Over the past 10 years, currency trading has been increasing in popularity. New traders are initially spooked by the volatility, but when they understand why currencies are volatile, they become more comfortable with the idea of dabbling in currencies and will learn how to control it. On a year-over-year basis, currencies are usually no more volatile than equities. In 2010 for example, the ASX rose more than 25% and during that same year, the Australian dollar rose 14% against the US dollar. The peak to valley difference in these two instruments was basically the same on a percentage basis but what makes forex trading more volatile than share trading is leverage or gearing. With brokers offering as much as 50 times leverage (some even more), the 14% move in the AUD/USD gets compounded exponentially. Just think, at 10 times leverage, a 14% move in the currency turns into a 140% move in your equity. This is advantageous if you are on the right side of the trade, but if you are on the wrong side, it can be very dangerous. The downside of leverage can be controlled using stops but seasoned traders know that placing stops is more of an art than a science. There are a million different ways to place stops. Some investors will place stops based upon significant levels while others will place a monetary stop based upon the amount that they are willing to lose. When trading forex it is important to realise that currencies can behave very differently with some being much more volatile than others.
The table below shows the average daily range over the past 10 years of the 21 most actively traded currencies. On the top of the list is EUR/NZD with an average daily range of 254 pips and on the bottom of the list is EUR/GBP with an average range of 57 pips. Each currency pair has a different pip or point value but most range from $7-$10 per 100,000 units traded. In other words, in EUR/NZD, each pip or point is worth $8.25 which makes a 254 pip move worth $2,095. EUR/GBP on the other hand has a pip value of approximately $16, which means the average range of 57 pips is worth $912. Even though the pip value of EUR/GBP is higher, its fluctuation on a dollar basis intraday is much smaller. EUR/CHF has a point value of $12, which makes its 74 pip move worth $888. Some traders view the prospect of a $2,095 intraday swing as extremely attractive while others will find it extremely scary.
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Power of Average Volatility
Knowing the average daily volatility of a currency can be extremely powerful for a handful of reasons. First it helps traders understand which currencies are more suitable to trade based upon their risk profile. For traders that love volatility, EUR/NZD, GBP/JPY and GBP/CHF could be extremely attractive. We like to consider these the equivalent of “Google” shares, which can rise and fall by as much as $15 a day, a value that exceeds the overall share price of many listed companies.
A pair such as GBP/JPY can be attractive for intraday traders because of its wild swings. In the 15 minute chart (above) of the currency pair, we can see that GBP/JPY fluctuated within a 140 pip trading range during the day. Even though this range is less than the average daily range for the currency pair (which means that it is a below average day), the price action is very characteristic of GBP/JPY – which sold off aggressively only to recover quickly during the trading day. For a day trader, this volatility can be looked at as opportunity to take advantage of both up and down moves on an intraday basis. In contrast, a currency pair such as EUR/CHF has an average daily range of 74 pips only, which means that even if the currency pair reversed intraday, the move may not be large enough for day traders to find interesting.
Another way to look at it is that the EUR/NZD and GBP/JPYs of the world tend to be more suitable for intraday breakout or trend trading and more attractive to volatility seekers. EUR/CHF and EUR/GBP on the other hand may be more suitable for investors who fear volatility and who would rather focus on trading ranges leisurely.
Knowing the average daily range of a currency pair also helps investors determine the right place to put a stop. Given that EUR/GBP has an average range of 57 pips, a stop of 75 pips, for example, is much more significant for a EUR/GBP position than it is for a EUR/NZD position. This is even true on an intraday basis because a quick 35 pip drop in EUR/CHF would be considered a big move while the same decline in GBP/JPY could happen much more easily. This means that when trading GBP/JPY or GBP/CHF a wider stop may be more appropriate for traders holding positions overnight because this would allow them to “ride out the volatility.” EUR/GBP and EUR/CHF on the other hand does not necessarily need as wide of a stop as currency pairs with more volatility.
The volatility of a currency pair can also vary based on the time. In the GBP/JPY chart, the big swing happened shortly after the European open and lasted until lunch time in NY. Before and after the big moves, GBP/JPY traded quietly and in a relatively tight range. In general, volatility in currencies tends to increase between the European trading session and the first half of the New York trading session which lasts from 4pm to 2am in Sydney. If Australia has economic data scheduled for release, we could see some volatility in the Australian dollar during the morning hours in Sydney but usually it tends to be quiet.