a new trader, should keep an eye out for are:

    Interest rates

    Central bank announcements

    Non-farm payrolls monthly report

    Monthly employment rate

    Unemployment rate

    Housing market reports

    Consumer confidence index

    Chicago Purchasing Managers Index (PMI)

    Federal reserve indices

    ISM manufacturing report

    Budget and deficit forecasts

    Government debt auctions

    Consumer price index

    Yield spreads

    Information causes volatility. So the best way to forecast or apprehend it is to have access to that information.

    The most important banks in the forex market are:

    • Central banks of individual countries
    • European Central Bank
    • Fed, Federal Reserve
    • FOMC, Federal Open Market Committee

    This is a lot of information and the pressure of keeping up with it all can be overwhelming. Therefore, the best thing one can do is to just keep an eye on channels and other information resources that compile and announce all such data regularly.

You can find this data on Business channels on cable, the Business section of newspapers or the major Business websites.

So make a habit of tuning in to these information resources regularly and you will find out everything you need to know to understand market movements. In the forex market, as in most other fields of work, knowledge is power. Especially for those who are more focused on fundamental analysis and who find it easier to understand the bigger picture, this is a mandatory practice.

Now that you know what you need to do to equip yourself with the right information, let us also take a look at some of the strategies that are most commonly used in the forex market.

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