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Volatility

Volatility is a measure of how much a currency pair is moving, usually measured by taking the standard deviation of movement, over a given time period and expressed as a percentage.  Traders will often refer to ‘1 month vol.’ as a standard measure of volatility.

Essentially it expresses how much a market is moving over a given time period.  A market with a low volatility is expected to have smaller moves on a given day than those with a high volatility.

For the trader, higher volatility is usually good, as profits tend to be made from movement, with a few exceptions such as some options strategies.

Volatility also has a direct impact on whether a strategy is viable.  If a currency pair has an average slippage per trade of 3pts but an average return per trade of 10pts, then slippage would reduce the profits by 30%.

If the same strategy were traded on a currency pair with a twice the volatility, but the same slippage of 3pts, it may yield an average return of 20pts per trade, as the average daily movement would be higher.  Slippage would then only reduce the profits by 15%; half the amount.

Slippage can be such a huge factor that some high frequency strategies, which look excellent before slippage is taken into account, can actually produce a significant loss if actually traded under real market conditions.  Therefore you often see volatility filters added to strategies and these are often simply a function of the minimum volatility the market needs to be trading at, for the strategy to overcome costs and to be viable; this will vary both from currency pair to currency pair and even by time of day.

Therefore, if a strategy is found to be a losing one after slippage is added, but was profitable before, then a simple volatility filter may be all that is required, to trade only when the expected movement is above a certain amount.

Interest Rates

Interest rates are another known, and quantifiable, factor affecting currency markets. Table 3 shows the current interest rates of the major currencies.

 

Currency

Interest Rate

New Zealand (NZD)

2.50%

Australia (AUD)

4.00%

Japan (JPY)

0.10%

Hong Kong (HKH)

0.50%

Singapore (SGD)

0.25%

Turkey (TRL)

6.50%

Europe (EUR)

1.00%

Switzerland (CHF)

0.25%

Norway(NOK)

1.75%

Sweden(SEK)

0.25%

Great Britain (GBP)

0.50%

Canada (CAD)

0.25%

United States (USD)

0.25%

Mexico (MXN)

4.50%

As of 2nd March 2010

Figure 3

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