Top 4 volatility indicators in forex trading and how they work

Volatility indicators are useful technical methods for measuring volatility rate. With these indicators, you are able to gauge a currency pair volatility, and identify breakout opportunities

BOLLINGER BANDS

What are Bollinger Bands?

Basically, Bollinger bands are typically 2 lines plotted with one above and the other below the moving average within a 2-digit standard deviation, for a specified timeframe as designed by you the trader. That is if we set our moving average at 20, then we will have 20 SMA along with two other line, the above one plotted at +2 standard deviations, while the below one at -2 standard deviations.

How it works is that if the bands contract, that signals LOW volatility. And when the bands widen, it means volatility is HIGH at that particular time.

Bollinger bands are one of the best tools for measuring volatility.

AVERAGE TRUE RANGE (ATR)

Average True Range indicator has been designed for measuring the True Range within a specified timeframe. J. Welles Wilder, a renowned innovator in technical analysis field, is the person behind ATR design among other indicators namely; RSI, Parabolic SAR and ADX indicators.

ATR tops the list of volatility indicators since it reveals the average trading range in the market within Z time which is time specified by you the trader. So what this means is that if you set ATR to 10 on the daily chart, then what you get is the average trading range within the past 10 days.

How ATR works is that it picks the difference between the high and low of the currency pair within the allocated time frame. Then the currency pair range is plotted as a moving average. If ATR decreases, this translates to LOW volatility and when it rises, indicates a HIGH volatility.

THE PARABOLIC STOP AND REVERSE (SAR)

The Parabolic SAR indicator was designed by same J. Welles Wilder the man behind the ATR.

Parabolic SAR for the next day is calculated as follows: -

·         SAR tomorrow = SAR today + AF x (EP – SAR today)

AF = Acceleration factor

EP = Extreme Point (highest value in an uptrend or lowest value in a downtrend).

However, it’s good to take note Parabolic SAR was meant for trending markets and thus not ideal to use for range-bound markets.

THE FOREX MOMENTUM INDICATOR

Momentum indicator is the other forex volatility indicator also referred to as the Rate of Change Indicator (ROC).

How it works:

Momentum = (Current close – close X periods ago) / close X periods ago x 100

Momentum indicator aims at measuring the rate at which movement changes plus the power/momentum behind every move. Momentum indicator is important in also noting possible reversal points through its identification of the strength and weakness of a market trend.