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Low Forex Volatility Favors Dollar Weakness, Range Trading

Low Forex Volatility Favors Dollar Weakness, Range Trading

2012-08-13 16:15:00
David Rodriguez, Head of Product
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DailyFX Individual Currency Pair Conditions and Trading Strategy Bias

forex_strategy_outlook_forecast_trading_body_Picture_1.png, Low Forex Volatility Favors Dollar Weakness, Range Trading

DailyFX PLUS System Trading SignalsForex traders continue to predict the smallest US Dollar (ticker: USDOLLAR) moves since the onset of global financial crises in 2007/2008, and such low expectations point to low-volatility range trading in the week ahead.

As we wrote in last week’s strategy outlook report, FX market complacency sets the stage for US Dollar losses. This week our outlook remains mostly unchanged as the US currency trades towards fresh lows. Yet it is worth noting that the Dollar remains surprisingly resilient versus the similarly-downtrodden Euro.

Given clear expectations of slow currency moves, we favor range trading strategies across the majority of US Dollar pairs in the weeks ahead. As we detail in our Traits of Successful Traders series, it is critical to match trading style to market conditions. In this instance, exceedingly low volatility levels favor range trading systems such as Relative Strength Index (RSI)-based “Congestion Opportunities”/Range2 strategies on DailyFX PLUS.

Else it seems as though low-volatility “Risk On” trades stand to do well. Last week we wrote that the Australian Dollar—a major recipient of “Risk On” money flows—stood to reverse against the US Dollar amidst such complacency. Yet we will have to see signs that volatility will move higher given such exceedingly low levels.

Market Conditions:

As we wrote last week, FX Options point to the smallest market moves since the onset of global financial crises in 2007 and 2008. Volatility tends to be mean-reverting; if vols are extremely low, they will often bounce. Yet timing that bounce remains all but impossible as the same argument could have been made a month ago.

We’ll cautiously favor low-volatility strategies and direction until further notice. Yet it is important to note that volatility could return at a moments’ notice, and these levels are consistent with past instances of financial market complacency.

forex_strategy_outlook_forecast_trading_body_Picture_2.png, Low Forex Volatility Favors Dollar Weakness, Range Trading

--- 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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