Volatility measures how widely the price of an instrument moves over a period. It describes the size of price swings, not their direction: a market can be highly volatile and still end the week unchanged. Higher volatility widens the range of possible outcomes on an open position, losses included.
How volatility is measured
Historical volatility is the standard deviation of returns over a lookback window. Returns are taken as r = ln(P₁ ÷ P₀) for each period, the mean return r̄ is subtracted, and the deviations are squared, averaged and square-rooted: σ = √( Σ(r − r̄)² ÷ (n − 1) ). A daily figure is annualised by multiplying by √252, the approximate number of trading days in a year. The result is a single number describing dispersion in the sample; it says nothing about which way the next move goes.
Implied volatility is different. It is not calculated from past prices but extracted from current option premiums: given the option price, the strike, the time to expiry and rates, it is the volatility input that makes an option pricing model return the traded price. It is the market's current pricing of expected movement, and it changes when option prices change. Indicator-based readings on a chart, such as band width, are covered in the lesson on Bollinger Bands.
Volatility is not direction and not liquidity
Two confusions are common. The first is treating volatility as a directional signal: a rise in σ tells you the swings have become larger, not that they will be upward. The second is treating volatility as liquidity. Liquidity is the ability to trade size without moving the price; a market can be quiet and thin at the same time, or volatile and deep. They often move together around news, but they are separate measurements.
The practical consequence of rising volatility is symmetrical and it works against an open position as readily as for it. Wider ranges mean a larger adverse excursion before any exit level is reached, so a fixed stop distance is hit more often. Spreads typically widen at the same time, and orders are more likely to be executed at a worse price than the level requested, because the price can move between the order being sent and being filled. Gaps can jump past a stop-loss level entirely, in which case the fill is at the next available price.
Why volatility changes through the day
Currency volatility follows the trading day. It concentrates when major centres overlap and thins out between sessions, so the same pair can move a multiple of its overnight range during the London–New York overlap. Scheduled data releases produce short, sharp bursts around a fixed time: non-farm payrolls is the standard example. This is why a volatility figure has no meaning without its window: a value measured on hourly bars across a full week and one measured on the release minute are not comparable.
Calculator: size the position to the current range rather than to a habit with the position size calculator.
