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Which Forex Volatility Indicator Do You Prefer?

March 30, 2020 by

Trading without indicators (naked Forex trading or pure price action) is popular among traders nowadays. Still, even many price action proponents rely on some measure of volatility to analyze charts and to time trades. This measure is most often provided by some sort of a technical indicator. What is volatility and which indicators are good at measuring it? Below, we will try to answer these these two questions.

There are multiple definitions of volatility. The simplest definition of Forex volatility is the currency rate’s price range — the difference between the period’s High and Low rates. The wider is the range, the bigger is the difference, the more volatile the currency pair is. For example, in our recent study of FX pairs’ trendedness, we used exactly this definition of volatility. More broadly, volatility can be defined as FX rate variability — expected or realized (past). There are many indicators, each with its own formula, to calculate the exact value of volatility.

Volatility is an important factor in building a Forex trading strategy because it measures the currency rate’s potential to change — and to profit from an FX trade, the rate has to change (unless you are trading options).

It is also important not to confuse the volatility of an asset price (currency pair rate) with the volatility of returns (ROI) — in this post, we talk only about the former. Although the latter is also very important, it should be studied along with general Forex money management and is out of scope of this post.

The following indicators are most commonly used to measure volatility in Forex:

Average True Range (ATR) — calculates an average true range over a number of chart candles. It is a good indicator if you want to know how big the rate changes were during the last N periods at a glance. It is commonly used for volatility breakout entry levels and volatility-adjusted position sizing.

Average True Range Volatility Indicator in MetaTrader 5

Bollinger Bands (BB) — another standard technical indicator included in all charting platforms. It measures the volatility by calculating the currency rate’s standard deviation and then subtracting and adding some multiple of it from and to a moving average. This creates bands that either widen (during the periods of high volatility) or get squeezed (low volatility). Bollinger Bands indicator has many applications in trading — measuring volatility is just one of them.

Bollinger Bands Volatility Indicator in MetaTrader 5

Chaikin Volatility (do not confuse with Chaikin Oscillator) — a less popular indicator, it calculates volatility as the ratio of change of the average High-Low difference compared to the average High-Low difference some time ago. However, this results in situations when prolong periods of high volatility would show near-zero value on Chaikin Volatility oscillator. Still, it can be used for comparative volatility analysis.

Chaikin Volatility Indicator in MetaTrader 5

Keltner Channel — although rarely present in trading platform as a built-in indicator, Keltner Channel is a rather popular measure of the market volatility in Forex. It is constructed similarly to Bollinger Bands but uses a moving average of a typical price for the middle line and then subtracts and adds the moving average of the High-Low difference from and to that line to form the bands. Like Bollinger Bands, Keltner Channel becomes wider when volatility rises.

Keltner Channel Volatility Indicator in MetaTrader 5"

VIX — while all other volatility indicators described here are showing the realized volatility (how varied the currency pair rate was in the past), VIX is an example of an implied volatility measure (the volatility as viewed by the market participants at the current moment). VIX is a Volatility Index by CBOE and is based on S&P500 index options. It is mostly used to indicate volatility of stocks, but is widely used in other financial markets too. However, for Forex traders, there are special versions of VIX based on currency options — EUVIX (euro), JYVIX (Japanese yen), BPVIX (Great Britain pound). It is a much more advanced way of measuring Forex volatility, albeit not as accessible to a common trader as a simple technical indicator (for example, VIX is only available in a delayed version on TradingView right now). Also, currency versions of VIX won’t help you much if you trade exotic currency pairs.

VIX EURO Volatility Indicator in TradingView

Volatility Bands — isn’t some particular indicator — there are many indicators called Volatility Bands, but they all are quite similar and use the same principle as Bollinger Bands. However, instead of using a multiple of standard deviation to form the bands, these indicators use other parameters of rate variability to form the bands. They are available for some trading platforms as custom indicators. For example, here is an implementation of Sylvain Vervoort’s Volatility Bands for MetaTrader 5:

Volatility Bands Indicator in MetaTrader 5

Volatility Ratio (Schwager) — is calculated as a ratio of the current true range to the exponential moving average of the true range. Basically, it shows how the current true range compares to the true range of in the previous candles. It is usually found as a custom indicator for your platform.

Volatility Ratio (Schwager) Indicator in TradingView

My own opinion is that when you need to measure the market volatility, the simpler is the better. That is why I prefer ATR over other technical indicators but I also use VIX currency versions when I need to assess long-term implied volatility for EUR, JPY, or GBP. And how about you?

What is your favorite volatility indicator in Forex trading?

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If you want to share your thoughts about volatility indicators you use in Forex trading, please feel free to do so using the commentary form below.

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