In finance, volatility refers to the amount of change in the rate of a financial instrument, such as commodities, currencies, stocks, over a given time period.
Essentially, volatility describes the nature of an instrument’s fluctuation; a highly volatile security equates to large fluctuations in price, and a low volatile security equates to timid fluctuations in price.
Volatility is an important statistical indicator used by financial traders to assist them in developing trading systems.
Traders can be successful in both low and high volatile environments, but the strategies employed are often different depending upon volatility.
Why Too Much Volatility is a Problem
In the FX space, lower volatile currency pairs offer less surprises, and are suited to position traders.
High volatile pairs are attractive for many day traders, due to quick and strong movements, offering the potential for higher profits, although the risk associated with such volatile pairs are many.
Overall, a look at previous volatility tells us how likely price will fluctuate in the future, although it has nothing to do with direction.
All a trader can gather from this is the understanding that the probability of a volatile pair to increase or decrease an X amount in a Y period of time, is more than the probability of a non-volatile pair.
Another important factor is, volatility can and does change over time, and there can be periods when even highly volatile instruments show signs of flatness, with price not really making headway in either direction.
Too little volatility is just as problematic for markets as too much, we uncertainty in excess can create panic and problems of liquidity.
This was evident during Black Swan events or other crisis that have historically roiled currency and equity markets.