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Just about two months ago I wrote about my expectations for an expansion in volatility in the dollar. That was based on looking at the weekly USD Index chart and observing very narrow Bollinger Bands, which is often a precursor to the start of a new trend in the markets. As we can see, the greenback has indeed broken clear of the range it started the year in, and of late has reached within striking distance of the 2012 peak.

We can see from the Band Width Indicator in the sub-plot above that the Bands are now in about the middle range of how wide they have been over the last couple of years. That means there is yet some room for further extension to the trend (thought it should be noted that sustained trends often seen the Bands start to narrow).

The daily chart gives us an indication that we just might see that fairly soon. Notice how in that time frame the Bands have reached their lowest levels in the last 12 months. That, in and of itself, is not a directional indication, however. It merely tells us that we probably don’t have long before the recent consolidation in the USD gives way.

So what can we glean about potential direction from the dollar pairs?

If we look at EUR/USD we can see the market has already extended its trend lower and turned a low Bollinger Band situation up.

The USD/JPY situation is quite different. Here we have a market which has already retraced quite a bit from its highs and has been developing a topping type of pattern overall of late.

Similarly, GBP/USD has also been working back higher, showing indications of a trend change.

AUD/USD has been moving higher for some time now. It does face important overhead resistance from the highs near the start of the year, however.

Meanwhile, USD/CAD shows a pattern not dissimilar to that of USD/JPY and GBP/USD in that the greenback has been weakening noticeably of late.

Taken together, we have a picture telling us that the only reason the USD Index is holding near its higher levels is the weakness in the euro. As a result, if the single currency develops some strength – even if it just takes a pause to consolidate the recent downtrend – we could see the index drop. That is not at all contrary to what we see on the USD daily and weekly charts. It would be quite easy for the greenback to retrace back toward the Q4 highs broken earlier this year. That would be important support now.

You may recall my post from a few weeks ago talking about how the strong stock markets may be signalling a turn in the dollar. In a way, we’ve already seen it happen as equity indices have continued to move higher. Now it’s just a question of whether the euro can stabilize and put the USD Index under pressure as a result.

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Be sure to read the full risk disclosure before trading Forex. Please note that Forex trading involves significant risk of loss. It is not suitable for all investors and you should make sure you understand the risks involved before trading. Performance, strategies and charts shown are not necessarily predictive of any particular result. And, as always, past performance is no indication of future results. Investor returns may vary from Trade Leader returns based on slippage, fees, broker spreads, volatility or other market conditions.

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Stocks are trending higher and the dollar is doing the same. That’s not something we’ve seen much of over the years. We can see from the chart below comparing the S&P 500 to the USD Index how unusual it is for the two to move in the same direction. No doubt the recent positive correlation has thrown a number of algos for a loop.

Of course the whole risk-on, risk-off pattern of the markets holding forth during long periods since the Financial Crisis played a major part in defining a negative correlation between stocks and the US dollar. Traders and investors would either flee from “risky” assets into the safety of the greenback (and US Treasuries), or do the reverse. Obviously, that’s not what’s happening at the moment.

So what’s happening now?

I’d argue we’re back to more “normal” markets which are less psychological and more fundamental. By that I mean exchange rates are moving on market participants’ perceptions of the differences between economies, rather than just reacting to fear.

That said, it is often the case that the USD falls in periods of economic strength. This is driven by American demand for imports. These days the US seems to be the strongest among the major Western economies, so we would expect to see a similar pattern. The markets, however, are reflecting other dynamics at work. Monetary policy is a big factor.

Better economic figures in the US lead investors to start to look at when the Fed will start taking a less accommodative stance. In and of itself, that tends to be positive for the greenback (less or no asset purchases means reduced increase in dollar supply). At the same time, though, Europe continues to have significant issues, and the same can be said of Japan. No one is talking about tighter monetary there, so those currencies are suffering by comparison.

The question is how long that will continue.

As we can see from the chart below, which includes the German DAX index as the lower plot, European stocks too have broken the 2011 highs and are close to the ones from 2007 (the FTSE is showing comparable performance).

