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Forex Analysis: Fiscal Cliff Tensions Favor High-Volatility Strategies

By , Quantitative Strategist
31 December 2012 17:00 GMT

Article Summary: An important jump in market volatility expectations warns that the US Dollar and major FX counterparts could see sharp swings in the New Year, and we favor trend-following and volatility-friendly strategies into January.

DailyFX PLUS System Trading SignalsFX markets are pricing in an important jump in volatility as US Fiscal Cliff tensions boost safe-haven demand for the US Dollar, and the lack of resolution heading into the final trading hours of 2012 suggests further big moves are in store.

In fact our FX-Options-based DailyFX Volatility Indices are sharply off of their lows, and the S&P 500 Volatility Index (VIX) is above the psychologically significant 20 percent mark for the first time since June.

DailyFX 1-Month Volatility Index versus S&P 500 Volatility Index (VIX) in 2012

forex_strategy_outlook_us_dollar_fiscal_cliff_body_Picture_1.png, Forex Analysis: Fiscal Cliff Tensions  Favor High-Volatility Strategies

We will not place any new trades until the New Year, as low liquidity and potentially difficult trading conditions worsen the potential reward to risk of trading. Indeed, our sentiment-based trading systems have all been shut down for the year.

Yet the prospect of further US Dollar appreciation and broader market volatility leaves us mostly in favor of trend and breakout-trading strategies into the New Year. Early signs suggest that our trend-following “Tidal Shift/Momentum2” trading system and our volatility-friendly “Breakout Opportunities”/Breakout2 strategies stand to do well in January.

Strong trends in the Japanese Yen have been particularly beneficial to several of our strategies, and the prospect of further JPY weakness bodes well for said systems. It goes without saying that past performance is NOT indicative of future results, but the combination of recent outperformance in key systems and forward-looking market conditions leaves us optimistic for the New Year.

DailyFX Individual Currency Pair Conditions and Trading Strategy Bias

forex_strategy_outlook_us_dollar_fiscal_cliff_body_Picture_2.png, Forex Analysis: Fiscal Cliff Tensions  Favor High-Volatility Strategies

--- 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.

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31 December 2012 17:00 GMT