The limit of volatility in Forex

The limit of volatility in Forex

The limit of volatility in Forex
John Dou - 07/12/2020

The movie "Risk Limit" or its original version "Margin Call" tells the story of an investment company that was one of the first to predict the onset of the global economic crisis in the United States in 2008. The main reason for the crisis was excessive revaluation of investments in mortgage-related securities. As soon as people started experiencing problems, they stopped paying their mortgage. All securities in this area have sharply depreciated.

limit of volatility

But something else is interesting. In the film, the crisis was predicted by a different condition — the limit of volatility. If the range of movement of the price of the instrument exceeds some average values, there was a high probability of collapse. If the Forex instrument makes an average movement of 3000 points per day during the year (the difference between the opening and closing price), then if suddenly its daily volatility is 60,000 points (exceeds the average value by more than 20 times), then there is a high probability that a kind of crisis will occur, traders will catch a lot of stops, lose a single Deposit, the real sector of the economy will have to bear losses due to a sharp change in the price of the instrument, which is unlikely to be ready for.

Understanding the limit of volatility

Volatility in Forex characterizes the degree and magnitude of the speed of price changes. So, the average daily volatility of the EUR / USD pair is about 1500 points (with 5 digits of accuracy).

Average daily volatility of the EUR / USD pair

During the day, the currency pair overcomes this value of points without any special drivers or reasons. This is its standard norm. And the limit of volatility for this pair in the absence of a fundamental background, any strong news may well be considered about 150% of this value. And if the price of a pair passes more than 2250 points per day, then this limit may well be considered a reversal price point. The price has worked out its norm, passed to its certain limit, and then, without fundamental reasons, it is unlikely to be able to continue the unidirectional movement. Exceeding the volatility limit is a kind of "black Swan" in Forex.

Trading in the volatility limit zones

But the "black Swan in the foreign exchange market is extremely rare, which means that we can use zones where a certain volatility limit is exceeded for trading. These areas show us or point a price correction or reversal points.

The rules for such Forex trading can be as follows:
1) Determining the average normal volatility using the ATR indicator, which shows the average true range in which the price fluctuates.
2) Determining the volatility limit as a percentage of the current indicator value, for example, 150 %.
3) if the price passes more than 150% of the indicator values on one candle, open a deal in the direction of correction or reverse movement.
4) Stop loss is set to a value of at least 150% of the indicator values, take profit-at least 100% of the stop loss.
Trading using the volatility limit
To trade the volatility limit on Forex, we recommend using initially high values of the current ATR, as well as taking into account the overbought or oversold state of the charts.

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