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Complacency Sets Stage for US Dollar Losses, Euro and Aussie Gains

DailyFX Individual Currency Pair Conditions and Trading Strategy Bias

forex_strategy_us_dollar_volatility_audusd_body_Picture_1.png, Complacency Sets Stage for US Dollar Losses, Euro and Aussie Gains

DailyFX PLUS System Trading Signals The Euro and Australian Dollar have started the week mostly unchanged against the US Dollar (ticker: USDOLLAR), but important declines in forex volatility suggest the EURUSD and AUDUSD may continue to gain in the week ahead.

Our DailyFX Volatility Indices show that options traders expect the smallest FX market moves since the onset of global financial crises in 2007 and 2008. Given a strongly negative correlation between the USDOLLAR and financial market volatility, we believe that such low levels set the stage for Dollar weakness.

As far as strategy selection goes, however, last week’s choppy price action emphasizes that traders should not chase price lower. In other words—our bias calls for US Dollar weakness, but we would not necessarily sell fresh USD lows versus the Euro or Australian Dollar.

Conditions may actually favor range trades that buy EURUSD and AUDUSD dips as long as each pair remains above key price support levels. The Euro is currently trading at important technical resistance, and a break higher would expose a move towards important multi-month highs of $1.2750. Yet we can’t ignore the possibility that the pair may test significant support at 1.2240, and long positions against such a level offer strong risk/reward.

We likewise see scope that the AUDUSD may trade as high as 1.0700 before risking substantial reversal. That said, the major caveat with our volatility-based currency forecasts is that volatility can be strongly mean-reverting. In other words, periods of exceedingly low volatility may lead to substantial breakouts.

As always we advise against trading with excessive leverage, but recent price trends suggest selling US Dollar rallies may provide attractive risk-to-reward levels amidst the broader downtrend.

Market Conditions:

Forex options volatility expectations are near their lowest levels since the onset of global financial crises in 2007 and 2008. A sharply negative correlation between our DailyFX 3-month Volatility Index and the Dow Jones FXCM Dollar Index suggests that the USD may continue to underperform in such market conditions.

The major caveat remains that exceedingly low volatility may lead into larger market breakouts. We’ll keep a close eye on any fast moves in market conditions and post updates on the Real Time News feed.

forex_strategy_us_dollar_volatility_audusd_body_Picture_2.png, Complacency Sets Stage for US Dollar Losses, Euro and Aussie Gains

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

To contact David, e-mail drodriguez@dailyfx.com

To be added to David’s e-mail distribution list for this and other reports, e-mail subject line “Distribution List” to drodriguez@dailyfx.com

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.

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