US Dollar Stabilizes, but Has it Bottomed?

DailyFX

Summary: Our retail sentiment-based evidence suggests that the US Dollar may have set an important bottom versus the Australian and New Zealand Dollars. Yet market conditions warn that it may be difficult for the USD to bottom as volatility is extremely low. We weigh pros/cons of USDOLLAR-long positions.

DailyFX Individual Currency Pair Conditions and Trading Strategy Bias

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DailyFX PLUS System Trading SignalsThe US Dollar (ticker: USDOLLAR) seems to have stabilized versus the Euro and the Australian Dollar. Yet are market conditions conducive to an important USD turnaround?

Our strategy bias remains mostly unchanged as our “Tidal Shift”/Momentum2 strategy continues to place strong trades across the board, and it is worth noting that said system has sold the Australian Dollar and New Zealand Dollar. The subsequent question is clear—does our trend-trading bias on both of these pairs support AUDUSD and NZDUSD shorts?

The answer is less clear, but ultimately favorable reward to risk on these positions leaves us in favor of getting long the US Dollar. As it stands the Australian Dollar is already 200 pips off of its September high, and a break below $1.0395 would give us a bearish short-term trading bias.

As far as other US Dollar pairs are concerned, we may want to see a more substantive shift in sentiment before calling for a larger turnaround. If we see crowds rush to buy EURUSD declines, we will likely see our “Tidal Shift” system go short.

Past performance is not indicative of future results, but that particular system’s performance tends to be very streak-prone. If it is doing well, it has historically done well for weeks and months at a time. We might be in the middle of one of those winning streaks—leaving us broadly in favor of Tidal Shift’s sentiment-based trades.

Market Conditions:

Extremely low forex options market volatility expectations suggests that currencies will continue to move in tight intraday ranges.

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Yet it is critical to note that volatility may in fact be too low and we may in fact be at a potential extreme. The chart below shows that 1-month EURUSD options price their lowest volatility since the Euro topped near $1.33 in May of this year and all-time highs of $1.60.

Major tops and bottoms are only clear in hindsight, but we see legitimate risk of a US Dollar turnaround given evidence of complacency across financial markets.

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

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Meet the DailyFX team in Las Vegas at the annual FXCM Traders Expo, November 2-4, 2012 at the Rio All Suite Hotel & Casino. For additional information regarding the schedule, workshops and accommodations, visit the FXCM Trading Expo website.

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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