Trading successfully in low volatility markets
The state of the markets
Many traders may have noticed of late, the markets experiencing a period of low volatility. Indeed, the VIX index which shows U.S. Stocks suggests that volatility is at a historical low. As shown in the Bloomberg charts below, the VIX index has fallen to 10.86, not far away from the seven year low of 9.4. For a comparison point on how low these levels are, during the Global Financial Crisis the average level was moving around the 30 mark.
This scenario has also been matched in the Forex markets. The volatility of major currency pairs has declined to lows not seen for many years. An obvious case is Dollar/Yen, which has been sitting in the current sideway for almost five months now. Its recent movement range has been narrowed into a channel between 101.50 and 102.50.
How do I trade when there is so low volatility?
MXT Global’s Chief Currency Strategist, Anthony Wu, shares his tips on how to capture profits during these times of low volatility.
Option 1. Narrow your take profit/stop loss distance
If you had set up take profits/stop losses for any of your trades, this may be the ideal time to narrow your take profit/stop loss distances.
During times that are lacking volatility, there is a very high chance that prices will reverse before hitting any previously set targets – rendering them useless. In this case scenario, traders may lose most of their profits or even experience loss. Correspondingly, if the profit taking distance is narrowed, whilst maintaining the return rate, the contract size also needs to be upwardly adjusted.
Option 2. Use the breakout strategy
Although the market volatility is relatively low at the moment, it doesn’t mean there aren’t any trading opportunities out there. The breakout strategy captures these opportune moments. When the price is moving within a parallel channel, traders can set a buy stop order beyond the channel and/or a sell stop order below the channel. By using this strategy, when the price ‘breaks’ out of its original consolidation model, possibly due to surprising data announcements or changing market sentiment, the trend outside of the model may continue for quite some time, which will provide traders a great chance to capture profits.
Option 3. Carry trade
The non-existent volatility can mainly be attributed to the easing policies implemented by the major Western Central Banks. Traders now tend to borrow from currencies with cheap borrowing costs and use the funds to pursue high-return currencies banking on the interest rate difference. Considering the leverage, the profits of this carry trade strategy could be very substantial. Taking note though, the disadvantage of the carry trade is that investors are open to the risk exposure of FX exchange rates for a long period.
More now than ever though, a carry trade strategy would be suitable for this current period of low volatility. Earlier in June 2014, the European Central Bank decided to introduce a negative-interest-rate policy and made the Euro available as a funding currency for carry trades. More traders are delving into trades shorting the Euro and going long for high-return currencies such as the AUD and NZD.
According to Bloomberg, in the recent six months, the return of shorting EURNZD and EURAUD were the best investing options. The historical return does not necessarily represent future performance but considering that the ECB will be keeping its easing policy for the mid-term, traders could still probably find chances to trade those two pairs.
The views and content above are Anthony Wu’s own and do not reflect the views of MXT Global.
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