The uncertain nature of any attempted quick-fix solution to the European debt crisis has had an abnormal influence on all of our global trading markets. Increased volatility is the watchword. The amplitude of daily trading ranges has definitely increased, but more aggravating is the increased frequency of sudden reversals, the whipsaw effect that most traders would prefer to avoid. Volatility does create arbitrage opportunities – the reason for speculative traders to exist in the first place – but sensitivity to frequent changes in direction creates a psychology of fear, another form of opportunity.
This double-sided volatility is most apparent in our currency markets, and the EUR/USD currency pair, accounting for nearly 30 percent of daily turnover of $4 trillion, is the best vehicle for observing this recent phenomenon. As the diagram below depicts, volatility in the forex pair has been steadily ramping up as the threat of a Greek default and possible contagion to other member states becomes more pronounced.
The Average True Range indicator for a 14-period cycle has been gradually increasing, a reflection of increased volatility in this pair, as fear has escalated in the global investment community. Typically, the Euro fluctuates over a 125 basis-point range versus the Greenback on a daily basis. The green trend line is now pointing toward 200 basis-point territory, although there has been a recent pullback for the holidays accompanied by increased optimism that the Eurozone will fix its problems.
Swing traders second guessing
Does this new condition create any new trading strategy opportunities? As mentioned above, traders welcome volatility in most cases, but the present type, supplemented with violent swings whenever the latest news article is published, has fomented a new form of sensitivity. Swing traders that may have routinely let open positions carry over to the next trading cycle have begun to second-guess themselves. This tendency is most visible when the London market closes while New York is still in session. The overlapping nature of this 24/7 informal network of exchanges is a contributor to observable abnormal trading behaviour.
The London forex market closes at noon on the east coast, as New York breaks for lunch. Traders in London, wary of what might happen soon after the close, begin to close their open positions, generally an hour or more in advance. For example, if the prevailing sentiment of the day is to be short on the Euro, you will often see a rally in buying activity, the classic short squeeze, resulting in runs of 50 basis points, more or less. With appropriate leverage and guidance from technical indicators, optimum entries and exits can be managed for favourable gains.
High-percentage trading setups
Day and swing traders, alike, generally search for high-percentage trading setups before taking action in the market. The objective is to recognise a prevailing trend, latch onto it, and ride it for all it is worth. Experienced traders have learned to take what the market gives them, and, although this London close squeeze is nothing new, its increased probability is a welcomed gift for those willing to receive.
Short the Euro to prevail
How long will this holiday gift be for the taking? Many experts, and the market as well, believe that major structural changes are necessary in Europe, the type that share the revenue benefits that major exporting states, like Germany and France, receive from a diluted currency. Since the potential for this type of corrective measure is slight, the overriding sentiment to short the Euro will prevail for some time, along with the fear of leaving an open position unattended to before the London close. Squeezes will continue to manifest themselves several times a week, not the typical once or twice over a two-week span, as is the more normal periodicity. Recent political activity and optimism will most likely dissipate as the new year commences.
The trend is truly your friend under these circumstances.
Tom Cleveland
SAXO BANK