Currency volatility may appear rather normal to many, but there is a big difference to seasoned Forex traders. Day to day moves up or down, or anything around 1% isn’t much to write home about. A double digit move in a matter of minutes, often caused by a Black swan event, is notable!
On any given Forex trading day, you will see a chart representing a currency pair, heading in a general upward or downward direction. The graph on the chart is not straight. it’s trajectory is more like a drunken ant staggering back to its termite after one too many. This daily movement, often called volatility is caused by supply and demand. If in any given minute, there are more buyers, the graph will tick up, if there are more sellers, the chart will tick down. This explains why although there is usually a trend up or down, the trajectory is not linear.
Very is the answer for retail Forex traders! One of the primary drivers of Forex is the yield on a currency. When a central bank adjusts the interest rates of the currency it looks after, this affects the desire of investors to own or sell it. Although interest rates were primarily used to control the flow of money, they are now seen as emergency tools by central banks to stop recessions. Large cuts in interest rates will often lead to currency volatility, as traders price in the new reality.
Governments have a history of putting their foot in it. Many politicians aspire to the top job in their country with dreams of changing the system. Problem is, a crisis is often lurking around the corner. They start off following their dreams, but are brought down to earth with a crashing bang. A currency where a politician is following his dream of exiting a relationship with close trading partners, will not be well received. Forex market participants will sell that currency, in favour of one where politicians have a little more ‘nous’ with regard common sense economics.
On the other hand a politician who follows an unpopular economic policy which makes economic sense, will often be rewarded with their currency appreciating. Either way, for those favouring volatility trading, politicians are a dream!
Central banks were historically dull places which only traders paid attention to. Today governors are rock stars worthy of front page news, who are covered in great detail by the press. Through their use of interest rates, central banks already have an influence on currency volatility. This influence increased even more through their use of quantitative easing. Anyone watching Mario Draghi’s famous press conference, where he stated those immortal words that he would do ‘whatever it takes‘ to protect the Euro, will not have failed to notice the positive and volatile response in the price of the Euro!
In times of panic people run to the hills for protection, on in a modern twist, to buy loo roll from the supermarket! How times have changed. When Forex news is bad, there is only one currency to hold: US dollar! Because the United States is considered the safest economy in the world, with a sound judicial system which upholds the law, the US dollar is trusted beyond any other currency.
In times of stress, all currencies, even major ones such as the Euro and Sterling, will be sold off as people rush to hold US dollars. Perhaps the only currencies which have a similar status are the Yen and the Swiss France whose currencies are seen, for different reasons, as safe places to hold currency.
There are any number of reasons why currency volatility can become apparent. The daily up and down, is little more than just ‘noise’. The big moves happen because of an unforeseen event which is either not priced in, or which the market is not yet capable of quantifying. For those wishing to learn to trade Forex, it is often worth going back in history to see which events have caused currency volatility. This will arm you with a basic knowledge of how to interpret feature economic crises and the effect on currencies. In turn, this will give you an advantage as you seek to profit from this volatility!