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US Dollar Targets New Highs Despite Pullback on Strong FX Volatility

By , Quantitative Strategist
04 June 2012 16:30 GMT

The US Dollar (ticker: USDOLLAR) has pulled back against the Euro, but strong forex market volatility expectations suggest that the safe-haven USD may rally to fresh highs in the week ahead.

DailyFX Individual Currency Pair Conditions and Trading Strategy Bias

forex_strategy_us_dollar_forecast_euro_body_Picture_1.png, US Dollar Targets New Highs Despite Pullback on Strong FX Volatility

DailyFX PLUS System Trading SignalsThe US Dollar (ticker: USDOLLAR) has surged to fresh multi-year highs as strong forex market volatility favors the safe-haven currency. The highest forex market volatility expectations since January favors a further flight to safety and US Dollar strength through the foreseeable future.

Our preference remains to look for breakout trading opportunities, and indeed our bias remains unchanged since last week when we favored the same high-volatility strategies. In particular we like the “Breakout Opportunities” (Breakout2) system on our sentiment-based forex trading signals systems.

Our “Traits of Successful Traders” series underlines the importance of picking the right trading strategy in specific market conditions. Our research shows that Range Trading systems—buying currencies that have fallen and selling those that have strengthened—tend to do poorly during volatile markets. That leaves us little choice but to trade any “Congestion Opportunities” (Range2) trades with caution in the days ahead.

Volatility has historically shown a tendency to drive performance in Range and Breakout strategies, but its effects on Trend-based strategies are less clear-cut. A continued US Dollar uptrend would nonetheless favor systems such as “Trend Follower” (Momentum1) and “Tidal Shift” (Momentum2) in the days ahead.

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 and attempting to pick tops and bottoms.

This in particular suggests that attempting to sell into US Dollar strength seems ill-advised. Past performance is NOT indicative of future results, but we will err on the side of caution and trade into the broader USD uptrend.

forex_strategy_us_dollar_forecast_euro_body_Picture_2.png, US Dollar Targets New Highs Despite Pullback on Strong FX Volatility

--- 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.

HYPOTHETICAL PERFORMANCE RESULTS HAVE MANY INHERENT LIMITATIONS, SOME OF WHICH ARE DESCRIBED BELOW. NO REPRESENTATION IS BEING MADE THAT ANY ACCOUNT WILL OR IS LIKELY TO ACHIEVE PROFITS OR LOSSES SIMILAR TO THOSE SHOWN. IN FACT, THERE ARE FREQUENTLY SHARP DIFFERENCES BETWEEN HYPOTHETICAL PERFORMANCE RESULTS AND THE ACTUAL RESULTS SUBSEQUENTLY ACHIEVED BY ANY PARTICULAR TRADING PROGRAM.

ONE OF THE LIMITATIONS OF HYPOTHETICAL PERFORMANCE RESULTS IS THAT THEY ARE GENERALLY PREPARED WITH THE BENEFIT OF HINDSIGHT. IN ADDITION, HYPOTHETICAL TRADING DOES NOT INVOLVE FINANCIAL RISK, AND NO HYPOTHETICAL TRADING RECORD CAN COMPLETELY ACCOUNT FOR THE IMPACT OF FINANCIAL RISK IN ACTUAL TRADING. FOR EXAMPLE, THE ABILITY TO WITHSTAND LOSSES OR TO ADHERE TO A PARTICULAR TRADING PROGRAM IN SPITE OF TRADING LOSSES IS MATERIAL POINTS WHICH CAN ALSO ADVERSELY AFFECT ACTUAL TRADING RESULTS. THERE ARE NUMEROUS OTHER FACTORS RELATED TO THE MARKETS IN GENERAL OR TO THE IMPLEMENTATION.

OF ANY SPECIFIC TRADING PROGRAM WHICH CANNOT BE FULLY ACCOUNTED FOR IN THE PREPARATION OF HYPOTHETICAL PERFORMANCE RESULTS AND ALL OF WHICH CAN ADVERSELY AFFECT ACTUAL TRADING RESULTS. Any opinions, news, research, analyses, prices, or other information contained on this website is provided as general market commentary, and does not constitute investment advice. The FXCM group will not accept liability for any loss or damage, including without limitation to, any loss of profit, which may arise directly or indirectly from use of or reliance contained in the trading signals, or in any accompanying chart analyses.

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04 June 2012 16:30 GMT