DailyFX+ Market Conditions Outlook

NOTE: Data has once again been changed. Due to the ineffectiveness of the 30-day horizon, we are returning to the original 90-day time horizon.

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 30 trading-day range. A very low number tells us that price is currently at or near monthly 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 monthly range.

Range High – 30-day closing high.

Range Low – 30-day closing low.

Last – Current market price.

Strategy – 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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Forex Strategy Outlook: US Dollar Action Bodes Well for Range Systems

Forex markets have remained rangebound as of late, boosting the appeal of currency range trading strategies. Indeed, the Euro/US Dollar currency pair initially looked as if it would break above critical resistance—ending the past month of directionless price action. Yet a US Dollar bounce quickly put an end to a sustained breakout. As a result, we continue to favor Range systems in our forex trading strategies.

We reluctantly shifted our trading biases away from Momentum systems exactly one week ago, and that has worked in our favor. Though Momentum1 and Momentum2 trading signals typically offer superior risk/reward profiles than the Range systems, current market conditions make it especially difficult to pursue trend-based trading strategies. Absent a noteworthy shift in volatility expectations, we will continue to favor systems that do well in low-volatility environments. Namely, Range-based signals and to a lesser degree, very short-term Breakout systems.

Recent market conditions have been especially challenging for trend-following Momentum1 and Momentum2 systems, while Range1 and Range2 systems have put in better performances on choppy price action. We have historically preferred higher-reward Momentum and Breakout systems, but it is clearly frustrating when currencies remain in small ranges for extended periods of time.

In our opinion, risk/reward almost always favors lower probability trend trades. Yet we cannot ignore that volatility expectations remain exceedingly low, and a steady succession of trend trade losses can frustrate even the most seasoned traders. Given such factors, we will favor Range1 and Range2 trades for the time being—treating Momentum and Breakout system trades with caution until we break out of key ranges.

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Post of the Day: Evening Star

Student’s Question:

Can candlestick patterns be used as conformational indicators?

Power Course Instructor’s Response:

Sure…

Take a look at the chart below…

We see a very well established trendline in place for about 4 months. A break of trendline support occurs when the bearish candle closes below the trendline. That in itself is significant. However, the pattern of which that candle is a part is an Evening Star. Since an Evening Star is a bearish signal, this would lend even more significance to the break of support.

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Dollar Edges High as Growth and Risk Factors Shift

The US dollar has appreciated steadily against most of its major counterparts this past week (the notable exception being USDJPY). However, the greenback’s rise has been conspicuously reserved. Realistically though, most markets are following the same slow pace. This is due to a sense of equilibrium that has fallen over the market.

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Forex Correlations (July): How Do Currencies Move In Relation To Each Other?

Over the past month, volatile risk fluctuations have settled and put the focus back on the theme of the US dollar against all its major counterparts. This is largely a reflection of the importance of growth (as the US is the largest economy in the world and is therefore expected to pace a recovery) and the greenback’s position as the world’s reserve currency.

The following is our monthly correlations update for July. As we have stated time and again, correlations between different currency pairs will inevitably shift over time. Therefore, it is of utmost importance to keep abreast of these fluctuating relationships to fully understand your trades and portfolio. Below are the one-, three-, six- and twelve-month correlations for the seven major currency pairs. Additionally, we have included the six-month trailing correlation for the majors against the EURUSD for a different view of correlation.

