What makes a currency volatile?

Sometimes a currency pair trends, with an inexorable unidirectional strength behind the price movement that encourages all traders to jump aboard for the ride. But sometimes it waffles, rising strongly then turning without warning. There’s no sense of direction, no certainty, and little opportunity to trade beyond scalping. A good example is the fifteen-minute chart of the U.S. dollar versus the Swiss franc, below:

Sometimes this volatility is caused by a lack of liquidity. This is often the case with the pound sterling, which lately seems never to have adequate liquidity even though it’s the second major economy in Europe (after Germany). During the trading day, market entry orders for pound crosses all seem to arrive within the four-hour period when both the London and New York markets are open, pushing the price action about for that time, then liquidity dries up and the currency pairs return to dithering.

However, a currency pair’s volatility is also due to its level of associated risk. Because commodities trading is considered risky, currencies associated with those raw materials (the dollars of Australia, Canada, and New Zealand) tend to be traded more cautiously than some others. Commodity currency traders tend to jump out of the market, closing orders en masse, at the first whiff of global risk aversion, increasing the likelihood of other traders being caught behind a jittery move.

As well, risk is associated with the carry trade, which doubles the jitters in the case of the high-yielding AUD and NZD.

Volatility is also caused by the level of associated uncertainty regarding the nation’s future economic strength. For a while, bond traders worried over a Grecian default, and that uncertainty increased the Euro’s volatility. As the uncertainty turns to the United States, with its mutating regulatory scenario and dramatically slowing economy, USD pairs may find their volatility increasing, as well.

Finally, volatility can be caused by market repositioning, as traders, particularly institutional traders with mountains of capital, close open positions and sometimes re-enter the market in the opposite direction. In a low liquidity environment, all it takes is one commercial trader closing a massive short position (for example) and re-entering long to drive the price action substantially higher.

If that repositioning is followed by another commercial trader, repositioning in the opposite direction (read “associated uncertainty,” above), the currency pair will be taken on a surge higher followed by a similar surge lower, similar to the u-turn spike on the USD/CHF chart, above.

The forex trading market can be confusing during times of chop and uncertainty. Retail traders should monitor their open positions carefully, to prevent being blindsided by volatility.