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Will Currency Markets Repeat Strong Volatility on Thanksgiving?

Wednesday, 21 November 2007 14:57:23 GMT  |  David Rodriguez, Currency Analyst

Holiday-shortened trading weeks have historically brought narrow trading ranges to the forex market, but recent volatility clearly shows that traders remain willing to force major moves ahead of the typically illiquid Thanksgiving holiday. Given that virtually all US financial markets will be closed on Thursday, November 22nd, there will be significantly less forex interest from major market makers and speculators. Yet it is exactly this market illiquidity that allowed speculators to drive the US dollar significantly lower through last year’s Thanksgiving holidays, and it remains relatively unclear whether or not we will see a repeat in the days ahead. The dollar has already posted its single-largest daily decline in over a year through Tuesday’s trading, and it seems that volatility may continue through the week ahead. Yet a 10-year study of average daily ranges over Thanksgiving clearly suggests that we may see progressively narrower ranges through Thanksgiving.

On Average, Thanksgiving Brings Range Trading – But What About the Exceptions?

 Last year’s Thanksgiving holiday brought substantial volatility to US dollar pairs, and in fact we saw sizeable breakouts from previously narrowing trading ranges. Though it is difficult to isolate the exact causes of such a spike, it does remain clear that forex market conditions were fairly different then than they are now.

  

One of the most salient differences between 2006 and 2007 has been the steadily increasing trading ranges in the key EURUSD currency pair. We can remember that the euro was trading within a progressively narrower trading range through the second half of 2006, with the chart above emphasizing smaller Average True Range from the peaks seen through May. At the time, directionless trade left little bias for the euro and other major currencies. Yet such conditions clearly shifted when major traders capitalized on limited liquidity to force substantial breakouts through the Thanksgiving holiday. We saw very similar results in 2004, when narrowed trading ranges eventually allowed for a similarly pronounced breakout in the EURUSD pair.

 

 Though the 2004 breakout was not nearly as pronounced as that of 2006, the Euro did manage to break through topside resistance to fresh all-time highs against the US dollar. This move was similar to that of 2006 in that the majority of price movement occurred on the day after Thanksgiving, which is similarly illiquid on limited interest from North American forex traders. A longer-term study suggests that the Friday after the Thanksgiving holiday produces, on average, relatively normal price ranges in the EURUSD (See table on first page). Yet we see two distinct similarities between the two years of above-average volatility in the EURUSD. Namely, price action had seen progressively narrower ranges heading into both events, while the majority of price movements happened the day following the Thanksgiving holiday.

Can we see a substantial breakout through the coming holiday weekend?

Looking at past years of Thanksgiving holiday weekend volatility, we believe that current market conditions will make for significantly less eventful end-of-week trade. Breakouts in 2004 and 2006 were preceded by shrinking volatility and trading ranges across all major forex pairs, and traders subsequently took advantage of limited liquidity to force breakouts in these currencies. Yet we see that volatility remains ample through recent trade, and continued breakouts in the EURUSD leave little motivation to force further volatility in the days ahead. Though anything can happen when trading volumes remain increasingly thin, we believe that risks remain for a slowdown in price movements in the days ahead.

 

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