What is Volatility?

Volatility Definition. Volatility in finance most frequently refers to the standard deviation of the continuously compounded returns or movements in price of a financial instrument within a specific time horizon. There are basically two ways to consider volatility in currency markets. The first way is to calculate the standard deviation in a series of rate changes that have already occurred in the past. In this case a forex trader can choose the time period that interests him, whether 10, 20 or 30 days. This calculation yields the historical volatility. However, a forex trader is more concerned about future expectations and will generally seek insights from the premiums charged in the options market. This approach is called the implied volatility. Implied volatility of options rarely correlates directly to the historical values due to market uncertainty about the future. As for currency markets, most studies have found that implied volatility is a good forecaster of future volatility, much better than historical volatility, particularly over a 30-day period, as well as a period of three months. Volatility is usually stated on an annual basis as a percent of change, and various websites give access to calculated values. To adjust for a shorter time period, the annual figure must be divided by the square root of the number of periods in one year.

Risk Statement: Trading Foreign Exchange on margin carries a high level of risk and may not be suitable for all investors. The possibility exists that you could lose more than your initial deposit. The high degree of leverage can work against you as well as for you.