The implication of rising stocks on a global basis is the anticipation of better times ahead. Stock market investors may have it wrong (wouldn’t be the first time), but if they don’t, then we should look for improvement in the European situation in the months ahead. That would very likely then mean the dollar losing its strength as more traditional patterns are seen (dollar weak in good economic times). That will be worth watching, as it we don’t see the USD rolling over before too long it may be a sign the stock rally will have trouble continuing.

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Be sure to read the full risk disclosure before trading Forex. Please note that Forex trading involves significant risk of loss. It is not suitable for all investors and you should make sure you understand the risks involved before trading. Performance, strategies and charts shown are not necessarily predictive of any particular result. And, as always, past performance is no indication of future results. Investor returns may vary from Trade Leader returns based on slippage, fees, broker spreads, volatility or other market conditions.

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The forex market continues to make some folks nervous. While there are certainly reasons to be cautious when playing exchange rates, a considerable amount of the nervousness of the average person on the street comes from misinformation. Most notably, they all too often think of the forex market as being highly volatile. I addressed this issue before in Looking at Volatility Across Markets, but I think it’s worth revisiting.

I’ve collected 5 years of weekly values for a number of markets to look at just how volatile they are. Let me first look at the US Dollar Index. Between July 2007 and July 2012 the average weekly range for the USD Index was just 2%. I derived that by taking the distance between each week’s high and low and dividing it by the midpoint for that week [( High – Low)/( (High+Low)/2) ]. At the same time, the standard deviation of weekly closing prices (which gives us an idea of how choppy the market is) was only 4.9% (relative to the average close for the study period).

As you will see, that’s not a lot of volatility.

Let’s start by comparing the USD Index values to those from the major US stock indices.

DJIA: 4.0% average weekly range, 15.0% standard deviation
S&P 500: 4.4% average weekly range, 16.0% standard deviation
NASDAQ 100: 4.7% average weekly range, 20.2% standard deviation
Russell 2000: 5.6% average weekly range, 17.3% standard deviation

As you can see, the major stock indices show considerably more volatility than does the USD Index.

How about individual stocks?

JPM: 9.4% average weekly range, 15.0% standard deviation
IBM: 4.8% average weekly range, 24.6% standard deviation
GE: 7.4% average weekly range, 39.9% standard deviation
XOM: 5.1% average weekly range, 12.0% standard deviation
KO: 4.0% average weekly range, 15.3% standard deviation
AAPL: 7.2% average weekly range, 53.5% standard deviation
KO: 6.2% average weekly range, 18.0% standard deviation

No real surprise to see that individual stocks are pretty volatile by comparison.

Looking at commodities:

CRB Index: 3.9% average weekly range, 18.2% standard deviation
Gold: 4.6% average weekly range, 28.1% standard deviation
Crude Oil: 8.4% average weekly range, 24.2% standard deviation

Here again we see markets with a great deal more volatility than the USD Index. The one place where there is something of a contest is the bond market. The long-date Treasury note/bond ETF is TLT. Looking at its weekly figures I come up with a 3.2% average range and 10.6% standard deviation. That’s considerably less volatility than the other markets and securities shown above, but still not at low as what we have seen the last five years in the USD Index. We would likely have to move down to short-term Treasury securities (like 2yr Notes and T-Bills) to find lower values.

The point of all this is that anyone avoiding the currency market because of the perception that it’s super volatile is operating on a false belief. The figures just don’t back that up.

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Be sure to read the full risk disclosure before trading Forex. Please note that Forex trading involves significant risk of loss. It is not suitable for all investors and you should make sure you understand the risks involved before trading. Performance, strategies and charts shown are not necessarily predictive of any particular result. And, as always, past performance is no indication of future results. Investor returns may vary from Trade Leader returns based on slippage, fees, broker spreads, volatility or other market conditions.

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Month and quarter ends are always interesting times in the market, with all kinds of capital flows offering the potential to move markets. This time of year in particular we also have Japanese fiscal year end to add to the mix. As we near the finish this quarter, though, I’d like to take a look at what might be coming our way in the next one. Specifically, I want to take a look at the research I’ve done on forex seasonal trading patterns to see what’s ahead for the market.

