Forex Volatility Jumps, We Shift our Trading Focus
- Risk aversion sparks sharp market sell-offs across the globe, brings volatility risk
- US Dollar looks in trouble into the New Year, but so far it has strengthened
- Our focus has shifted to the volatility-friendly Breakout2 system with a clear caveat
A sharp overnight sell-off in Chinese equity markets set the stage for similar moves across broader Asian, European, and eventually North American markets. The inauspicious start for global equity markets led to strong volatility for the US Dollar and Japanese Yen in particular. And indeed, traders are now pricing in considerably stronger currency market moves as a result.
Our DailyFX Volatility indices show that short-term volatility prices have risen significantly on the first full trading day of the year.
FX Volatility Risks Rise Considerably on First Full Trading day of New Year
Data source: Bloomberg, DailyFX Calculations
The sharp shift in market conditions thus encourages us to focus on our volatility-friendly Breakout2 trading strategy until further notice. Past performance is not indicative of future results, and we were reminded exactly of said fact when the system performed especially poorly following the European Central Bank interest rate decision.
Yet a sustained build in market volatility would likely favor the trading system, and a jump in market expectations makes this the higher probability strategy.
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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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.
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DailyFX provides forex news and technical analysis on the trends that influence the global currency markets.