Dollar and Yen Likely to Slow Down – Here’s What We’re Watching

Article Summary: After a week of some truly violent moves in the Japanese Yen, forex markets seem likely to slow down in the week ahead. How might we trade such a slowdown?

DailyFX PLUS System Trading Signals – Volatility prices have dropped as markets seem likely to catch their breath after last week’s panic-driven forex moves. Yet everything’s relative—even slower price moves haven’t stopped the USDJPY from rallying over 400 pips from last week’s lows. What’s our next move?

I wrote last week that it seemed we were in the early stages of a market deleveraging, and big volatility would likely result in substantial Japanese Yen strength. That forecast worked out better than I could’ve reasonably imagined as we saw carnage in the extremely crowded JPY-short trade (USDJPY long). If I’m right in calling for a slowdown in FX market moves, we’ll likely see (and have seen) the opposite: a USDJPY bounce and broader Dollar recovery.

Short-dated forex volatility prices (chart below) have come off of recent peaks, while more medium-term expectations have remained relatively steady.

That makes short-term trading admittedly a bit confusing: we don’t want to lose sight of the fact that forex market conditions have likely seen a substantive shift.

Forex Options Market Volatility Prices Across Major Pairs
Source: OTC FX Options Prices from Bloomberg, DailyFX Calculations

Past performance is not indicative of future results, but our sentiment-based trading strategies have done well amidst recent moves. The risk is obvious as nothing moves in a straight line, and it would be natural for the same strategies to give back some of their recent gains. In other words: now is probably not the time to press our trades.

Strategy preferences remain roughly unchanged with a couple of key caveats. Our Breakout2 trading system had a banner week of performance on the massive Japanese Yen surge and could potentially do well across a number of pairs. But it would be poorly positioned for a JPY pullback (currently underway) as it has historically done poorly amid sharp market reversals.

Our major preference thus turns to the Momentum2 strategy—also known as the “Tidal Shift” system. It was named “Tidal Shift” because it was designed to catch major market reversals. And if this is indeed the start of key short-term reversals, it could potentially do well across key JPY and US Dollar pairs.

View the table below to see our strategy preferences broken down by currency pair.

DailyFX Individual Currency Pair Conditions and Trading Strategy Bias
View how to automate the high-volatility Breakout2 Trading System via our previous article and webinar recording
Auto trade the trend reversal-trading Momentum2system via our previous article and webinar recording.
Use our counter-trend Range2 Trading system and view an archived webinar guide on automation
— 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.
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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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Source: Daily fx