April is not a very strong month for the USD. In fact, statistically it has been one of the worst. Looking at data back to the early 1980s, we can see that in general terms the dollar has fallen about 60% of the time and lost about 0.5% in value against the other major currencies (I’m not specifically using the USD Index here, but close). The pattern is even stronger since the introduction of the euro. Going back to 1998, the dollar has been down 61.5% of the time for an average annual loss of 0.72%. Only December has a more negative pattern.

One thing that is worth noting, though, is that we would expect to see a positive transition over the next few weeks. We can see that on the chart below, which looks at the 1-month forward returns on a week-by-week basis (measuring 7-day periods, not calendar weeks).

The featured area is the next 4 weeks, with week 14 representing April 1 to April 7. We can see we start April off in a period of strong negative indications for the dollar, a pattern which began a couple weeks ago. That shifts from negative to positive as we get into the middle part of April, though.

As for what to play on the other side, the pound is the major currency with the best April statistics. The GBP been up in general terms nearly 70% of the time during the month since the euro launch for an average 0.45% gain.

We would therefore expect GBP/USD to have a strong positive bias heading into April and that is indeed the case, as the weekly returns chart shows.

Notice here, though, that the pattern shift is much more swift, if also more abbreviated.

This seasonal bias information isn’t a suggestion to go out and get long GBP/USD, though. These biases are just that, biases. There are no sure things and even when the market does move in line with tendencies it can do so in a very choppy fashion. As such, you would likely be better off using this information to help shade your trading – like perhaps being more aggressive on trades you do in the direction of the bias and less so against it.

It’s all about putting the odds as far in your favor as possible. This sort of data, if used prudently, can help you do that.

Now, as to what this means for the global markets…

That’s a bit trickier now that we aren’t seeing the same market patterns that we were seeing in the past whereby the dollar and stocks and interest rates all had pretty well-defined relationships. As a result, we need to be aware of whether the market is in “risk” mode whereby stocks and commodities are rising and the dollar is falling, or in the recent mode whereby the dollar and US Treasury yields have moved together, mainly as a function of whether the market sees more QE coming from the Fed. I personally don’t expect anything like that, but Bernanke has done is best to keep the markets thinking he’s inclined to maintain an accommodative monetary policy and doesn’t want to see long-term rates rising too much.

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Be sure to read the full risk disclosure before trading Forex. Please note that Forex trading involves significant risk of loss. It is not suitable for all investors and you should make sure you understand the risks involved before trading. Performance, strategies and charts shown are not necessarily predictive of any particular result. And, as always, past performance is no indication of future results. Investor returns may vary from Trade Leader returns based on slippage, fees, broker spreads, volatility or other market conditions.

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The blogosphere was atwitter yesterday following Ben Bernanke’s class presentation at George Washington University. He did a hatchet job on the idea of the US ever going back on the gold standard, and the overall idea of having a gold standard period. This is obviously a major hot-button topic in both the markets and the broader world these days, so naturally there have been some heated reactions. I won’t wade into that particular battle, but did think it’s worth looking at how the metal is doing.

The chart below is the continuous front-month gold futures contract with open interest (green) and volume (purple) plotted below. There are some interesting things to be gleaned from the last two years of trading activity.

Two things jump out at me.

First, notice the general downward slope in the peaks of Open Interest (OI). Ignore the sharp declines which are spaced through as that represents the futures roll-over period. Just look at the relative heights of the peaks and how they have been sloping lower since early in Q4 of 2010. That’s a sign of falling participation in the market, especially over the last several months following peak last year. This is a good explanation for why gold hasn’t been able to manage even a retest of that prior peak on the last couple of upswings.

The other observation, which is harder to specifically see the chart, is that we’ve seen a pattern shift in volume. Heading into the peak in August the volume spikes tended to be on moves higher. Since then, though, the major volume spikes have all come on big down days. That’s an indication of a change in psychology whereby the longs are no longer as secure in their positions as they were previously and are thus quicker to exit, and/or shorts are more eager to jump in.

I think gold is in trouble here and could easily fall back below 1500 on the next move down. That sort of thing would probably be indicative of support for the USD, but the correlations these days have become somewhat muddled, so it’s hard to be sure.

