As 2008 ends, the environment for currency trading has undergone a shift towards greater volatility. A consequence of this shift is its impact on forex trading strategies and tactics. With volatilities much higher, strategies such as set-and-let, where a trader enters a position and places a profit target and a stop loss and can walk away are becoming very difficult to use. Additionally, getting stopped out of positions in patterns that previously worked well is increasingly being reported. The forex trader needs to be able to respond to these changes with new tactics that cope with the volatility surges. But there is help on the way.
Since volatility is a mathematical concept that tracks price over time, there are a variety of ways of detecting the volatility path. First, intraday price intervals reflect volatility with the commonly used indicator of average true range. A good way to see volatility changes is using Bollinger Bands. The range in pips between the lower and upper bands will increase as volatility increases. During recent surges in volatility, traders were able to see huge pip ranges in five Bollinger Channels. A signature of greater volatility is the patterns in the candles where the low to high of candles extend over 75% of the range. We can see this in “Wide berth.”
The market has become so fluid that one-minute price changes have experienced wide ranges that have generated opportunities for capturing five pips and more. Price intervals using tick data are available and watching them as well as tick volume can help decide if the market is ripe for momentum trades. For example, a spot check of one-minute price intervals on the USD/JPY in recent afternoon trading confirmed that a USD/JPY trader looking for five pips or more had the environment for it. In 16 one-minute intervals, the net pip changes showed only five intervals producing less than five pips (see “Pips by the minute”). Clearly the data are confirming the relatively faster pace of today’s forex environment.
These changes will require traders to become more skilled in momentum trading because the rise in volatility undermines the effectiveness of technical indicators. All technical indicators necessarily lag because they filter data. But the indicators that are particularly vulnerable are those that generate variations of moving averages.
The question therefore becomes, what then works well for today’s high volatility environment? It may be counter-intuitive to some, but classical tools of trendlines, support and resistance lines should always be used. They do not lag and they provide an effective and dynamic real-time “map” of sentiment. Another effective tool is multiple time analysis. The trader needs to use several time frames to evaluate price action and how sentiment has changed. However, instead of comparing four-hour, 15-minute and five-minute intervals, in today’s environment, we compare 10-minute, five-minute and one-minute intervals. This will allow the trader to focus on the most recent sentiment patterns. The question often arises that at a one-minute time interval a lot of noise occurs. A great help is to use chart tools that take out the noise. This class of tools includes Price Break, Renko, Point and Figure, and Kagi Charts. Renko charts set to show one-pip closing increments provide powerful visualizations of the persistence of sentiment at these micro-time frames and can yield much more clarity than candlesticks.
It is worthwhile to hone your skills in these charting tools as today’s volatile environment looks to be with us for a while.
Abe Cofnas is the author of “The Forex Trading Course” and the upcoming “The Forex Options Trading Course” (Wiley). Reach him at email@example.com.