Volatility is a key measure of how much the price of a financial asset fluctuates over time. It plays a crucial role in assessing market risk, as it indicates the potential for both profit and loss in a trade.
How Does Volatility Affect Trading?
- High Volatility: When market volatility is high, prices experience larger swings in a short period. While this increases profit potential, it also raises the risk of significant losses.
- Low Volatility: Assets with low volatility tend to have more stable prices, making them lower-risk investments with smaller profit opportunities.
Volatility and Its Impact on Spreads
Just like liquidity, volatility directly affects the spread — the difference between the buy (ASK) and sell (BID) prices of an asset. When volatility rises, spreads tend to widen, increasing the cost of trading.
For this reason, traders should always consider volatility levels when entering the market, especially during economic news releases or major geopolitical events that can cause sudden price swings.
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