In a blog post from Sunday, Adam Kritzer suggests that volatility in the Forex market continues to run high. This is based on a look back over the last five years (though the chart he shows only goes back four). I decided to take a longer look and instead of using options implied volatility, I went with actual range-based volatility.
The chart below shows the USD Index (cash version) going back to 2001. The sub-plot is of the Normalized Average True Range (N-ATR) indicator. Basically, the N-ATR takes the 14-period average High-Low range and divides it by the 14-period average closing price to get the range expressed as a % of the average. That allows for easier comparison across markets and timeframes.
As we can see on the chart, weekly ranges averaged between about 1.5% and 2.5% from 2001 to 2006. It dropped sharply into mid-2007, then took off to above 3% during the height of the financial crisis. The green line on the chart is the 5-year moving average of the N-ATR, which currently comes in below 2%. Since the current N-ATR is above that, we have agreement with Adam's comments about volatility. Interestingly, though, N-ATR has recently dipped back below the mid-point (50% retracement level) of the wide range of N-ATR valued between the 2007 low and the 2009 high.
It must be noted, though, that volatility varies among the pairs. The USD Index is very heavily weighted toward the EUR (57.6%). That means the volatility for the index is generally going to be very close to that of EUR/USD. As we can see from the weekly USD/JPY chart below, however, in some places the volatility is below average.
Notice how N-ATR for USD/JPY has fallen below the 5 year moving average. Interestingly, though, in this case N-ATR never got as low (about 1.5% vs. about 1.0% for the index) and got much higher at the peak. It currently is about the same level.
It's a similar case for GBP/USD.
Again, here was saw a higher low and a higher high, and now we've see N-ATR move below the 5-year average and into the lower 30% or so of the high-low range. We're also looking at N-ATR getting close to where it is for the USD Index.
The takeaways from all this are:
- Volatility in the Forex market can vary significantly between pairs
- Volatility is falling in some pairs, but not in others. That has implications for the way different pairs trading heading into the new year.
- N-ATR can be used to compare volatility across pairs to help identify good trading opportunities and/or helping you allocated funds to different Trade Leaders.
Hope your holidays have treated you well. Best of luck with your trading and trader development in 2011.
Be sure to read the full risk disclosure before trading Forex. Please note that Forex trading involves significant risk of loss. It is not suitable for all investors and you should make sure you understand the risks involved before trading. Performance, strategies and charts shown are not necessarily predictive of any particular result. And, as always, past performance is no indication of future results.