Written by David Rodriguez, Quantitative Strategist
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.
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.
Forex Strategy Outlook: US Dollar Action Bodes Well for Range Systems
