US Dollar Nears Critical Support – When Might we Buy?

– Forex Volatility prices are near year-to-date lows
– The US Dollar trades at critical support
– We won’t buy until we see a turn in FX trader sentiment

The US Dollar has started the week lower, but the fact that the DJ FXCM Dollar Index trades at key moving average support suggests that further downside may be limited. Forex volatility prices likewise continue trading near year-to-date lows, which in itself suggests that few are betting on or hedging against continued Greenback weakness.

How might we trade here?

Forex Volatility Prices Continue to Drop as Traders Bet on Slow Market Moves
Source: OTC FX Options Prices from Bloomberg; DailyFX Calculations

As we wrote last week, extremely low volatility typically favors simple range trading strategies. That is—buying at the lows/support and selling at the highs/resistance.

Our trend-following Momentum2 trading strategy had previously done well selling into US Dollar weakness, but current market conditions suggest they might do less-well until we see a further breakdown/breakout in the USD.

The Momentum2 system buys when our retail forex sentiment data shows that most traders are selling. It tends to do well in times of strong trends and poorly during slower market conditions.

That said, a turn in sentiment could serve as the first sign that this is indeed the start of an important US Dollar reversal. We’ll cautiously continue to favor our Momentum2 trading system until further notice. And indeed, a bigger shift in volatility prices could help confirm a USD turnaround.

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DailyFX Individual Currency Pair Conditions and Trading Strategy Bias
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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.
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