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US Dollar Targets Fresh Highs as Forex Volatility Elevated

By , Quantitative Strategist
28 May 2012 15:00 GMT

The US Dollar (ticker: USDOLLAR) continues to hit multi-year highs against the Euro and other counterparts. Risk of reversal is high as sentiment is extreme, but we favor buying US Dollar dips and selling EURUSD rallies.

DailyFX Individual Currency Pair Conditions and Trading Strategy Bias

forex_trading_forecast_market_conditions_body_Picture_1.png, US Dollar Targets Fresh Highs as Forex Volatility Elevated

DailyFX PLUS System Trading SignalsThe US Dollar (ticker: USDOLLAR) rally has thus far defied expectations in both speed and breadth, and a strong jump in forex options market volatility expectations suggests it could continue.

Our volatility-driven “Breakout Opportunities” (Breakout2) trading signals system remains our favored strategy amidst such strong market moves. Indeed, this system has historically done well when our “Volatility Percentile” readings have hit above 75 percent. It is based on a Channel Breakout forex trading system, which according to our automated trading research stands to do well during active markets. Our research similarly shows that low-volatility range trading systems do poorly in such market conditions, and as such caution is advised.

High volatility likewise favors specific currencies over others as we typically associate strong currency moves with investor fear. We specifically favor buying the safe-haven US Dollar and Japanese Yen against the high-yielding Australian Dollar and New Zealand Dollar.

Recent US CFTC Commitment of Traders data shows that large speculators recently hit their most net-long US Dollars against the Euro (short EURUSD) in history. Such extremely one-sided sentiment warns that counter-trend moves could be sharp and caution is advised. Yet we believe the broader trend remains clear, and the US Dollar remains poised to challenge fresh highs.

Market Conditions:

Forex options market volatility expectations continue near their highest levels of the year, and such sustained calls for currency breakouts give us firm conviction in our calls for major moves. In such an environment we will avoid range trading (attempting to pick tops or bottoms) and instead trade with broader market trends.

forex_trading_forecast_market_conditions_body_Picture_2.png, US Dollar Targets Fresh Highs as Forex Volatility Elevated

--- Written by David Rodriguez, Quantitative Strategist for DailyFX.com

To contact David, e-mail drodriguez@dailyfx.com

To be added to David’s e-mail distribution list for this and other reports, e-mail subject line “Distribution List” to drodriguez@dailyfx.com

Definitions

Volatility Percentile – The higher the number, the more likely we are to see strong movements in price. This number tells us where current implied volatility levels stand in relation to the past 90 days of trading. We have found that implied volatilities tend to remain very high or very low for extended periods of time. As such, it is helpful to know where the current implied volatility level stands in relation to its medium-term range.

Trend – This indicator measures trend intensity by telling us where price stands in relation to its 90 trading-day range. A very low number tells us that price is currently at or near monthly lows, while a higher number tells us that we are near the highs. A value at or near 50 percent tells us that we are at the middle of the currency pair’s monthly range.

Range High – 90-day closing high.

Range Low – 90-day closing low.

Last – Current market price.

Bias – Based on the above criteria, we assign the more likely profitable strategy for any given currency pair. A highly volatile currency pair (Volatility Percentile very high) suggests that we should look to use Breakout strategies. More moderate volatility levels and strong Trend values make Momentum trades more attractive, while the lowest Vol Percentile and Trend indicator figures make Range Trading the more attractive strategy.

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28 May 2012 15:00 GMT