This is the second part of our forex trade risks and pitfalls tutorials. You can read the first part of this series here. If you would like to continue receiving tips on how to trade forex in Kenya, consider joining our newsletter.
Understanding Volatility and How it Poses a Risk to Your Account
Just like human beings, the forex markets have certain traits and behaviors that can be observed and studied to better understand them.
Volatility is the measure of how much a currency fluctuates. If a currency shows high and erratic fluctuations, it is said to have a high volatility.
Volatility is one of the easiest ways to gauge exposure to risk. By looking at the recent volatility of a currency pair, you can gauge how much risk you will be exposed to if you decide to take a position.
However, volatility can also be a risk in and by itself.
Volatility spikes around news releases. If you understand that a major news release is due, and your account cannot afford a potential loss on the account, consider closing down your positions or scaling down the leverage.
Even if you are not a fundamental trade (i.e. you are not trading the news) it is important to be aware of the dates when major news releases come out and their potential impact on your portfolio.
How Does Volatility Affect your Account?
Swing forex traders view volatility as a negative as it represents risk and uncertainty. Contrariwise, high volatility makes the forex market more attractive to day traders.
Sudden and high volatility in a currency pair can make the price plummet below your stop-loss order. This leads to premature execution of stop loss orders.
For instance, if in a volatile market you placed your stop loss at 100 pips, and then the currency rebounds, it is possible that it will crash through your stop loss in no time at all.
Before you open a position in the forex markets, study the recent volatility history of the currency pair.