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US Dollar Breaks as Volatility Tumbles - How do We Trade?

US Dollar Breaks as Volatility Tumbles - How do We Trade?

David Rodriguez, Head of Product

DailyFX Individual Currency Pair Conditions and Trading Strategy Bias

forex_strategy_us_dollar_breakdown_trade_opportunities_body_Picture_1.png, US Dollar Breaks as Volatility Tumbles - How do We Trade?

DailyFX PLUS System Trading SignalsThe US Dollar (ticker: USDOLLAR) has finally broken out of its tight trading range against the Euro and other major counterparts, but extremely low volatility expectations make significant dollar losses unlikely.

In our weekly trading forecast we underlined the reasons for which we believed the sudden US Dollar downtrend could prove short-lived. And indeed, it seems like major FX market moves may need to wait until critical event risk in the month of September.

In the meantime we like range trading across the majority of USD currency pairs—selling large intraday bounces and buying sharp declines. As far as our DailyFX PLUS Trading Signals systems go, this means favoring “Range2”/”Congestion Opportunities” trades. More generally, benchmark range trading strategies tend to do well during slow-moving markets.

Market Conditions:

FX Options traders are now paying the lowest prices for volatility since the onset of the global financial crises in 2007/2008, and exceedingly low volatility expectations give us little reason to expect big moves. There is clear risk that we may be witnessing extreme market complacency and the “calm before the storm”. Yet we’ll need to see a clear catalyst that breaks the trend of lower lows in volatility expectations.

forex_strategy_us_dollar_breakdown_trade_opportunities_body_Picture_2.png, US Dollar Breaks as Volatility Tumbles - How do We Trade?

Low volatility likewise favors US Dollar weakness through normal market conditions. Yet it’s worth noting that the short-term correlation between volatility and the USDOLLAR has weakened considerably through recent price action. The disconnect between vols and the US Dollar gives us further reason to believe that a bigger USD breakdown is unlikely through the foreseeable future.

forex_strategy_us_dollar_breakdown_trade_opportunities_body_Picture_3.png, US Dollar Breaks as Volatility Tumbles - How do We Trade?

--- Written by David Rodriguez, Quantitative Strategist for DailyFX.com

Meet the DailyFX team in Las Vegas at the annual FXCM Traders Expo, November 2-4, 2012 at the Rio All Suite Hotel & Casino. For additional information regarding the schedule, workshops and accommodations, visit the FXCM Trading Expo website.

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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