One of the most challenging aspects of foreign exchange trading for beginners is deal with volatility in the Forex market. Volatility is defined as a measure of price variation. There are a number of techniques to deal with both large and small price variations in currency pairs.
Adjusting the amount of leverage used - Most every Forex broker allows you to vary the amount of leverage you use in your account. If a currency pairs price variations are much larger than normal you can scale down your leverage to compensate for that. If your method of trading risks 100 pips per trade, but the currency pair's movements have become larger than anticipated, try scaling your leverage back from 100:1 to 50:1. 25:1, or even 10:1. This allows you to continue to trade, but make the necessary adjustments to control your risk.
Have a volatility filter - The first thing we will need to use volatility to our advantage is some method of measuring it. One such technique is the Average Range (AR). The range is defined as the difference between the high and the low of a particular price bar. Using a daily EURUSD bar as an example, if the high = 1.4100 and the low = 1.4000 then the range = 100 pips. If the range was the same for 10 consecutive days then the 10-day AR = 100 pips x 10 =1000 pips/10 = 100 pips. The Average True Range (ATR) is another popular measure. The ATR uses a bar's high and low in its calculation, but also includes the previous bar's close.
So how do we use either the AR or the ATR to trade more effectively? One method is to use the AR or the ATR to judge our exposure to risk. If our trading system dictates that we risk 20 pips per trade and the AR is 200 pips it may be best for us to simply not take the trade. By staying out of trades which may have a greater probability of failure we can preserve our capital and avoid some needless losses along the way.
AR and ATR can also be used to help identify "stale" market conditions. When the AR is much smaller than normal a trader may wish to wait to enter a trade. This is because the smaller price movements can mean smaller profits or possibly that it will take longer than normal to reach a profit. Logically, the longer you are in a market waiting to profit, the longer you are also exposed to risk.
Another good use of a small AR is for trading breakouts. Some traders live for the price range to get smaller and smaller and form a narrow channel. There are traders that believe that the longer the prices stay within a narrow price channel, the more dramatic the channel breakout will be.
You can easily use volatility to your advantage by being mindful of the magnitude of the AR or ATR. Treat it as your friend and not your enemy. Remember that it and the high levels of leverage available in the Forex market are what make foreign exchange trading so lucrative.
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