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Forex Market Conditions Favor Selling US Dollar, JPY Strength

By , Quantitative Strategist
22 October 2012 15:30 GMT

Article Summary: We remain bearish the US Dollar and Japanese Yen as forex market conditions favor further losses in the safe-haven currencies. We will look for any noteworthy USD and JPY bounces to sell into strength, while range trading most broadly represents our favored trading style in the week ahead.

DailyFX PLUS System Trading SignalsWe favor selling US Dollar (ticker: USDOLLAR) and Japanese Yen strength as forex volatility remains low—which strategies stand to do well in these market conditions?

The DailyFX Volatility indices continue near 5-year lows as FX Options traders bet on the slowest forex market moves since 2007. As we wrote last week, real forex trader data emphasizes that slow market conditions favor specific trading styles.

When volatility is very low, we most often look to range trade—buying low and selling high. In concrete terms this means monitoring systems such as our proprietary “Congestion Opportunities”/Range2 strategy.

In more general terms we can watch technical indicators such as the Relative Strength Index to identify overbought or oversold conditions across forex pairs and trade accordingly.

DailyFX Individual Currency Pair Conditions and Trading Strategy Bias

forex_trading_strategy_us_dollar_japanese_yen_body_Picture_1.png, Forex Market Conditions Favor Selling US Dollar, JPY Strength

We will thus look for opportunities to sell into US Dollar and Japanese Yen strength. Both the US currency and the Yen tend to do poorly in quiet market conditions; if they strengthen they are unlikely to hold gains.

Such trades could come from our Range2/”Congestion Opportunities” system or our trend-based Momentum2/”Tidal Shift” strategy. Indeed, the Momentum2 strategy is currently heavily short the Japanese Yen as it has gone long the USDJPY, CHFJPY, EURJPY, and GBPJPY.

The key to watch for the JPY itself will be the next moves in US Treasury Yields. The chart below highlights the strong link between US interest rates and moves in the USDJPY pair. Given a recent jump in yields, the USDJPY has rallied. Yet such an interest rate-driven move will be put to the test on the key US Federal Open Market Committee rate announcement.

US Dollar/Japanese Yen versus US 2-Year Treasury Yield

forex_trading_strategy_us_dollar_japanese_yen_body_Picture_2.png, Forex Market Conditions Favor Selling US Dollar, JPY Strength

Low vols have likewise correlated with important US Dollar weakness, and that indeed is a major reason behind our broadly bearish USD trading bias. Given that we’re bearish both the US Dollar and the Japanese Yen, the best JPY trade setups could in fact come in other JPY cross rates (e.g. AUDJPY, EURJPY).

Market Conditions: Our DailyFX Volatility Indices remain at their lowest levels since 2007. Such slow market conditions may be unsustainable given significant risks to global financial markets. Yet we think it’s unwise to bet on strong currency moves when the trend towards lower volatility is crystal-clear.

DailyFX Volatility Indices from 2011-2012

forex_trading_strategy_us_dollar_japanese_yen_body_Picture_3.png, Forex Market Conditions Favor Selling US Dollar, JPY Strength

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

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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 90-day 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 90-day 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.

DailyFX provides forex news and technical analysis on the trends that influence the global currency markets.
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22 October 2012 15:30 GMT