The Basics of the Olsen Scale

The Scale of Market Quakes (SMQ), simply known as Olsen Scale, is a tool that measures the impact of political and economic events on the currency markets. Just like how the Richter Scale measures the intensity of earthquakes, the Olsen Scale quantifies the “shocks” in the Forex market caused by events such as elections, economic news releases, and even the execution of large trade orders. The SMQ uses a scale of 0 to 6, with 6 having the highest impact.

But why “Olsen Scale,” you ask? Well, the tool is named after Jǿrgen Olsen, a physics professor who made a feasibility study for a first version of the SMQ in 1996.

Let’s look at a specific example so that you can understand the Olsen Scale better. Check out the U.S. retail sales report due next week:

If you’re wondering where we got this awesome diagram from, it’s all in our BabyPips.com Forex calendar. Just click on an upcoming event in the calendar then select the Olsen Scale tab, and voila! Pretty cool, huh?

The line graph (a) on the left side plots the historical average of USD prices versus the major currencies, while the blue area (b) underneath it shows the corresponding Olsen Scale values. In that area, you can see a green vertical line (c) that marks the date of the most recent release of the report. In this case, the green line falls on February 15, 2011, which means that the previous U.S. retail sales report was released then.

To the right of the SMQ chart, you can see a large blue number (d) which represents the SMQ value. In this example, the SMQ value, which is the average impact of the release on the USD, is 1.1.

And no, that diagram on the very right isn’t a squashed spider. That’s the SMQ radar, which gives a quick overview of the price action during the release. The currency in the middle (USD in this example) is called the “master currency” while the rest are called the “legs” of the radar.

The SMQ radar shows the impact of the previous report on each major currency pair. The SMQ radar above shows that GBP/USD had the largest price action during the February 15 U.S. retail sales release while USD/CHF had less pronounced movement then.

By using the Olsen Scale you can QUANTITAVELY measure the impact of a particular news event on price action instead of just using your gut feel. It also tells you exactly which currency pair will likely move the most. And since you can use the Olsen Scale to record a pair’s reaction to specific news releases, you can make a higher probability prediction on where price may go.

Let’s say you wanted to trade the U.S. Non-Farm payrolls. You can look at the Olsen Scale of the previous 12 releases to create a directional bias in your news trade. While it does not assure a win, it does help to tilt the odds in your favor. After all, one of the most important aspects in forex trading is creating an edge.

Needless to say, the Olsen Scale is a great tool to add to your trading toolbox, especially if you’re a scalper or a news trader.

For more information on the Olsen Scale, just head on over to http://www.olsenscale.com and please check out our Forex calendar for the latest Olsen scale measurements.

• Bernard

I’ve been kind of puzzled by the explanation on olsenscale.com (read: I didn’t take much time to read it all and read it thorough), but after reading the above it’s a lot clearer to me. I’ll definitely take a look at it now when trading the news. Thanks.

• Bernard

I’ve been kind of puzzled by the explanation on olsenscale.com (read: I didn’t take much time to read it all and read it thorough), but after reading the above it’s a lot clearer to me. I’ll definitely take a look at it now when trading the news. Thanks.

• andros

I understand the olsenscale better now but is there a way to understand which way the market is going other than it will have an effect on the market?

• andros

I understand the olsenscale better now but is there a way to understand which way the market is going other than it will have an effect on the market?