FX Volatility - CASE STUDY

Written by Trade Team | 31 August 2009

Actual FX Volatility Trades - CASE STUDY I

Period Covered From : August 18, 2009 - August 28, 2009

The Case Study presented on the Foreign Exchange transactions are based on '  Real and Actual ' trades executed from the above stated period covered and it would clearly show how ' An Effective FX Trading Strategy ' in a worst case scenario can be best utilized in the form of hedging techniques between major pairs, cross-rates, futures and the precious metals markets.

Although, these practises are more complex and carries a higher degree of sophistication  and / or trading skills which could be develope through proper due diligence, research, a reliable source of information and  experiences in the Foreign Exchange Trading and the Commodity Futures Market. The results of trading in a volatile market like the Foreign exchange rates may well vary for each individual investor and trader since primary objectives and financial conditions differ from one another. As a matter of record, there is no guarantee that future results like in this case study may or may not be the same and should be used as an informational reference only.

US Dollar Index

FUNDAMENTALS SUPPORTING A SIGN OF RECOVERY - ? -

As it has been a given fact, that the US Dollars' value has depreciated since the beginning of the year and has continued there on to this writing. The US Dollar better known in the industry as the ' USDX / DXY ' or the US Dollar Index, is an index that measures the value of the US Dollar versus a basket of foreign currency in basis points. As it maintains the price range levels of the US Dollar Index between 78.80 basis pts., high range and a low range price of 77.30 ( figures were rounded-off for simplicity ) the second lowest levels from a low of 70.90 historical low, it may be difficult to find fresh incentives for investors to buy the currency even as a flight to quality investment being the World's Reserve currency. As stocks tries to move and sustains its good levels since the first two (2) qtrs. of the year; investors are also weary of the physical recovery of the economy inspite of the signs and figures on the reports say. 

The week starting the 18th of August - to - the trading week ending August 28, 2009 have been quite supportive for the US Dollar as a barrage of fundamental reports and the recent comments from the Fed Chairman Ben Bernanke that the US is at the verge of economic recovery, the economic report from the National Association of Realtors that home resales is the highest levels from the past 10 years, durable goods, retail sales and a better than expected consumer report from an expected 48.7 in July revised to 54.1. With all these encouraging reports stocks have made some decent positive mioves although the real sentiments never followed through with the volumes. 

So in conclusion since the ' Directional ' Major Trend, fundamental factors and price range levels have been established and from previous trades made prior to this case example; the currencies and commodity identified here were the choices for the investment.

GBP/USD DAILY 

EUR/USD DAILY

Both Major pairs of the Pound and the Euro is also a well defined ' Major Trend ' choosing the two as the lead currency to trade is only but logical sice the highest presence of liquidity is obviusly with the pair compared witht he rest of the other foreign currency being traded for the past months. As it is shown with the weekly charts above since March of this year 2009. And observe that the low support prices on both pairs are higher from their previous weeks and months. Any draw-down on prices were limited to a week or the most to two weeks. But with the average trading range between 150 - 200 pips up and down and price swings are very active covering every high and every low within a short period of time as it would show on the daily and four hourly charts on the succeeding formations.  

The relative Cross Rate of the Euro & British Pound ( EUR/GBP ) were supporting the consistency of the major UpTrend for the pair, however the EUR/USD has been the pace setter ahead of the GBP/USD as both the German Chancellor Merkell and the French President Sarkoszy has expressed the recovery of both countries from the recent economic recession. This has given a full support for the Euro and the Pound as shown in the chart of the EUR/GBP cross-rate below. 

Please take note that the Foreign Exchange trading is not limited to US dollar base trading but also Foreign Currency base trading. As most interbank trades are not limited to US dollar; as these major banks holds substantial foreign currency denominations which are allowed to use and leverage trade for all intents and purposes by hedging against adverse price fluctuations in the international market.

As most Retail broker-dealers offering FX trading services are limited to US Dollar base trading. Although, only a few brokers, FDMs do acknowledge the importance of having a combination of both. As retail investors and traders are limited in funds investments and are more inclined to speculative trading by nature.

EUR/GBP DAILY

On a day to day basis, even when a major trend is established signals and bearish formations are reflected more often such as the examples above shows. The decision and analysis to stay within the trend is the more likely scenario and not go against the trend. But to be able to define how much of a corrective move will it take for the Pound and the Euro before they continue back to their upward momentum.

