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Summer Volatility Blues in the Forex market

Discussion in 'Forex Discussions' started by painofhell, Sep 9, 2015.

  1. painofhell

    painofhell Content Contributor

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    Common Themes in the FX Market

    The Sell in May & Go Away Approach

    Implied Volatility to Help See the Future


    Seasons are common occurrence in life. Seasons of helped farmers for centuries plan their year and determine when it’s time to so and when it’s time to reap. Seasons are common in the Forex market and one of the more popular seasonal sequences is summer and fall.

    Common Seasonal Themes in the FX Market

    1929, 1987 and 2008 have something in common. These massive drops in markets all happened in the fall. These three big drops were also preceded by low volatility run ups in the season before, summer. The FX market tends to have common seasonal volatility themes similar to how commodity markets tend to find volatile times of year based on possible drought and supply problems or winter and crop problems.

    More applicable to the FX market than commodities is the seasonal patterns of volatility. The early part of summer typically experiences with the lowest volatility of the year, which ramps up into fall were volatility is typically highest for the year. If you are familiar with the past few years, the Forex market has experienced significant directional changes in the summer which tend to ramp up aggressively towards the fall when volatility pushes higher.

    The Sell in May & Go Away Approach

    The sell in May and go away approach refers to the tendency for stock market traders to exit their position from May to September and come back to the market from October to April.

    From 1997 to 2007, August and September were often the worst months of performance with October, November, and January often seen the best gains and another small pop before in April summer begins. Typically, a short-term top happens in May and potential bottom in August before resuming the uptrend later in the fall.

    Stepping back, it is important to note what the data shows as common over that 10 year period. Over the last five years, we have seen major turns in the FX market around the US dollar in the summer. These big turns backs up the view that major market turns can happen in the summer which tend to accelerate through the fall when volatility heightens.

    If big turns are happening in the summer, which changes the picture as to what a trader should be doing when volatility is low. First, a trader should be looking at turns in fundamental data or on the charts that signify a large shift. In summer of 2008, the dollar began to strengthen as fears of the credit crisis grew and then blue to a full on dollar bull market after Lehman Brothers declared bankruptcy in mid-September of that same year. In the summer of 2011, the dollar bottomed after faith in the dollar fell to new lows on the back of the government shutting office temporarily over the inability to negotiate a better budget. In the summer of 2013, the chairman of the Federal Reserve, Ben Bernanke addressed the ‘taper tantrum,’ by assuring markets that the Federal Reserve would remain very accommodative in their monetary policy for the for foreseeable future sending the US dollar lower for nearly 12 straight months. In the summer of 2014, the US dollar began what would soon be the largest bull run in its history as many started to price and massive monetary policy divergence between the Federal Reserve and other central banks.

    With these documented big turns in the summer, it’s unlikely you’ll be the first one on the train but it is possible to begin seeing the pieces come together. When you recognize such a turn, you can begin to take small bats and add to that trade if you have indeed found a large shift forming.

    Implied Volatility to Help See the Future

    While no one knows the future, options markets are a sophisticated way to see how much volatility is expected over a certain time frame. Specifically, traders can look to the implied volatility for at the money or ATM options as well as one-month, three-month, six-month, or 12 month implied volatility for currency options.

    When implied volatility is slow, currency markets are not expected to move very much relative to prior ranges. However, when a large election is coming up recently saw with Greece’s referendum, implied volatility can skyrocket. A move higher in implied volatility can often be a warning sign of big moves about to happen and should be a warning sign to traders to limit exposure or tighten risk. Either way, while volatility in the summer often starts low, big turns tend to happen and volatility picks up through the summer leading to rather volatile autumns.

    Happy Trading!
     
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