Hello XM customers/viewers,

Today we are introducing our new weekly post that helps you locate instruments that might make big moves in the coming sessions; the Implied Volatility Table.

So, what is Implied Volatility and why it is important?

Implied or expected Volatility is a forecast of a likely movement in a financial instrument's price, which is derived from market-traded option prices. The instrument could be an individual stock, a commodity, an equity index, a currency pair, or even a cryptocurrency.

For traders, implied volatility is important because it provides insights into what the market thinks about an asset’s upcoming movement, whether it will be large, moderate, or small. Expected volatility is also useful as it offers a range of prices that a security is anticipated to swing between, and therefore helps traders select potential entry and exit points.

In general, as the expected volatility rises, the probability of a sizeable move, up or down, in the instrument’s price increases. However, implied volatility does not predict the direction of an impending move.

Another thing that traders should be aware of is that the expected volatility should mainly be compared with the specific instrument’s historical values. Riskier assets like cryptos or stocks will almost certainly have higher volatility than major currency pairs.

An example of what information the table is going to provide for each instrument

Now let’s take a look at the output of our volatility table and describe each variable separately.

We will begin with a specific trading day and the closing market price of each examined instrument.

Then, for each instrument, we will provide the level of its implied volatility and the upper and lower boundaries of its 30-day range. In this way, the reader can easily understand whether on that particular day, the instrument is considered ‘hot’ or ‘quiet’, relative to what has been happening in the past month.

We do this by comparing the current level of implied volatility with the recent past, through the use of deciles. Put simply, being in the highest deciles e.g. 6 and above means that current implied volatility is higher than the values of half of the previous 30 days.

Therefore, this decile figure shows some elevated chances of bigger moves going forward. It is worth noting that the higher the decile number, the higher the chances of big moves - according to the market's forecasts. Similarly, for deciles 5 and below, the market's view of chances of big moves is relatively lower.

We also provide the decile from 7 days ago for comparison purposes. For instance, a change of decile from 1 in the previous week to 3 this week, may still show less-than-average expected volatility for this particular asset, but its expected volatility is picking up.

Finally, we also calculate the 7-day return, which is also important for traders to have in mind.

So finally, how we are going to identify increasing or decreasing volatility?

Now let’s see a hypothetical example of two pairs whose volatility moved in different directions.

On the one hand, it is clear that the expected volatility for EUR/USD, in the examined day, is now near the upper end of its 30-day range as it has jumped from decile 6 in the previous week to decile 10. In other words, the pair’s volatility shifted from neutral to extreme levels, hinting at a higher probability of a significant move in the upcoming sessions.

On the other hand, EUR/JPY seems to be experiencing lower volatility compared to what happened on the same trading day in the previous week, resulting in a decline from decile 6 to decile 2. Thus, the pair’s volatility shifted from average to low levels, suggesting that the price is more likely to remain more or less flat in the upcoming sessions.

We hope that this tool will enhance your trading experience and provide insightful information about relative movements in major trading instruments.