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Be sure to read the full risk disclosure before trading Forex. Please note that Forex trading involves significant risk of loss. It is not suitable for all investors and you should make sure you understand the risks involved before trading. Performance, strategies and charts shown are not necessarily predictive of any particular result. And, as always, past performance is no indication of future results. Investor returns may vary from Trade Leader returns based on slippage, fees, broker spreads, volatility or other market conditions.

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Have you been paying attention to the changing dynamics in the markets of late?

We’re no longer in a world where the dollar moves in the opposite direction from stocks on a consistent basis – the risk-on/risk-off pattern. Of late, in fact, stocks and the buck have moved in the same direction, as we can see in the chart below (USD Index in green, S&P 500 in black). For the last few weeks that direction has been higher.

As we can see from the weekly chart below, things have been pretty muddled all year long. The stock/dollar correlation (based on a 20-period calculation) has been a bit positive since December, though only slightly so. Basically, the two markets have been mainly uncorrelated, taking us back to a time when the financial markets mainly traded on their own factors.

Ahhhh…the gold old days. :-)

Right now the thing that has the two markets moving in unison is something that was actually part of the story even back during the financial crisis. The US markets are benefiting from the view that the US is well into recovery mode while the Europeans (the USD Index being heavily weighted in those currencies) still have a lot of stuff to work through to get themselves on track.

Now, the European problem has been in place for a while now, which is why if we look at the relative performance of the S&P 500 and the German DAX index below we can see that while US stocks have pushed above last year’s highs, German one still have a ways to go.

What’s changed of late where the dollar is concerned is the view on what the Fed will be doing – or more correctly, what it won’t be doing. The better US data has lessened the need for Bernanke & Co. to further loosen monetary policy by piling on new quantitative easing (QE) at some point, and statements out of the central bank have indicated that these figures aren’t being viewed as some kind of anomaly, but rather as part of a developing pattern. This reduces even further the odds of QE3, and as the chances of the Fed pumping more dollars into the system decline, the dollar is at least less pressured, if not outright supported from buying by those who expected QE3, especially in the face of the ECB dumping close to a trillion euros into the system via the LTROs.

So we’ve got improving economic data helping stocks and also helping reduce the chances of Fed action which would be negative for the dollar. That’s what’s causing the two markets to move in tandem of late. Just keep in mind, however, that the dollar tends not to do great when (all things being equal) when the US economy is very strong because of our increasing demand for imports. We’re not exactly in strong economy mode yet, but it’s something that will become a factor as things improve.

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Be sure to read the full risk disclosure before trading Forex. Please note that Forex trading involves significant risk of loss. It is not suitable for all investors and you should make sure you understand the risks involved before trading. Performance, strategies and charts shown are not necessarily predictive of any particular result. And, as always, past performance is no indication of future results. Investor returns may vary from Trade Leader returns based on slippage, fees, broker spreads, volatility or other market conditions.

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One of the things that’s gotten a fair bit of chatter in the press of late has been the idea of a de-coupling between US markets and those in Europe. It is suggested that traders and market participants are taking a comparative look at the two economies and seeing better opportunities in the US, which is leading to better performance for US stocks and also for the dollar. Let’s take a look at the numbers to see how that’s really playing out.

The chart below looks at the correlations between the USD Index and the S&P 500 (red), US 10yr Note yields (green), Oil (purple), and Gold (yellow). The correlation figures are based on a 20-period look-back calculation using daily closing data.

What immediately jumps out is that the dollar has become much more positively correlated to all of these major markets in the last several weeks. In the case of the stock and bond markets, this has been developing since mid-November, meaning the commentators talking about this stuff recently have actually be rather late to the game, which is often the case.

Interestingly, just as stocks and bonds were shifting toward more positive correlations in mid-November, the commodities were moving toward more negative ones. They have obviously since turned that around again, very sharply in the case of gold since the start of the new year.

Be aware, though, that there’s a difference between “more positively correlated” and being actually positively correlated. In all these cases we’re talking about markets having gone from very negatively correlated (the closer you get to -1 the more directly opposite the two markets tend to move). At this point these markets have only reached near the 0 correlation level, meaning the markets haven’t really been trading in unison at all of late.

