Volatility — Definition Explained Simply | Examples & Role
Volatility is the degree of fluctuation in an exchange rate or the price of a financial asset over a given period of time. If a rate changes quickly and noticeably (for example, when the euro rises and falls against the US dollar), it is called high volatility. If the rate remains almost unchanged, volatility is low. The higher the volatility, the stronger the price swings — and the greater the investment risk.
What is volatility
Volatility is a statistical measure that reflects the extent of price changes (fluctuations) of a market asset — such as a currency, stock, or bond — over a specific period of time. It shows how much and how often the price deviates from its average value.
Economic meaning
Volatility represents the level of uncertainty and investment risk. High volatility means that the price of an asset can change rapidly and significantly, increasing both potential profit and the risk of loss. Low volatility, on the other hand, indicates stable prices and predictable returns.
Types of volatility
- Historical volatility – measures how much the price of an asset has changed in the past, based on statistical data for a selected period.
- Forecast (expected) volatility – an estimate of future price fluctuations based on mathematical models and economic factors.
How volatility is calculated
Volatility is usually calculated as the standard deviation of percentage price changes over a defined time frame. For example, if a currency’s exchange rate fluctuates by ±2 % per day, its volatility is 2 %. High volatility (above 10 % of the average level) indicates an unstable market, while low volatility (1–2 %) shows stability.
Volatility in the foreign exchange market
On the Forex market, volatility is used to assess the risk of currency pairs. Highly volatile pairs can yield greater returns but require more caution. Calmer pairs such as EUR/CHF or EUR/USD are more suitable for conservative trading strategies.
Volatility and risk
Volatility is a quantitative measure of risk: the higher it is, the greater the probability that results will deviate from expectations. It is used in risk metrics such as the Sharpe ratio, beta, and Value at Risk. According to the IMF, volatility is one of the key indicators of instability in global financial markets.