In forex markets, volatility measures the variation in a currency pair price over time. The broader the scope of the variation, the higher the volatility. For example, if the pair EURUSD has sequential closing prices of 1.111, 1.113, 1.112, 1.111, then it is much more volatile than if it has sequential closing prices of 1.111, 1.131, 1.121, 1.111. Currencies with higher volatility are considered riskier, as the price variation (in both directions) is expected to be wider. The volatility of a pair is measured by calculating the standard deviation of its returns. The standard deviation is a dispersion index used in statistics.
A forex trader should always be aware of volatility of the currency pairs he is trading. For example, if he aims to preserve his capital without taking on much risk, he should choose a currency pair with low volatility, like the EURUSD. If instead he is less risk averse, he must look for a currency pair with higher volatility like the USDTRY. There are many websites which calculate currency pairs’ volatility, which allow a trader to observe the most and least volatile currency pairs, in order to help him formulating the most suitable strategy.
There are many events or macroeconomic data releases which are able to affect volatility. A change in the interest rate by the Federal Reserve, the European Central Bank and the Bank of England is the typical example. A change in oil prices is another example. The degree of volatility is generated by different aspects of the paired currencies and their economies. A pair of currencies – one from an economy that is commodity-dependent (e.g. Russia or Venezuela), the other from a services-based economy (e.g. Switzerland or the U.K.) – is more volatile than a pair of two countries with similar economic characteristics. Economies having very different interest rate levels have also more volatile pairs than those having similar interest rates.