In order to be an effective trader, it is important to understand how different currency pairs move in relation to each other. There are a few reasons why this is significant, but most importantly, it allows traders to understand their exposure. For example, having a portfolio that consists of the EURUSD and AUDUSD is different than having a portfolio comprised of EURUSD and USDCHF. Over the past month, volatile risk fluctuations have settled and put the focus back on the theme of the US dollar against all its major counterparts. This is largely a reflection of the importance of growth (as the US is the largest economy in the world and is therefore expected to pace a recovery) and the greenback’s position as the world’s reserve currency. With the dollar taking its place as the universal counterpart once again, we have seen the USDCHF ease its correlation to general risk appetite and aversion and take up as the counterpoint to EURUSD once again (-0.91). The same would happen as much for the yield heavy pairs as the anemic. Like EURUSD, AUDUSD holds a significant interest income; yet it is clearly the dollar’s influence guiding this pair as the shifts in correlation have changed little from last month (0.76) to current levels (0.74). From a trading perspective, this means that having long exposure in both EURUSD and USDCHF would offset much of the profit or loss that could be derived by holding a single position because when EURUSD rallies, USDCHF will sell off the majority of the time. Of course, these two currencies may have different pip values and the correlation is not perfect, so the P/L will not be exactly zero. On the other end of the scale, holding long EURUSD and AUDUSD positions would be akin to nearly doubling up in one of the pairs since the correlation is positive and strong.

Furthermore, we can tell from our tables correlations rise and fall through different periods. There is clear evidence from the month to month changes of the correlation that risk influences are shifting. Comprised of two sensitive currencies, USDJPY will only track the changes in more ‘exposed’ currency pairs when the shifts in risk appetite are extreme. This is why USDJPY has seen its one-month link to AUDUSD drop so sharply (from 0.63 to -0.17) from June first to July first. Overall, having this knowledge will allow traders to effectively diversify and manage their portfolios over time.

Regardless of your trading strategy and whether you are looking to diversify your positions or find alternate pairs to leverage your view, it is very important to keep in mind the correlation between various currency pairs and their shifting trends.

FX Correlations (data as of 07/01/09)

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How To Trade This Event Risk

The Canadian dollar may face increased selling pressures over the next 24 hours of trading as economists forecast employment to fall 35.0K in June, and fears of a protracted economic downturn could weigh on the exchange rate over the near-term as the central bank maintains a dovish outlook for future policy. At the same time, the International Monetary Fund raised its outlook for the world’s eighth largest economy, and projects economic activity to fall at an annual rate of 2.3% this year amid an initial forecast for a 2.5% drop in GDP, while the group expects the growth rate to expand 1.6% in 2010. However, a report by Statistics Canada showed the trade balance unexpectedly fell to -0.2B in April, driven by a 5.1% drop in exports, while retail spending plunged 0.8% in May as households faced a weakening labor market. Moreover, wholesale sales slipped for the seventh consecutive month in May, while the economy shrank for the ninth month in April, and businesses may continue to scale back on production and employment throughout the second half of the year as they face fading demands from home and abroad. As a result, the Bank of Canada is widely expected to hold the benchmark interest at the record-low of 0.25% throughout the first half of the following year, and may adopt policy tools beyond to interest rate to stimulate the ailing economy as the outlook for global growth remains weak. However, researchers at the central bank argued bond purchases by the BoC could ‘distort the capital and credit allocation process,’ and saw high uncertainties tied to ‘quantitative easing,’ which could hamper the prospects for a sustainable recovery. Meanwhile, Governor Mark Carney said that the ‘bank retains considerable flexibility in the conduct of monetary policy’ during June rate decision even as borrowing costs remain at a record-low, but went onto say that the recent appreciation in the Canadian dollar could ‘fully offset’ the pick-up in economic activity, which rises the risk of a protracted downturn. Moreover, the central bank head expects the economic recovery to be ‘more muted than usual’ and forecasts GDP to contract at an annual rate of 3.0% this year, and fears of a protracted downturn is likely to weigh on the exchange rate as investors weigh the outlook for future policy. However, a rise in market sentiment paired with higher oil prices could temper the reaction to a dismal employment report as risk trends continue to drive price action in the currency market.

