From the January 01, 2012 issue of Futures Magazine • Subscribe!

Top 5 tips for surviving a volatile forex market

Experiencing a weird sense of déjà vu when you look at the markets? Can’t shake that nagging feeling that you have been here before but can’t quite put your finger on it?

Take heart — you’re not alone. In many ways the events of 2011 have followed the 2008 timeline closely of wild stock prices swings and amplified volatility. Let’s just hope that unlike 2008 where the global economy fell into a profound recession, 2012 yet can avoid the same fate.

Most investors will recall vividly the dramatic drop in stock prices during the first quarter of 2008. The uncertainty this sell-off created, in conjunction with rising unemployment and the resulting weaker demand for consumer goods, led to the recession that spared few of the world’s major economies.

In a similar fashion, the Dow likewise fell more than 20% from May to September of this year. Some of those losses since have been recovered, but thanks to the on-going events in the Eurozone, uncertainty once again is hampering market sentiment.

Much of this uncertainty is centered on the continuing saga that is the Greek debt fiasco. The story took on a farcical tone when Prime Minister Papandreou nearly scuppered plans to provide Greece with emergency funding by insisting on a referendum to ratify the deal. Ultimately, Papandreou was forced from office following his actions and a coalition government was formed to pass the austerity legislation required to secure the bailout funds; but even this does not signal the end of the crisis.

If anything, the problems facing Italy will make the Greek experience pale in comparison. This reality ensures that, for investors, the roller-coaster ride is far from over and price volatility is likely to continue.

Investor uncertainty on the rise

The Chicago Board Options Exchange’s Volatility Index — or simply the VIX — measures volatility in the markets based on options contracts contained in the S&P 500. The higher the measured degree of volatility, the greater investor fear and uncertainty. VIX values greater than 30 are considered to be a sign of high volatility.

Leading up to the credit crisis of 2008, the VIX reading was well above 30 with a high surpassing 90 in October 2008. Comparing this to more recent history, the VIX reading during the first part of 2011 was relatively benign, running between 20 and 30 on the scale. However, as of early November, volatility once again appeared to be on the increase and measured above the warning level at 34 before dipping back below 30.

So, what does this mean for currency traders? Tracking the EUR/USD currency pair from January 2007 to the present, it is clear that the exchange rate has endured tremendous volatility.

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