US Dollar Trading Strategy for a Potential Breakdown

DailyFX

- US Dollar trades at pivotal support

- A Dollar breakdown could lead to much sharper market volatility

- Range trading favored, but we'll use our sentiment-based strategy to position for USD breakdown

The Dow Jones FXCM Dollar Index continues to trade at critical support levels, and the next move could be decisive.

Currencies will often make their highs and lows at the beginning and end of each calendar period; the fact that we are just now starting the Fourth Quarter suggests this could be a key turning point in FX pairs.

How might we trade here?

Forex Volatility Prices Continue to Drop as Traders Bet on Slow Market Moves

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Source: OTC FX Options Prices from Bloomberg; DailyFX Calculations

Our trend-following Momentum2 trading strategy had previously done well selling into US Dollar weakness, and the system may be well-positioned to trade a USD breakdown or reversal. We like following Momentum2’s next signal on the EURUSD, GBPUSD, USDJPY, and other Dollar pairs.

The key caveat is that these systems might do poorly if market volatility remains especially low for an extended period of time.

Volatility prices continue to trade near year-to-date lows, and as we wrote last week such slow conditions typically favors range-trading strategies. Or in other words: buying the USD near its lows and selling near the highs.

Yet the possibility of a major US Dollar breakdown or move higher suggests we should remain nimble. We’ll position ourselves for the next major Dollar move higher or lower via our sentiment-based trading systems.

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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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