The move in the S&P 500′s correlation to the USD Index is the most interesting in that we’re seeing the most positive reading we’ve seen since June of last year. What makes this really interesting is that in the past the higher correlations between the two markets have come when the dollar was falling. The last time the two markets were positively correlated during a USD rally was during the latter part of 2009 and early 2010.

Notice how there was a kind of choppy positive correlation between the two markets (S&P 500 in green) during December 2009 that broke down in January before things turned back again in February. Now consider that we’ve got a choppy kind of positive correlation between the two markets working now. Could be we’re setting up for some kind of repeat performance.

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Be sure to read the full risk disclosure before trading Forex. Please note that Forex trading involves significant risk of loss. It is not suitable for all investors and you should make sure you understand the risks involved before trading. Performance, strategies and charts shown are not necessarily predictive of any particular result. And, as always, past performance is no indication of future results. Investor returns may vary from Trade Leader returns based on slippage, fees, broker spreads, volatility or other market conditions.

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With the start of 2012 comes the start of the strongest “seasonal” trading pattern of the year for the US dollar. That would be the one for the month of January. Going back to 1982, the first month of the year has been up 2/3rds of the time, averaging a gain of 0.89%. For those who have a statistics bent, T-Test analysis indicates this is significant at a 97% confidence level. (It should be noted that I’m not actually talking about the USD Index here, but rather an equal weight index calculated using the USD exchange rate against the other majors, though indications suggest the results for the USD Index are quite similar).

And for those who think these sorts of patterns degrade over time, consider the fact that the USD has been up 9 out of 13 Januarys since the launch of the euro in 1999, with a very similar average monthly change. This figure isn’t as statistically significant because it includes fewer observations, but it’s meaningful never the less.

Why is this the case?

I can’t give you a definitive answer, as I’m not involved in that side of the business, but I can venture what I think is a good educated guess. It likely has a lot to do with the corporate capital flows as US multi-nationals repatriate overseas earnings as they close up the books for the year gone by. There’s been a lot of talk in recent years about money sitting overseas to avoid US taxation, but that’s likely overstated.

So why is this important?

Given the recent negative correlation between the USD and stock prices and interest rates, the expectation of a rising dollar during January would tend to suggest weaker stocks and lower yields. Just keep in mind, though, that correlations change. As the chart below shows, the correlation between the USD Index and the S&P 500 (lower red plot) has been moving toward 0 of late and actually got well into positive territory a couple times in 2011.

The other risk management consideration is that a strong seasonal pattern is no guarantee. The dollar may have been up 20 out of 30 months, but that means 10 out of 30 it wasn’t, so caution is always warranted. As with other markets, forex seasonal patterns are good for biasing, but risky to use outright.

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Be sure to read the full risk disclosure before trading Forex. Please note that Forex trading involves significant risk of loss. It is not suitable for all investors and you should make sure you understand the risks involved before trading. Performance, strategies and charts shown are not necessarily predictive of any particular result. And, as always, past performance is no indication of future results. Investor returns may vary from Trade Leader returns based on slippage, fees, broker spreads, volatility or other market conditions.

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I had a chat with a reporter from Smart Money the other day. She wanted to know what kind of impact the big move in EUR/USD on Wednesday following the announcement of improved dollar swap line terms would have had on forex market participants. It was a pretty easy question to answer. After all, a 200+ pip move in either direction is always going to catch half the market in a bad spot. The speed of the appreciation in EUR/USD (and other markets) in and of itself is evidence that a lot of standing orders (stops) were tripped to accelerate things along.

Of course that brings up the subject of risk management.

No matter whether you’re an investor or a trader, the current market situation is a challenging one. The market is hyper-responsive to news, especially news that has to do with the Euro Zone.

Witness Monday’s market reaction to word that S&P was going to put the EZ countries on negative credit watch. Was that really a significant market development? No. Just as the swap line news from last week wasn’t something that altered the fundamental economic and political landscape in Europe. Nor was it something that represented a meaningful change in dollar or euro supply/demand considerations. All it did was ensure that a worst case scenario of a major bank failure due to lack of dollar funding wouldn’t happen. That’s why there was no follow-through.

