What is volatility? What is the volatility and why is it needed?

What is volatility? This term indicates the variability of prices. If the chart determines the minimum and maximum prices for a certain period, the distance between these values will be the range of variability. This is volatility. If the price sharply increases or decreases, the volatility will be high. If the range of variation fluctuates within narrow limits, then it is low.

Origin of the term

The term "volatility" comes from the "volatile" - the Middle French word, which, in turn, came from the Latin "volatilis" - "fast", "volatile". It is worth noting that in French there is another definition of volatility. This term also denotes overstatement of value.

Theory of volatility

This theory is based on an analysis of changes in any economic indicators: interest rates, prices, and so on. This takes into account changes that take place over a long period of time. Defining what is volatility, econometrics is distinguished by two main components. The first is the trend, when price fluctuations occur according to a certain pattern. The second is volatility, when the changes are random. To accurately predict the situation, it is necessary to take into account not only the average value, but also expected deviations from the average level.

For example, when analyzing the securities market, it is necessary to take into account random deviations of indicators, since the value of options, shares and other financial instruments is very much dependent on risks. The theory of volatility was developed by the American economist Robert Engle. He determined that deviations from the trend can change significantly in time - periods of minor changes are followed by periods of strong ones. The real volatility of the exchange rate is variable, for a long time economists used in the analysis only static methods based on the constancy of this indicator. Robert Engle in 1982 developed a model that assumes a variable variance of volatility, through which it became possible to predict price changes.

Types of volatility

Considering what volatility is, it is necessary to note two of its types: historical magnitude and expected. The historical view is an indicator equal to the standard deviation of the prices of a financial instrument for a specified period of time, which is calculated on the basis of available information on its value. If we talk about the expected market volatility, then this indicator is calculated on the basis of the value of a financial instrument, taking into account the assumption that the market price reflects possible risks.

In the market, you need to take into account not only the direction of the movement, but also the period for which the changes occur, since this determines the probability that the price of assets will exceed the values critical for the participant. To establish the indicator of volatility of market prices as a whole, it is necessary to calculate the stock index of volatility.

How and why volatility is measured

The easiest way to determine this indicator is the standard deviation indicators and use the true price range - ATR. First of all, you need to determine the average value of volatility for your currency pair over a long time period and then in the process of analysis you need to note the ratio of current and average volatility.

To establish what the price volatility is, it is necessary to analyze the potential yield of a currency pair. When the price change indicator is at a high level, and the spread is insignificant at the same time, one can speak about high profitability. It should be noted that a high level of volatility is associated with greater risks, since the protective stop loss order will be significant, and possible losses also increase.

Bollinger Bands

To visually see what volatility is, you need to use an informative indicator - Bollinger bands. He draws a channel for prices, which significantly expands with a sharp jump in the changes. If the breakdown is in a narrow range, this may indicate the beginning of a profitable move, but it should be remembered that quite often such breakdowns can be false. When we determine the average value of the volatility of currency pairs per day, then we can subtract this indicator from the formed daily minimum or maximum and, in the end, get the goals of taking profitability and setting a Stop Loss order.

Let's say that if you take into account that the pair usually goes within a hundred points per day, then there is no need to put a "stop loss" at a distance of two hundred and there is no sense to expect a big profit exceeding the average daily range. If we analyze the price risk in the financial markets, then, for example, the calculation of stock volatility should take into account not the sequence of prices, but the sequence of relative changes. Thus, it will be possible to achieve greater comparability of various assets. For example, new shares may increase and decrease in value in tens of times, so it is impossible to calculate the volatility of these shares using absolute values. In addition, the sequence of relative changes is more stable, in the sense that for it the variance and the average value are stationary if compared with the same indicators of prices not analyzed. In any case, it is generally accepted.

Volatility indicators

Despite the fact that many employees of dealing centers say that the volatility of currency pairs indicates a good profitability of the transaction, do not forget that a high level of volatility is an increased risk. On a mutable pair, luck can quickly turn away, and losses will increase at times. To reduce risks, you must always use the Stop Loss order, even if the market goes in the direction of profit and does not say anything about possible losses. In the Forex market, volatility indicators include Bollinger bands, CCI, Chaikin indicators . Also indicators of standard deviation are used as indicators.