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Forex Analysis: Low Volatility Favors Dolllar Reversal

Forex Analysis: Low Volatility Favors Dolllar Reversal

2012-10-29 16:00:00
David Rodriguez, Head of Product
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Article Summary: Extremely low forex volatility levels warn against chasing US Dollar strength as it starts the week higher. We continue to favor low-volatility range trading until further notice. Yet it will be critical to watch US economic event risk in what may be a busy week of forex trading.

DailyFX PLUS System Trading SignalsThe US Dollar (ticker: USDOLLAR) has rallied to start the week, but a busy US economic calendar and adverse market conditions warn that the USD could see sharp pullbacks in the days ahead.

Our US Dollar forecast remains cautiously bearish as our FX Options market-based DailyFX Volatility Indices remain near their lowest levels since 2007. The safe-haven currency typically strengthens during times of market turbulence, and the fact that traders are betting on such small forex market moves favors USD weakness.

Yet the critical caveat is that forex economic event risk is quite elevated in the days ahead—especially with the US Nonfarm Payrolls report for October due Friday. If we see any especially significant surprises, expect US Dollar pairs to respond in kind.

In terms of currency trading strategy, we’ll continue to favor low-volatility trading systems such as our proprietary “Congestion Opportunities”/Range2. That said, our trend-based “Tidal Shift”/Momentum2 has been doing well in selling the US Dollar through recent trading. We remain in favor of trend trades in key FX pairs—full summary in the table below.

DailyFX Individual Currency Pair Conditions and Trading Strategy Bias

forex_strategy_favors_us_dollar_weakness_body_Picture_1.png, Forex Analysis: Low Volatility Favors Dolllar Reversal

The US Dollar rally to start the week might present a good selling opportunity, but first we would like to see similar signs of turnaround. That would come on fresh “Tidal Shift” positions, and we’ll be looking at trade opportunities in the EURUSD and AUDUSD in particular.

Fresh selling opportunities in the Japanese Yen might come on the heels of the Bank of Japan interest rate decision. We see evidence that the USDJPY may have set an important bottom, but the Japanese Yen’s next moves will very much depend on the trajectory of US Treasury yields and broader interest rates.

US Dollar/Japanese Yen versus US 2-Year Treasury Yield

forex_strategy_favors_us_dollar_weakness_body_Picture_2.png, Forex Analysis: Low Volatility Favors Dolllar Reversal

Market Conditions:Our DailyFX Volatility Indices remain at their lowest levels since 2007. Such slow market conditions may be unsustainable given significant risks to global financial markets. Yet we think it’s unwise to bet on strong currency moves when the trend towards lower volatility is crystal-clear.

DailyFX Volatility Indices from 2011-2012

forex_strategy_favors_us_dollar_weakness_body_Picture_3.png, Forex Analysis: Low Volatility Favors Dolllar Reversal

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

To receive the Speculative Sentiment Index and other reports from this author via e-mail, sign up to David’s e-mail distribution list via this link.

Contact David via

Twitter at http://www.twitter.com/DRodriguezFXFacebook at http://www.Facebook.com/DRodriguezFX

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 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.

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

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