Too often, the headlines we’re seeing these days serve as reasons for short-term traders to pile in and out of positions, creating lots of volatility. This needs to be accounted for by participants at every level of involvement.

While it’s true that the forex market isn’t any more risky than any other market, and is less so than most, it can still hurt you badly if you aren’t careful about your exposure. The EUR/USD move on the swap line news was close to 2%. A trader using 50:1 leverage would have been completely wiped out by that if he didn’t have protection against that kind of move. Even a position half that size would have seen an account lose 50% of its value in less than an hour.

Whether it’s through hedging in some fashion or trading smaller positions (potentially with wider stops), forex market participants these days need to guard against the market’s volatility. With volumes likely to drop as we head deeper into the holiday season, the potential for rapid directional moves will only tend to increase in the weeks to come.

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Be sure to read the full risk disclosure before trading Forex. Please note that Forex trading involves significant risk of loss. It is not suitable for all investors and you should make sure you understand the risks involved before trading. Performance, strategies and charts shown are not necessarily predictive of any particular result. And, as always, past performance is no indication of future results. Investor returns may vary from Trade Leader returns based on slippage, fees, broker spreads, volatility or other market conditions.

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The S&P 500 broke down below its August lows on Monday. That was something a lot of folks were not expecting to happen (including some in my own office). As such, it begs the question of how far the market may yet go, especially with all the talk now about how it’s officially reached bear market status based on a 20% decline from the most recent highs. This also ties in with the dollar given the negative correlation between the two markets. So with that in mind, let’s take a look at a couple of potential indications of what may yet be to come.

First we have the weekly S&P 500 chart. It could be said that the consolidation we saw following the August lows which saw the index move around in about a 1120-1120 primary range was the building of a bear flag pattern. If we go along with that then Monday saw the expected trend continuation on the new lows, meaning we should be able to derive a basic target based on the height of the flag poll. The first red box on the chart encompasses the poll. The second one plots that area from Thursday’s peak to provide a conservative projection of about 970 for the index.

It’s worth noting that the 2010 market low is not far away from where the flag projection comes in. That gives us a pretty good expectation for support to develop in the general zone around about 1000.

For me the important leading indicator is the German DAX, which has already taken out its 2010 lows. The sovereign crisis over there is obviously a major motivator in the selling seen thus far. It’s been interesting to observe, however, that the DAX has not made new lows in line with those of the S&P 500 in most recent trading. The German market successfully tested support just below 5100 a couple weeks ago and hasn’t re-challenged that level on the latest downturn yet.

Significant in chart the above is the volume pattern of late. Notice how the volume has not been as strong on the down days as much as was the case earlier in the move. At the same time, there’s been some uptick in volume on the positive days. If that pattern holds and we see the DAX form a bottom here it would be a very good development for the global markets, and likely a negative for the dollar.

Note in the daily EUR/USD chart how the DAX actually led the euro lower by starting to break down late in August. Could it also be leading by potentially putting in a bottom?

The DAX bottom obviously works against the S&P reaching the bear flag target, but I’m not sweating that. My suspicion from looking at the monthly chart is that the market is due for a bounce in that timeframe, one which could rally the index back into the 1200s. Beyond that though would be a challenge based on the current situation. The sell-off from the year’s highs has been very aggressive, which bespeaks a weak market.

I think the best case scenario for stocks is a consolidation centered on about the 1200 level as we see the volatility come down, narrowing the monthly Bollinger Bands in preparation for the next meaningful trend move. That’s looking well down the line, though. In the nearer term, watch to see if the DAX holds its bottom. If it does, stocks will probably post a decent rally, putting the dollar under pressure as the “risk-off” trade is unwound.

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Be sure to read the full risk disclosure before trading Forex. Please note that Forex trading involves significant risk of loss. It is not suitable for all investors and you should make sure you understand the risks involved before trading. Performance, strategies and charts shown are not necessarily predictive of any particular result. And, as always, past performance is no indication of future results. Investor returns may vary from Trade Leader returns based on slippage, fees, broker spreads, volatility or other market conditions.