Tag Archives: normalized average true range

The so-called "commodity" currencies (those that tend to be correlated with the major global commodity markets) have been very interesting of late. As you can see from the charts below, the Bollinger Bands for AUD/USD, NZD/USD, and USD/CAD all go VERY narrow before this week's break. In fact, the Bands were the narrowest they've been in years, which is generally an indication to expect something explosive to be forthcoming. AUD/USD and NZD/USD both certainly made big threats to do just that earlier this week when they broke down.

AUDUSD Chart

 

Notice too that the Normalized Average True Range (N-ATR), has also gotten very low. This tells us that not only have the daily closes been narrowly spaced (as indicated by the narrow Bollinger Bands), the daily high/low ranges have been getting increasingly small. The implication is that not only can we expect a directional move, we can expect the ranges to expand as well.

NZDUSD Chart

 

We can see a similar sort of move (in the opposite direction) in USD/MXN. The Mexican currency is another one that tends to be very sensitive to commodity and overall risk market moves.

USDMXN Chart

 

It's interesting to note, though, that we actually saw USD/CAD break down prior to the breakdowns in AUD/USD and NZD/USD. It then reversed back up into the range in the move that saw the other two pairs fall out of their narrow ranges.

USDCAD Chart

 

We've now seen all of the breaks reversed to a large degree. The risk there is of a fake-out break which sees the market completely turn and go out the other end of the prior range and develop a new trend in that direction. In this case, it would mean AUD/USD and NZD/USD moving higher, while USD/MXN and USD/CAD would go lower.

Right now I think the charts all suggest a stronger dollar moving forward, meaning a continuation of the AUD/USD and NZD/USD breakdowns (especially given the AUD/USD double top) and a general extension of the USD/MXN uptrend that is highlighted by the blue trend line on that chart. USD/CAD would then be expected to break above 1.0050 and continue higher. The implication here would be that stocks and interest rates would fall, along with the commodity markets in the weeks to come.

If there's to be a fake-out break, though, USD/CAD may be the canary in the coal mine. The Canadian currency is the one that has performed best of late. If that market cannot overcome the resistance in the 1.0050 area, then the prospects for a fake-out break will be quite good and all our stock-invested retirement accounts will likely be much better off.

 

In a blog post from Sunday, Adam Kritzer suggests that volatility in the Forex market continues to run high. This is based on a look back over the last five years (though the chart he shows only goes back four). I decided to take a longer look and instead of using options implied volatility, I went with actual range-based volatility.

The chart below shows the USD Index (cash version) going back to 2001. The sub-plot is of the Normalized Average True Range (N-ATR) indicator. Basically, the N-ATR takes the 14-period average High-Low range and divides it by the 14-period average closing price to get the range expressed as a % of the average. That allows for easier comparison across markets and timeframes.

As we can see on the chart, weekly ranges averaged between about 1.5% and 2.5% from 2001 to 2006. It dropped sharply into mid-2007, then took off to above 3% during the height of the financial crisis. The green line on the chart is the 5-year moving average of the N-ATR, which currently comes in below 2%. Since the current N-ATR is above that, we have agreement with Adam's comments about volatility. Interestingly, though, N-ATR has recently dipped back below the mid-point (50% retracement level) of the wide range of N-ATR valued between the 2007 low and the 2009 high.

It must be noted, though, that volatility varies among the pairs. The USD Index is very heavily weighted toward the EUR (57.6%). That means the volatility for the index is generally going to be very close to that of EUR/USD. As we can see from the weekly USD/JPY chart below, however, in some places the volatility is below average.

Notice how N-ATR for USD/JPY has fallen below the 5 year moving average. Interestingly, though, in this case N-ATR never got as low (about 1.5% vs. about 1.0% for the index) and got much higher at the peak. It currently is about the same level.

It's a similar case for GBP/USD.

Again, here was saw a higher low and a higher high, and now we've see N-ATR move below the 5-year average and into the lower 30% or so of the high-low range. We're also looking at N-ATR getting close to where it is for the USD Index.

The takeaways from all this are:

  1. Volatility in the Forex market can vary significantly between pairs
  2. Volatility is falling in some pairs, but not in others. That has implications for the way different pairs trading heading into the new year.
  3. N-ATR can be used to compare volatility across pairs to help identify good trading opportunities and/or helping you allocated funds to different Trade Leaders.

Hope your holidays have treated you well. Best of luck with your trading and trader development in 2011.

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