Learning FX

The Deviation Between USD & GBP, GBP/EUR & EUR/USD

US Dollar bill

Deviation in forex is the measurement of a currency pair's volatility compared to its current average. Standard deviation helps forex traders measure the amount of risk attributed to price movements to make more informed choices about buying, selling, and holding pairs.

What Is Deviation in Forex?

Deviation in forex is the measurement of a currency pair's volatility compared to its current average. Standard deviation helps forex traders measure the amount of risk attributed to price movements to make more informed choices about buying, selling, and holding pairs.

Currency pairs move up and down over time, so the standard deviation is crucial in identifying which currency pairs are safe bets and risky investments. A currency pair with a high standard deviation will experience more significant price movements than a downward deviation.

Standard Deviation in Forex

The standard deviation of a currency pair is the measurement of its volatility. The higher the standard deviation, the more volatility in price fluctuations is seen in a currency pair. Deviation in forex will change over time, so it's important to know how to calculate it:

  • Deviation = (Close – Average)2 / Average

This formula extends the calculations used to calculate the average of a currency pair. For example, the weekly average of the GBPUSD is the average of the closing prices for the last five days, so to find the standard deviation for the GBP/USD, you would use this formula:

  • Deviation = (Close – Weekly average)2 / Weekly Average

Deviation vs Volatility

Standard deviation is an essential metric for analyzing a currency pair. It measures the range of prices that a currency pair can fluctuate between. The deviation of a currency pair is used in conjunction with other financial factors, such as interest rates, economic factors, and political factors, to determine that currency pair's future value.

On the other hand, Volatility is used as a measure of the inherent risk (both up and down ) for a currency pair.

Conceptually, it's easy to understand how deviation can measure volatility. The more the price of a currency pair fluctuates, the higher its deviation will be, and the less the price of a currency pair fluctuates, the lower its deviation will be.

A currency pair with a high deviation will have a higher risk of fluctuation, and it will yield a higher rate of reward. In comparison, a currency pair with a low deviation will have a lower risk of fluctuation and will cause a lower reward rate.

What Affects Deviation?

A few factors in the forex market can impact how much a currency pair deviates from its average. The four main reasons a forex pair's deviation will change are:

Economic indicators

Economic indicators like interest rates and Gross Domestic Product (GDP) help predict the future direction of a currency pair. High-interest rates lead to a bullish market, while low-interest rates lead to a bearish market. High GDP can lead to a bullish market, while low GDP can lead to a bearish market.

Interest Rate Effect

For example, the GBPUSD trades with a bearish bias when UK interest rates are higher than in the United States (US). The same goes for the EURUSD, which trades with a bearish bias when European interest rates are higher than in the United States.

GDP Effect

Similarly, the GBPUSD trades with a bullish bias when UK GDP is higher than in the United States (US). The same goes for the EURUSD, which trades with a bullish bias when European GDP is higher than in the United States.

Economic News

Economic news can also impact the deviation of a currency pair. The higher the index, the more people are optimistic about the economy; this is bullish for the pair. The lower the index, the more people are pessimistic about the economy; this is bearish for the pair.

Political News

Political news can also impact the deviation of a currency pair. The more political uncertainty, the more the price of a currency pair will fluctuate. For example, political uncertainty could raise the US dollar price against the euro.

The Basics of Currency Pairs

The forex market is the largest financial market globally by a significant margin, with more than $5 trillion changing hands each day. Global currencies are traded on several exchanges, each with its own daily trade volume.

Trading volume can be broken into two categories: spot market and forward market. The spot foreign exchange market, which is by far the larger of the two categories, represents the current trading of currencies. The forward foreign exchange market represents a form of trading in which delivery and settlement occur later.

The spot market is used for trading major currency pairs, which are the most popular in the industry. The forward market is used for trading specialised currency pairs, known as exotic currency pairs.

  • Standard Currency Pairs

The most widely traded currency pairs globally are the major currency pairs. These are the standard currency pairs, and they are the most commonly traded instruments in the forex market. Major currency pairs make up roughly 80 per cent of the global market.

  • Exotic Currency Pairs

The majority of the other currency pairs in the forex market are exotic currency pairs. These are currency pairs that are more volatile and less liquid than the standard currency pairs, so they are traded in smaller amounts.

The most liquid of the exotic currency pairs will trade around $100 million per day from both the buy and sell sides. In contrast, the least liquid of the exotic currency pairs gives the illusion of trading hundreds of millions of dollars per day. In reality, the amount that moves through the market is much smaller.

Deviation in the USD/GBP Currency Pair

Deviation in the USD/GBP varies wildly, depending on whether the UK is in a recession or a recovery. The GBP/USD reaches a low deviation during a recession, while the USD/GBP reaches a high deviation. The GBP/USD reaches a high deviation during recovery, while the USD/GBP reaches a low deviation.

This is because the UK enters a recession when it has high-interest rates and low GDP, and the US enters a recession when it has low-interest rates and high GDP.

  • GBP/USD versus USD/GBP Deviation

Over the long run, the standard deviation of the USD/GBP will remain stable, even when the same amount of money is in play. This is because the amount of money in play is relative to the amount of liquidity in the market.

