- Forex volatility rise notably ahead of US Federal Reserve interest rate decision
- We see the potential for a trend shift and will watch the Momentum2 strategy in particular
- The strong risk of major volatility in the JPY likewise favors the Breakout2 trading system
It’s shaping up to be a big week for FX markets as key central bank meetings set the stage for big currency volatility. Here’s what we’re watching.
All eyes turn to the highly-anticipated US Federal Open Market Committee interest rate decision on Thursday as short-term FX volatility prices/expectations jump to important highs. Traders widely expect that the US central bank will leave interest rates unchanged. Yet a key question is whether Fed officials will shift rhetoric and hint towards raising interest rates at their last meeting of 2015 in December.
The US Dollar trades at multi-month highs versus the Euro, and any major disappointments from the FOMC could change that in a hurry. It is with this in mind that we cautiously look to trade the Momentum2 trading system in the EUR/USD pair in the week ahead. The system looks to trade major shifts in crowd sentiment and is often the first to switch direction if we see a notable change in direction.
Our DailyFX volatility indices show broader 1-week FX volatility prices at their highest in over a month, and the risk of big moves is especially elevated in the Japanese Yen. A strong correlation between the USD/JPY and interest rate expectations suggests it would likely see strong reactions to any surprises out of the Fed meeting.
Short-Term Volatility Prices Jump Ahead of key Fed Decision
Data source: Bloomberg, DailyFX Calculations
We’ll keep an eye on our volatility-friendly Breakout2 system on JPY pairs; as it stands we believe it is in a position to do well in the EUR/JPY and potentially other risk-sensitive Yen exchange rates.
See the table below for full detail on market conditions and preferred trading strategies.
DailyFX Individual Currency Pair Conditions and Trading Strategy Bias
Understand the Breakout2 Trading System via our previous article
Auto trade the trend reversal-trading Momentum2 system via our previous article.
Trade with strong trends via our Momentum1 Trading System
Use our counter-trend Range2 Trading system
--- Written by David Rodriguez, Quantitative Strategist for DailyFX.com
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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.
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