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US Dollar Breaks Out - Here's How We Like Playing It

US Dollar Breaks Out - Here's How We Like Playing It

2013-05-20 14:00:00
David Rodriguez, Head of Product
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Article Summary: The US Dollar surge seems like the beginning of a much larger move, and our volatility-friendly and trend-following trading strategies look attractive in the week ahead.

DailyFX PLUS System Trading Signals Big moves in forex markets can often lead to periods of consolidation and/or pullbacks, but it’s shaping up to be another big week for the US Dollar (ticker: USDOLLAR). Why?

We think the surge in forex volatility prices points to much larger US Dollar moves ahead. (Read what I wrote on Friday for full explanation on why I think this is only the beginning for the resurgent USD.)

To summarize: we came into this recent Dollar surge on the lowest FX market volatility in years, and there are plenty of reasons to believe this is likely the “year of the breakout.”

We look to FX options markets to gauge how much traders are paying/receiving for volatility, and it’s definitely worth noting that 1-month vols trade near year-to-date peaks on major US Dollar pairs(See chart below). Japanese Yen volatility, on the other hand, has recently come off of multi-year peaks. Together with clear signs of a popular sentiment extreme in the JPY, the drop in vols suggests the USDJPY could almost certainly see an important pullback.

1-Month Volatility Prices across Major Pairs versus Japanese Yen Pairs

us_dollar_breakout_trading_setups_body_Picture_1.png, US Dollar Breaks Out - Here's How We Like Playing It

Source: OTC FX Options Prices from Bloomberg, DailyFX Calculations

When I discuss vols in the context of broader currency moves, I most often need to take the extra step of translating it into actionable trade ideas. But if you’re reading this report, you’re probably aware of our sentiment-based trading strategies and the fact that different strategies fit various market conditions better than the others.

Right now I think the volatility-friendly Breakout2 trading system and the trend-following Momentum2 strategy stand to do well. Range2 is not in a great position as volatility hits fresh peaks.

View the table below to see our strategy preferences broken down by currency pair.

DailyFX Individual Currency Pair Conditions and Trading Strategy Bias

us_dollar_breakout_trading_setups_body_x0000_i1026.png, US Dollar Breaks Out - Here's How We Like Playing Itus_dollar_breakout_trading_setups_body_1a.png, US Dollar Breaks Out - Here's How We Like Playing It

It’s shaping up to be another big week for the resurgent Greenback, and I like trading it higher across most major counterparts except the Japanese Yen. This admittedly leaves an unclear trading bias for the USDJPY, but if anything I would look for the first opportunity to go long JPY against the Swiss Franc, Euro, Australian Dollar, or other counterparts in the days ahead. (short CHFJPY, AUDJPY, EURJPY, etc…)

View how to automate the high-volatility Breakout2 Trading System via our previous article and webinar recording

Auto trade the trend reversal-trading Momentum2system via our previous article and webinar recording.

Use our counter-trend Range2 Trading system and view an archived webinar guide on automation

--- 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/DRodriguezFX

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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