As Forex traders, forex volatility is dependent on the time it takes for a currency pair to move from a certain price to the other. A knowledge of the volatility of the pairs you trade is crucial to your success as a trader.
We say a currency pair is highly volatile if it has the ability to move over a great amount of pips within a short period. Currency pair volatility increases risk when trading.
You might still be struggling as a Forex trader because of the currency pairs or even the assets you trade. When I started trading, I had the idea that the more the pairs I traded, the more the profit I booked. In the trader’s world, that newbie idea would be interpreted as; more pairs, more risk and a high rate of failure.
Before I delve into the topic of forex volatility and liquidity, let us first get to know the types of currencies that are existent in the Forex market. There are major pairs (not to be confused with the 8 major currencies), minor pairs and exotics.
Knowing the Currency pairs.
Generally, major currency pairs are those which have the USD involved as a base or counter currency in its quotation. There are 7 of those; EURUSD, GBPUSD, USDJPY, USDCHF, AUDUSD, NZDUSD and USDCAD. The first four pairs are the most popular majors. The last 3 of these majors are commodity currencies alternatively.
Commodity currencies, because the AUD is backed by gold whereas the NZD has a very high correlation to the AUD, therefore the price of gold heavily affects both currencies. Also CAD is backed by oil, therefore the black gold’s direction heavily influences the CAD.
Many countries in the world have their reserves estimated and valued in USD so these pairs are heavily traded on the forex market because of their association with the USD.
Currency pairs that do not include the USD are minor currency pairs or crosses. Taking into consideration the 8 major currencies with the exception of the USD, the rest of them (EUR, GBP, JPY, CHF, AUD, NZD and CAD), when paired are known as minor pairs. Examples of crosses are NZDJPY, EURAUD, GBPCHF, CHFJPY and so on.
The USD is the world’s most important currency followed by EUR, JPY and GBP in descending order. This brings us to the majors of the minor pairs. Out of those emanates EUR crosses, GBP crosses and JPY crosses. EUR crosses are those that have euro in its quotation. GBP crosses are those that have GBP in its quotation…in that manner. Got it?
The exotic pairs are the least traded on the forex market, as opposed to the majors. Exotics are the currencies of countries with emerging economies. For instance, MXN (Mexican Peso), ZAR (South African Rand) and SGD (Singaporean Dollar) are all exotics. Though they pair with the USD, they are not major pairs. USDMXN, USDSGD, USDZAR, USDNGN are all exotic pairs.
Least volatile and most volatile currency pairs.
Least volatile currency pairs.
With reference to forex volatility, the major pairs are the least volatile. This is so because, they are heavily traded and therefore highly liquid. Liquidity of a currency pair is dependent on how much and how easy it moves.
What high liquidity means for you as a price action trader is that, your support and resistance levels stand a high probability of being acknowledged by price. Also the spreads are very tight most of the times. I favor trading all the major pairs, since the high liquidity helps a lot in informing right decisions most of the time.
The “majors” of the majors (EURUSD, GBPUSD, USDJPY & USDCHF) come first in liquidity and least in volatility followed by the commodity currencies.
With that put across, the commodity currencies (AUDUSD, NZDUSD & USDCAD) tend to be very volatile at times because gold and oil are some of the most volatile assets.
When it comes to volatility in the currency crosses, the JPY crosses also have the soundest volatility after the major pairs. However the AUDJPY, NZDJPY and CADJPY remain the most volatile among the JPY crosses because they are still affected by their respective commodities.
Just because the major currency pairs are the least volatile does not mean that they do not have any volatility at all. Volatility tends to pick up during major economic news releases.
Midway volatile currency pairs.
The less popularity a currency pair has, the more volatile it gets. High volatility causes unpredictability in price. This means you are likely to be wrong than right.
The CHF is one of the less predictable currencies in this business of uncertainties. Going beyond the EUR and GBP crosses to trade commodity pairs like NZDCAD, AUDCAD, CADCHF, AUDNZD and a whole lot of unpopular currency pairs tends to get tougher for the newbie.
Commodity currencies paired together or pairs that have something key in common tend to have some fair amount of volatility. A major example of a pair that has a key thing in common is the CHFJPY. CHF and JPY as individual currencies act as safe havens.
Safe haven currencies are basically currencies that are expected to rise in value in times of global economic uncertainties.
Such pairs tend to be choppy most of the time, but make no mistake, when they begin to trend, they give some of the most amazing “free falls or easy rises” (run away markets). The choppy aspect aside, the spread of a pair becomes more and more expensive with the level of unpopularity.
Most Volatile currency pairs.
You’re better off not trading any of the exotic currency pairs. They are monstrously volatile. If monster spreads, unexpected forex volatility and low liquidity does not bother you; you can trade those.
Slippage is an issue here as well. If you buy or sell an exotic currency pair, you may not get filled at your desired price.
Due to the small volumes and the minute liquidity on exotics, technical analysis (esp. with price action) is the hardest. Also, since most of them were not available to trade on the market many years ago; it is likely that your broker doesn’t have chart data dating back till then.
That is something which is really crucial when hunting for support and resistance levels. Take a careful look at the shots below.
The relationship between forex volatility and forex liquidity.
Even as volatility is the duration an asset takes to change its price; liquidity refers to the amount of volume or activity in an asset.
In a liquid market, it is easier to buy and sell because there is a lot of activity ongoing. Liquid markets tend to be less volatile.
In a less liquid market, volume is small since there isn’t a lot of money exchanging hands. Less liquid markets experience high volatility.
Large economies are more liquid and emerging economies are barely liquid. This explains why major pairs have higher liquidity than exotic pairs.
In summary, high volatility = low liquidity whereas low volatility = high liquidity.
How forex volatility and liquidity benefits you as a trader.
Forex volatility proves that the major pairs are the best pairs to trade, followed by the JPY crosses, then the rest of the crosses.
There is too much risk involved when trading highly volatile currency pairs. If you can’t resist the urge to trade them, always reduce your lot size when doing so.
Also in very low volatile market conditions fairly increase lot size to make significant gains or losses.
If and only if you’re new to trading and price action alike, I recommend that you stick to trading the major currency pairs. Whilst progressing you can add some of the crosses and familiarize yourself with its movement.
I don’t really know much about you and how much of a risk taker you are, but I’d advice that you refrain from trading the exotics.
Which currency pairs do you trade? Why do you trade them? Tell me in the comment section below.