Adapting To Low Volatility Trading Conditions
Forex market conditions often change the effectiveness and profitability of a trader's strategy; low volatility conditions make it much harder to capitalize on trending strategies. Should a trend emerge, it is often weak and won't carry through to target profit levels. A range-bound currency pair may bounce cleanly within the extremes of the range or it may get hung up in the middle as it struggles to carry through. In either condition, an adaptation of your strategy may be in order to ensure you're still locking in profits.
Economic Factors Of Low Volatility Currencies
A currency may experience a loss of volatility for numerous reasons. Identifying the supposed cause is in the discipline of Fundamental Analysis. It is a good idea to try and identify the potential reasons for a loss in volatility so you can better identify when price action may be ready to pick back up. The following are some major points to consider, but by no means it is an exhaustive list.
Interest Rates: The interest rates of a country have a strong effect on currency values. Countries that raise their rates or have a higher rate often have lower circulation. Participants will often hold large amounts of currency to take advantage of the interest rate or carry trade pairs that pit it against a low interest rate currency. A central bank will lower interest rates when it wants to facilitate spending of the currency, which adds to volatility.
Growth: A country that posts positive growth numbers are likely to experience a strengthening currency. A stronger currency facilitates more transactions as investors come into that international sector. There will come a time when the number of people coming will peak. Volatility will taper off and possibly fall off depending on the other economic circumstances in the country.
Retail Sales: There is a strong correlation between positive retail sales and a currency's volatility. A decline in retail sales is an indication that people do not want to spend money on products that are not essential to their living. It indicates fear and hesitation among the population, which is typically precipitated by economic reasons. There may be a significant number of businesses closing or lay-offs that are causing people to fear and withdraw into their shells. Poor retail sales data may indicate that the country is in a period of low volatility or is approaching one.
Economic Rumour and Policy: It doesn't take an official announcement to drive a currency in a particular direction or cause participants to pull their chips out of the game. There are numerous occasions where top officials hint at a coming change and the market reacts to it. Theorizing by major financial figures or politicians about economic circumstances may be enough to cause participants to withdraw from their holdings or move into other currencies for a time. It happens with official policy on a regular basis.
These are just a handful of the fundamental factors you can look at to try and gauge potential volatility in the near-term. Keep in mind that you are trying to pinpoint factors that are going to facilitate money-changing hands to look for an increase in volatility. Anything that causes participants to do that is a good thing for volatility, at least temporarily.
Adjusting For Trading In A Low Volatility Environment
There are several ways to go about trading in a low volatility environment. Certain points should be examined before you decide to step into it though.
Are your profit targets reasonable for low volatility trading?
Should a signal fire that indicates a trade, what is the relative probability that price action will move to your target? A low volatility means greater chances for failed, premium set-ups. A pristine pin-bar may form with all of your indicators pointing towards a potential winner; gain a little way and plunge into loss. Traders that are aiming for a 3-4x gain are likely to find their positions left to flap in the breeze as price action struggles for a direction.
As forex traders, we are playing the percentages of what is most likely to be in our favour. Far reaching targets should be dialled back to a more attainable level. 1-2x gain is a good place because a Take Profit can be triggered off of an initial burst of volatility from that signal. And speaking of Take Profit...
Are you using a static Take Profit to lock in profit from pristine formations?
Profit acquisition and protection are typically a personal approach. Some traders like to chase the long-term profit targets using a manual exit instead of an automated Take Profit. The problem with that approach in a low volatility market is that there is little strong support for the price to continue moving in a favourable direction to lock down the bigger winners. The times that are most likely to have volatility are going to be breakthroughs and solid formations off of Support and Resistance. Once that movement has expended itself, it can easily rubber band back to carve an invalid pin-bar out.
The trader using a Take Profit is going to lock in profit from that movement. A trader that aims for the longer target is now sitting back at the point of origination. Long-term approaches are great if the fundamentals are there to support them, but during low volatility times? Not so much.
Are you using a Timed Stop for your trades?
The savvy trader should consider instituting a Timed Stop when operating in low volatility conditions. A majority of entries are going to be when several factors perfectly align and cause the trader to fire off a transaction. In normal conditions, a reversal pattern may indicate a change in trend. In low volatility conditions, it can just be a very abrupt hiccup in the general direction of the pair. Different trading styles put varying weights on the validity of a perfect signal and how long it should take to actually play it. Others simply use benchmarks on the charts.
For example, a pin-bar can be considered valid until the plane of the tip of the long side of the wick is broken. Many traders will fire and forget a trade with a Stop Loss and Take Profit based on targets derived from that position.
On the other hand, some traders utilize a two-candlestick rule for validity. They may place a trade, but if there isn't appreciable movement at the end of two candlesticks after the pin-bar, they will exit the trade at whatever gain or loss there might be. The reason for this is that more than enough time has passed for several other traders to pile into the market on that signal. If it hasn't started to move within two candlesticks, then it is likely that other traders aren't seeing the candlestick as a good signal. The trader then exits the trade to minimize their losses.
A Timed Stop like the 2 candlestick method is a good choice in a low volatility pair. It is much harder to make money in forex than it is to lose money. Any steps you can take to embrace the highest volatility periods in the market and protect yourself before it dips out are good ones.
A Simple Addition To Your Strategy
There is a great way to bank some profit in low volatility conditions. Some of the greatest periods of volatility surround news announcements and economic data releases. Trading these news releases can be fairly simple and short; provided you have the tolerance for the stress you'll be immersed in.
You will want to be signed in to your client about 15 minutes before the announcement so you're not trying to sign in with everyone else at the last minute. Switch your time frames down to 5-minute increments and wait for the announcement to drop.
You'll know when it does because price will start moving pretty erratically as the market tries to figure out where it wants to go. Just sit and wait. Once that first candlestick closes, it's time for some analysis.
Does the candlestick have a dominant direction? Does it close in the favourable 25% of the direction of the candle (IE a bull candle, the top 25%; a bear candle, the bottom 25%)? If the answer to these two questions is yes, then you have an actionable candlestick.
Place a trade with the Stop about halfway through that candlestick. You are only aiming to secure at least 1x return on the trade. If you want to play it a little looser, you can advance the Stop Loss to break even when you gain the number of pips that you risked. You're striving to ride the next 5 to 30 minutes of momentum for as much profit as possible.
There are a variety of exits you can use. Take Profit at 1 or 1.5x risk, stay in the trade until candlesticks start to show sign of reversal, or just exit after a set number of candlesticks. The right approach will depend on your approach to trading. Be aware that if you decide to watch for reversal, you're in on a lot of volatility at the moment. You may not get a good sign until you're stopped out. If you want to wait a number of candlesticks, anywhere from 2 to 5 periods is a good choice.
This simple system doesn't require an in-depth knowledge of fundamentals. It is pure, technical price action that works very well for its purpose. It is easy to incorporate with about any trading strategy if you want to try and supplement your general strategy earnings. This strategy is a great way to take advantage of predictable periods of volatility when the market is flat.
A Final Choice For Flat Markets...
The final choice? Take a break!
Everyone needs time away from the markets to keep their head clear and focused when they're in the game. If markets are flat and there are no opportunities, take a break and enjoy some well-deserved rest for a little while. The second week of December to the first week of January is typically low volatility from the holidays. That is an excellent time to schedule a predictable break.
This post was written by Daniel Lindsay.
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