Expectations for a 35.0K drop in employment favors a bearish forecast for the Canadian dollar but nevertheless, the jump in business spending paired with the rebound in housing starts has left the door open for an enhanced labor report. Therefore, if payrolls fall 20.0K or less in June, we will look for a red, five-minute candle subsequent to the release to confirm a sell-entry on two lots of USD/CAD. Once these conditions are met, we will place our initial stop at the nearby swing high, or a reasonable distance taking volatility into account, and this risk will establish our first target. Our second target will be based on discretion, and we will move the stop on the second lot to breakeven once the first trade reaches its target in an effort to preserve our profits.

On the other hand, the slump in global trade paired with rise in raw material prices may lead businesses to take further steps to lower their cost structure, and price action following the release could set the stage for a short Canadian dollar trade. As a result, an in-line print or a drop of more than 35.0K in employment would favor a bullish outlook for the USD/CAD, and we will follow the same setup for a long dollar-loonie trade as the short position mentioned above, just in reverse.

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What To Look For Before The Release

Traders with access to market depth information via the FXCM Active Trader Platform may use it to gauge the potency of the economic data release as well as to shed some light on the market’s directional bias. Increasing volume ahead of the announcement will telegraph likely follow-through behind whatever move is to materialize, while an imbalance in available liquidity on the Bid versus the Offer side of the market will tell us the direction major institutions are likely favoring ahead of the announcement:

Bullish Scenario: If we see substantially deeper available liquidity on the Bid side of the market, this tells us that major price providers in the market are looking to buy the CAD against the US Dollar. Considering that close to 60% of all FX market volume is cleared through just six top banks, we see it prudent to be on the same side of the trade as major institutions and will favor a bullish bias on USDCAD ahead of the data release.

Bearish Scenario: If we see substantially deeper available liquidity on the Offer side of the market, this tells us that major price providers in the market are looking to sell the CAD against the US Dollar. Considering that close to 60% of all FX market volume is cleared through just six top banks, we see it prudent to be on the same side of the trade as major institutions and will favor a bearish bias on USDCAD ahead of the data release.

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AD: Trading the Net Change in Canadian Employment

The Canadian dollar may face increased selling pressures over the next 24 hours of trading as economists forecast employment to fall 35.0K in June, and fears of a protracted economic downturn could weigh on the exchange rate over the near-term as the central bank maintains a dovish outlook for future policy.

Trading the News: Canada Net Change in Employment

What’s Expected

Time of release: 04/09/2009 11:00 GMT, 07:00 EST
Primary Pair Impact : USDCAD

Expected: -35.0K

Previous: -41.8K

Impact Canada’s change in employment had over USDCAD for the past 2 months

May 2009 Canada Unemployment Rate

Employment in Canada plunged 41.8K in May, with the jobless rate rising to an 11-year high of 8.4%, and conditions are likely to get worse as businesses continue to scale back on production and employment following the downturn in global trade. The breakdown of the report showed full-time positions slumped 58.7K from April, with self-employment falling 32.0K, while part-time jobs increased 17.0K during the month. The data foreshadows a weakening outlook for the region as households face a weakening labor market paired with the slump in housing, and conditions may get worse throughout the year a trade conditions falter. As a result, the Bank of Canada continued to hold borrowing costs at the record-low for the second time in June, and pledged to hold the interest rate at 0.25% throughout the first half of 2010 in an effort to stimulate the ailing economy.

April 2009 Canada Unemployment Rate

Labor demands in Canada unexpectedly rose in April, marking the first increase in six months, with employment rising 35.9K from the previous month, led by a 39.4K jump in full-time positions. At the same time, the annual rate of unemployment held steady at the seven-year high of 8.0% for the second consecutive month in April, and the data encourages an improved outlook for the world’s eighth largest economy as policymakers take unprecedented steps to stem the downside risks for growth and inflation. However, as businesses face fading demands from home and abroad, firms may continue to scale back on production and employment throughout the second-half of the year in an effort to lower their cost structure. As a result, the BoC is widely expected to hold the benchmark interest at the record-low of 0.25% and may adopt unconventional measure over the near-term in order to jump-start the economy.

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