FP Markets

Volatile FX Markets

Numerous factors contribute to price fluctuations in the FX market, prompting investors to adjust their strategies to capitalize on these changes while maintaining currency protection.

Currency volatility can be quantified by calculating the standard deviation or variance of currency price movements over a specified duration. Greater volatility indicates larger price oscillations, which can be favorable for trading. However, investors should exercise caution and avoid overconfidence. Additionally, they should consider the true average range and the percentage spread of the spot price.

A higher level of currency volatility corresponds to increased market risk, and the reverse is also true. Volatility and risk are often used synonymously. More volatile currency pairs tend to exhibit higher market risk.

Some investors favor highly volatile currency pairs due to their potential for significant returns. However, these potential gains come with increased risk, so investors should reduce position sizes when trading volatile pairs to maintain currency protection.

Most Volatile FX Pairs

To enhance your currency protection, be aware of the following volatile currency pairs:

  1. AUD/GBP (Australian Dollar/Pound Sterling)
  2. AUD/JPY (Australian Dollar/Japanese Yen)
  3. AUD/USD (Australian Dollar/US Dollar)
  4. CAD/JPY (Canadian Dollar/Japanese Yen)
  5. NZD/JPY (New Zealand Dollar/Japanese Yen)

These currency pairs exhibit lower volatility while maintaining higher liquidity:

  1. EUR/USD (European Euro/US Dollar)
  2. GBP/USD (Pound Sterling/US Dollar)
  3. USD/CHF (US Dollar/Swiss Franc)
  4. USD/JPY (US Dollar/Japanese Yen)

Meanwhile, the following emerging currencies display high volatility ratings and low liquidity, despite being newcomers to the trading scene:

  1. USD/MXN (US Dollar/Mexican Peso)
  2. USD/TRY (US Dollar/Turkish Lira)
  3. USD/ZAR (US Dollar/South African Rand)

One indicator of volatility is the expansion or contraction of emerging market currency pairs over time. For instance, the USD/ZAR (US Dollar/South African Rand) pair expands nearly 25 percent within a month. Several other instances of emerging market currency pairs experiencing similar fluctuations in a short time frame exist throughout history.

Currency Protection Against Volatile Currencies

Armed with this knowledge of currency volatility, you can optimize your investments:

Opt for Countries with Strong Currencies: When investing domestically or internationally, consider countries with strong currencies compared to your local currency. Investing in countries with robust currencies is advantageous for those with strong home currencies, as it enhances their purchasing power when converting assets back to their local currency.

Identify countries with stable currencies by examining historically low debt-to-GDP ratios. High debt-to-GDP ratios may lead to inflation, which undermines investor confidence in the local currency, causing its value to decline.

Exercise Caution with Foreign Bonds: Amid low-interest rates, such as those experienced in the U.S. in recent years, investors often explore foreign markets for opportunities. However, bonds can be particularly risky.

If a country's currency is stronger (relative to the foreign bond's currency), the bond's value and future interest payments may be significantly diminished.

Considering the substantial risk associated with foreign bonds, investors may choose to avoid them. Conversely, foreign stocks may present a unique opportunity, as they can grow more quickly and offer greater upside potential.

What is the Least Volatile Currency Pair?

The least volatile currency pairs typically involve major currencies from large, well-developed economies, as exchange rates in these economies are more stable. This stability fosters higher trading volume and improved price stability among the most liquid currency pairs.

Currency pairs with the least price volatility generally involve the Euro, Swiss Franc, and British Pound.

Examining the historical relationship between the US Dollar and Swiss Franc reveals that their positive correlation results in reduced volatility.

Unexpected Market Volatility

Even typically stable currency pairs, such as the EUR/USD, can experience heightened volatility due to high-impact news or unforeseen events. Factors that can trigger such fluctuations include political developments, economic reports, natural disasters, or sudden shifts in investor sentiment.

To navigate these unexpected market volatilities, consider the following suggestions:

  1. Stay Informed: Keep up-to-date with economic calendars and relevant news sources. Being aware of upcoming high-impact events can help you prepare for potential market turbulence.

  2. Utilize Stop-Loss Orders: Incorporate stop-loss orders into your trading strategy to limit potential losses during periods of heightened volatility. This can help protect your investments and provide a safety net in case the market moves against your position.

  3. Diversify Your Portfolio: Diversification across different asset classes and currency pairs can reduce the overall impact of market volatility on your portfolio. Spreading your investments can help mitigate risks associated with sudden market movements.

  4. Adopt a Longer Time Horizon: Consider adopting a longer-term trading strategy, which can help you ride out short-term fluctuations caused by high-impact news or unforeseen events. Long-term traders are generally less affected by temporary market volatility.

  5. Monitor Market Sentiment: Analyze market sentiment indicators to gauge investor confidence and anticipate potential market movements. By understanding the overall sentiment, you can better predict how the market may react to unexpected events.

  6. Be Prepared to Adapt: Flexibility is crucial when dealing with market volatility. Be ready to adjust your strategies or exit positions if necessary, to minimize losses and capitalize on potential opportunities.

By implementing these suggestions, you can better safeguard your investments and navigate volatile market conditions, even when typically stable currency pairs like the EUR/USD are impacted by high-impact news or unforeseen events.