Measuring Forex Volatility

[MDS]

I've looked through a lot of these threads and I've noticed that there isnt a lot of talk about using quantitative techniques to understand the market you trade. When I first got interested in forex I spent a large part of my time using various statistical techniques to understand the volatility behind each ccy pair. I didnt use anything really fancy. I just used basic statistical techniques taught in any beginners stats. class.

The first thing I did was get a years worth of ccy data. I calculated the daily difference in closing prices and using that difference I calculated the standard deviation. Excel has the standard deviation calc. built in so all you need is the data.

What i found was the following:
GBP/USD moves 90 pips a trading session
Eur/Usd moves 70 pips per trading session
Usd/Jpy moves 60 pips per trading session
Nzd/Usd moves 40 pips per trading session
Aud/Usd moves 40 pips per trading session

Once you know the daily move you can then scale it down for 5, 15 and hourly settings. I scaled it down on a ratio of 6:1. Which led me to believe that for every minute you have to think 6 minutes ahead

I was then able to find that if you want to trade the 5 min chart you have to think 30 min ahead. If you trade the hourly chart you have to think 6 hrs ahead. If you trade the daily chart you have to think 6 days ahead. If you understand the volatilty you can then say to yourself using this 5 min chart is the ccy pair going to move X amount in the next 30 min.

I am now able to take the data above and use it to set my stop losses.

I also use all of the technical techniqes that everyone talks about here. But I look at the charts keeps the volatility discussed above in mind. I also found that everything has to be lined up before you put on a trade. In other words before I put on a trade I make sure that the 5 min and hourly charts are going in the same direction. For instance, if i look at the RSI on the 5 min chart and it is moving towards being overbought and on the hourly chart the RSI is moving towards oversold I would stay out of this ccy pair. I woudl wait until both the 5 min and hourly chart are saying overbought and moving towards oversold. I also use the MACD with the RSI and I would wait until the MACD was in aggreement between the 5 min and hourly chart as well. Ideally, what you want is the 5 min, hourly and daily charts to all be moving in the same direction, but the daily chart usually isnt.

I then use fundamental analysis and check the calendar to see what major reports are coming out and what the consensus is. I also read the economic and ccy reports published by major banks.

Based on all of the above I would then take a position.

Finally, using the above information, I would set my stop loss and limit.

[TraderPierre]

Originally Posted by MDS

Based on all of the above I would then take a position.

Gosh, don't you get fed up waiting for all those ducks to line up?

[MDS]

No. I learned through demo accounts that you will loose if things arent lined up. If one chart is saying overbought and the other chart is saying oversold then the market is trending and its hard to make money. You have to be careful about tieing up your capital. You only have so much money to trade with and you have to be selective. There are only 2 ways to make money in trading. You can make it with volume or volatility. If you want to make it with volume you better come up with some software that can execute trades for you quicly. If you dont have the software then all your left with is volatility. And not understanding the volatitily you are playing with is foolish.

Baseing my trading decisions on the steps i outlined below allows me to make an informed decision. Also, by knowing the avg, volatility of the ccy pair i know when to get out for profit and where to cut my losses.
For instance, say the GBP/USD goes in my favor and moves 90 pips in 2 hrs. Statistically thats all it should move in this trading session. If you hit the 90 pips taht quickly most of the time the market goes flat and trends in a tight range for the rest of the session. Based on this I would close my position and sit out. On the flip side, if the position goes against me then I've set my stop and my position is closed out. Preserving my capital. If I set my stop at 50 pips and it goes through it statistcally it should only go 90 and then stop. During this time I can regroup and see what caused the move against me, reverse my position and try to catch the extra 50, or look for another ccy pair. Most of the time if I break my stop i dont immediately reverse my position. I sit back and look for my next set up.

[TraderPierre]

Fair enough, sounds like you've put a lot of thought into it which is always a good thing.

Isn't there an indicator that measures range and volatility, I'm sure I saw one somewhere on one of the charting packages, or was it exporting data to excel, can't remember now. If I find it I'll post it, it might be of some use.

[sunabeach]

Originally Posted by TraderPierre

Fair enough, sounds like you've put a lot of thought into it which is always a good thing.

Isn't there an indicator that measures range and volatility, I'm sure I saw one somewhere on one of the charting packages, or was it exporting data to excel, can't remember now. If I find it I'll post it, it might be of some use.

True Range measures range and an average of True Range or ATR can give you a measure of volatility.