As the USD becomes stronger against the GBP, the GBP rallies, the deviation increases, and the USD/GBP falls. As the GBP becomes stronger against the USD, the GBP declines, the deviation decreases, and the USD/GBP rallies.

The Bank of England's Role in USD/GBP Deviation

Inflationary pressures are closely monitored by the Bank of England, which sets interest rates based on the latest consumer price index (CPI). The bank's goal is to keep inflation at the target rate of two per cent.

When inflation is rising, the bank raises interest rates, but when inflation is declining, the bank lowers interest rates. If the rate of inflation in the UK is higher than the rate of inflation in the US, this will result in a downward price correction in the USD/GBP.

Deviation in the GBP/EUR Currency Pair

The GBP/EUR currency pair changed drastically over the last five years. In 2007, the GBP/EUR had a high deviation, while the EUR/GBP had a low deviation. In 2010, the GBP/EUR began to rise, and its deviation dropped, while the EUR/GBP started to fall, and its deviation rose.

The GBP/EUR is a very liquid currency pair, and the EUR/GBP is a not-so-liquid currency pair. When the liquidity of one of these currency pairs is higher than the liquidity of the other, the deviation will rise as the market becomes more volatile.

  • EUR/GBP vs GBP/EUR Deviation

Over the long run, the deviation of the EUR/GBP will remain stable, even when the same amount of money is in play. This is because the amount of money in play is relative to the amount of liquidity in the market.

As the EUR strengthens against the GBP, the GBP rallies, and the EUR/GBP falls. As the GBP becomes stronger against the EUR, the GBP declines and the EUR/GBP rallies.

Brexit's Role in GBP/EUR Deviation

Three factors impact deviation in the GBP/EUR. Brexit, monetary policy and economic forecasts. Brexit is likely to have the most significant impact, although it is not the only factor that will move the price of the EUR/GBP.

The Bank of England and the European Central Bank (ECB) are currently at odds with monetary policy. The Bank of England is set to raise interest rates, while the ECB lowers interest rates. If the UK raises interest rates and the ECB does not, this will impact the price of the EUR/GBP.

Deviation in the EUR/USD Currency Pair

The EUR/USD is a very liquid currency pair, and the USD/EUR is a not-so-liquid currency pair. When the liquidity of one of these currency pairs is higher than the liquidity of the other, the deviation will rise as the market becomes more volatile.

When the EUR/USD rises, the USD/EUR falls, and the deviation of the EUR/USD rises. When the EUR/USD falls, the USD/EUR increases and the deviation of the EUR/USD falls. A rising EUR/USD means rising interest rates, so the USD/EUR rallies.

  • USD/EUR vs EUR/USD Deviation

Over the long run, the deviation of the USD/EUR will remain stable, even when the same amount of money is in play. This is because the amount of money in play is relative to the amount of liquidity in the market.

As the euro strengthens against the USD, the USD rallies, and the USD/EUR falls. As the USD becomes stronger against the euro, the USD declines and the USD/EUR rallies.

The Fed's Role in EUR/USD Deviation

The Federal Reserve Bank is in charge of monetary policy in the United States, so it is their job to monitor inflation and keep it at two per cent. To do that, the Federal Reserve sets interest rates in the US and monitors the performance of the US economy.

When the US is in an inflationary period, the Federal Reserve raises interest rates. When the US is not in an inflationary period, the Federal Reserve lowers interest rates. If the US has rising inflation and the Eurozone does not, this will create a downward price correction that will move the EURUSD.

How to Read a Price Chart

Currency pairs trade differently than equities and bonds for several reasons. For one, their volatility is not anchored to a set schedule, like it is for equities, bonds, commodities, and futures.

Volatility in the Forex market is determined by supply and demand. Supply and demand will affect the price of a currency pair no matter what the time of day, week, or month. The forex market is open 24 hours, five days a week.

The other reason is that currency pairs are priced different than equities and bonds. The USD/JPY trades between 0.03 and 0.04, and the USD/CAD trades between 0.02 and 0.03.

It is possible to buy and sell a large number of shares without changing the price of a share, but it is not possible to buy and sell a large number of currency pairs without changing the price of the currency pair.

This is because the price of a currency pair is based on the value of two currencies relative to one another. When you buy the USD/CAD, you are not just buying the Canadian dollar; you are buying it concerning the US dollar.

The USD/CAD is the relative value of the US dollar to the Canadian dollar. When you buy the USD/CAD, you are purchasing the US dollar in relation to the Canadian dollar, which is why the price of the USD/CAD will rise or fall with fluctuations in the price of the Canadian dollar.

To buy and sell many currency pairs without affecting the currency pair's price, you must purchase and sell the same value of currency pairs.

Conclusion

Deviations can be difficult to predict, but you will better understand how a deviation works if you follow the above steps. When you learn how one currency pair trades in relation to another currency pair, you will better understand how the market works in general.

Bound shows you live exchange rates in the forex market with our auto hedging platform dedicated to making currency protection better for businesses. We work with a range of providers, but unlike a bank or broker, we can instantly give you the best rate without you having to pick up a phone. By using our proprietary tech, we can streamline and automate much of what used to be manual processes, optimising your trades in real-time whilst giving you total visibility on what’s happening. If you’re looking for an fx risk protection for businesses, we can help. Sign up today!

Share on :
Twitter iconLinkedin iconFacebook

Related Blogs