Market Tensions Ease Ahead of ECB, NFPs - How Might we Trade?

DailyFX

- Forex market tensions have eased ahead of critical event risk this week

-Our focus will remain on two of our sentiment-based strategies: Breakout2 and Momentum2

- A potentially significant shift would mean big moves across Dollar and Yen pairs

Market tensions have eased ahead of a key ECB rate decision and a potentially pivotal US Nonfarm Payrolls report. How might we trade a major shift in market conditions?

We recently highlighted a big build in forex volatility expectations as a key reason to favor US Dollar and even Japanese Yen strength. And yet the Yen has resumed previous declines as the US S&P 500 recovers from recent losses. An ease in market tensions has likewise left volatility expectations lower.

What’s the key risk? Our Senior Currency Strategist Kristian Kerr writes that the recent rally in the S&P 500 may soon favor an important market reversal as investors may be overly optimistic. Timing is far from clear, however, and we clearly have to search for trades that might work in both “risk on” and “risk off” markets.

Forex Volatility Prices Drop, Showing an Ease in Market Tensions

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Source: OTC FX Options Prices from Bloomberg; DailyFX Calculations

Past performance is NOT indicative of future results, but our sentiment-based trading systems have done fairly well in mixed market conditions as of late. Specifically our contrarian Momentum2 system has done fairly well in several important currency pairs in shifting markets.

Yet arguably the greater potential is if market conditions once again become strained—something that seems possible ahead of critical market event risk in the next two days.

If market tensions do in fact flare up and volatility rises, we would then look to our volatility-friendly Breakout2 strategy as our preferred tool to take advantage of changing conditions.

Take a look at full strategy preferences below and sign up for future e-mail updates via my distribution list.

DailyFX Individual Currency Pair Conditions and Trading Strategy Bias

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--- 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.

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.

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