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2014 Promises Much Larger US Dollar Moves for this Reason

By , Quantitative Strategist
23 December 2013 17:30 GMT

- Dollar and major forex counterparts likely to see very small trading ranges in holiday-shortened week- We’re shifting away from our sentiment-based trading strategies until the New Year- Key shift in US Federal Reserve dynamics promises much larger FX volatility in 2014

Short-term forex volatility prices have fallen to their lowest levels on the year, and indeed it seems likely that major currency pairs will remain quiet in the final days of 2013. Yet longer-dated volatility prices are actually significantly off of their lows. What does this mean?

Short-term Forex Volatility Prices are Near Yearly Lows

forex_trading_focus_shifts_to_the_New_Year_body_Picture_1.png, 2014 Promises Much Larger US Dollar Moves for this Reason

Source: OTC FX Options Prices from Bloomberg; DailyFX Calculations

The US Federal Reserve’s recent decision to begin the so-called “Taper” of Quantitative Easing policies was a game-changer: interest rate expectations have suddenly picked up and taken FX volatility with them. To put this into context we look at what kind of effect yields have had on FX market volatility through recent history:

Forex Volatility Expectations Heavily Correlated to Yields, Point to Big Moves Ahead

forex_trading_focus_shifts_to_the_New_Year_body_Picture_2.png, 2014 Promises Much Larger US Dollar Moves for this Reason

The link between forex volatility prices and Eurodollar interest rate futures is now at its strongest in at least 5 years, and the fact that implied yields have broken higher suggests that that volatility can continue to rise. The Fed’s moves likewise have substantial implications on the Dollar:

US Dollar Stands to Rally Further Versus the Low-Yielding Japanese Yen

forex_trading_focus_shifts_to_the_New_Year_body_Picture_3.png, 2014 Promises Much Larger US Dollar Moves for this Reason

The Greenback has rallied significantly versus the low-yielding Japanese Yen as the Bank of Japan keeps interest rates exceptionally low. The potential for further rises in US interest rates could send the USDJPY exchange rate to further peaks.

Stay tuned for more on the USDJPY as we publish our top trades for 2014 in the coming week. Spoiler alert: mine will revolve around the Dollar and Yen in particular.

In the meantime, we’ll stay flat on our strategy trading biases but look to trade opportunities in the New Year.

forex_trading_focus_shifts_to_the_New_Year_body_Picture_4.png, 2014 Promises Much Larger US Dollar Moves for this Reason

forex_trading_focus_shifts_to_the_New_Year_body_Picture_5.png, 2014 Promises Much Larger US Dollar Moves for this Reason

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--- 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.

23 December 2013 17:30 GMT