13.1 What is Volatility?

Additional Reading About What Exactly is Volatility

What is Volatility? - Text Version

Volatility is a measurement of how much the price of something moves, regardless of the direction of the movement.

For example, if the price of a share in company A usually moves by about 2% per day, and the price of a share in company B usually moves by about 4% per day, we would say that usually, share A is half as volatile on a daily basis as share B, or that share B is twice as volatile as share A. Another way of thinking about it is to see the bigger candlesticks on your Forex price chart as being more volatile than the smaller candlesticks.

Sometimes, the word “volatility” is used to mean a price movement which is very messy, flying rapidly up, down, and back up again. It is important to try to not get confused between these two meanings.

So, if volatility means the size of movements in price, why should we care? Because measuring volatility is just as important to profitable trading as measuring trend or momentum – these measurements can be used to make a more accurate forecast of the most likely next direction of the price movement, and when you can do that, you can trade more profitably. We’ll be explaining more about how to do that in the next lesson in this course.

All technical analysis is, is looking at historical prices and using them to forecast the next likely movement in the price. Although there are hundreds of indicators with different names, they are all based upon measuring historical prices. The amazing fact is that there are really only two things about prices which indicators measure: trend, which is often called “momentum”, and volatility. All the fifty or one hundred indicators you see on your trading chart are just slightly different ways of measuring these two things.

The good news for you as a trader is that volatility is easy to measure. Although professional technical analysts use a complicated formula called standard deviation to measure it, we can keep it very simple and just measure the average pip movement or percentage change of any currency pair or commodity. There is an easy to use indicator built into practically every trading platform which can do this.

In the next lesson, we will explain three rules of volatility which you can apply to markets after measuring their volatility, which can help you decide what to trade, when to trade it, and whether to make a long trade or a short trade.