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US Dollar Trading Favors Trend Strategies, but Reversal Risk High

US Dollar Trading Favors Trend Strategies, but Reversal Risk High

2012-01-09 18:00:00
David Rodriguez, Head of Product
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A sharp drop in forex volatility expectations suggests the US Dollar may move little in the days ahead. Yet overriding trends favored continued Greenback highs and EURUSD lows.

DailyFX Individual Currency Pair Conditions and Trading Strategy Bias

forex_forecast_us_dollar_market_conditions_body_Picture_1.png, US Dollar Trading Favors Trend Strategies, but Reversal Risk High

DailyFX PLUS System Trading SignalsOur trend trading systems have aggressively bet into US Dollar strength through the first week of the year, and we expect similar trades into the days ahead. Given the consistency of Greenback rallies, there is little obvious reason to go against it. The major caveat remains that US Dollar sentiment is at or near bullish extremes against the Euro and other key currencies.

If the EURUSD does indeed turn, we expect a reversal to be swift and quite sharp. It is obviously difficult to plan around that, however, so we will stick to our overall bearish bias and keep risk relatively tight.

Market Conditions:

Volatility expectations have fallen sharply into the second week of the year, and indeed it seems that traders are pricing in low-volatility trend conditions until further notice. The clear caveat here is that low vols suggest that markets are becoming increasingly complacent. Volatility tends to be mean-reverting. That is to say: it can’t stay depressed without end, and any jump could be substantial.

Again, it’s difficult to form a trading plan around an event you can’t predict. Thus we will stick to our trend trading/range trading biases until we see reason to do otherwise.

forex_forecast_us_dollar_market_conditions_body_Picture_2.png, US Dollar Trading Favors Trend Strategies, but Reversal Risk High

--- 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.

DailyFX provides forex news and technical analysis on the trends that influence the global currency markets.

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