Has anybody noticed that starting the 13th of August, the movement of the Lead currency movement upwards by the Euro is totally the opposite of the Pound; as the GBP/USD daily chart shows the contrary movement heading lower until the 25th of August? Pls. look at the charts on both currencies above.

In additon, is it not true that when the US Dollar weakens in value; the British Pound and the Euro gains strengh? How can this happen? And this scenario was not even mentioned in the reprots made by these broker-dealers as our trade team scanned through their reports and analysis while the market was actually in this stage.

Ever wondered Why? Or nobody just noticed!  We'll get to that in the next portion of the case study. So. . .

Buying on the way up has always been proven well with our trade team and we knew that the next upward direction may take sometime to continue due to the lost momentum as the barrage of good economic numbers prevailed in the market place and the sentiments were weak. As we have previously settled a long standing positon on the EUR/GBP recognizing the  behavioral pattern that both major pairs were making and prior to this case situation it was just a matter of time.

The 1st executed trade was made on a Tuesday the 18th of August as indicated in the 1st small blue triangle on the upper part of the two other triangles. As shown on the chart above that there are three ( 3 ) executed trades done in several intervals separated by days. At the closing of Friday the 21st of August barely three days in the market after experiencing a volatile up and down swings the Pound closed lower unexpectedly as shown in the GBP/USSD - 4 hourly chart below. 

Market capitulation for later buyers as market sellers on rapid liquidation took part when the Pound made an initial high of 1.6623 on August 21 in a brief rally that reflects the long wick on that high price ; a low at 1.6418 added more settlements and finally closing at the price of 1.6486. A trading range of 205 pips has been established and continued lower on the closing week. 

the opening week thereafter was a little more interesting as the head and shoulders formation on the GBP/USD is more defined. The second trade ws initiated at the neckline of the formation which obviusly failed after several attempts was made. So the ultimate equation has to be incorporated as to where the full head and shoulders formation would have a stonger support price. Which led us to the price level of 1.6180 which also happens to be our third executed entry price on the GBP/USD; just as few pips away from the registered low price for the week ending 28th of August which is 1.6153.

When all these actions were happening, the sugsequent trades made on the other positons will also be discussed as we move on the the next phse of the case study. The EUR/USD chart below was an added support, if and when the prices did continue for the Euro very briefly on the 4 hourly chart of the 27th of August and then consolidated to move lower. It would have been good but proved to be otherwise as it was executed on the 27th a day before the end of the month closing. This was after the fact as always.

The chart below as shown in the GBP/JPY and the EUR/JPY reflected why the GBP/USD was influenced more to move downwards as the two major cross-rates was dragging it lower. As most banks and other interbank strategist were actually building carry trades on the Japanese Yen by using the British Pound to leverage-buy the Japanese Yen in anticipation of the elections for new government in Japan that prompted the Japanese Yen to gain in strength more this coming week.

When a foreign currency major such as the GBP/USD does the opposite or any foreign currency for that matter; it is heavily crossed as the term implies with the cross-rate as a strategic hedge BY MAJOR PLAYERS AND BANKS IN THE MARKET. When something like this happens stay away from the market! However, in this case where the trades were caught within heavily cross-traded transactions hedging is more than applicable. Which has been initiated before with Gold and the Australian Dollar in our next discussions.

Only a few would have recognize the discrepancy on the directional movement between the EUR/USD and the GBP/USD. As we have mentioned earleir that most major banks use other foreign currency denomination to carry a trade other than the US dollar as it is very weak today. And on a day to day basis all these market action may not even be reported in the financial news.

These is just one of the important part of trading the FX market. Being able to read the price behavior in-between the lines would take a little more than just learning the trade. Experience plays a significant role and all aspect of the market has to be considered. Now that has been said, what would be the next step?

GBP/JPY 4 HOURLY CHART                               

EUR/JPY DAILY CHART

ON GOLD TRADES :

As an alternative, when our trade team recognized the discrepancy on the directional movement between the GBP/USD and the EUR/USD since the 13th of August 2009; to diversify the FX investment funds a trade was similarly executed on the 18th of August at the price level of USD 942.50 reflected on the Gold Daily chart below and subsequently held on to the position and bought another position on the way up on the 25th of August at USD 944.45 as also reflected on the 4 hourly chart below. Only one posiition hs been setttled in Gold at the price level of USD 954.50 and one is till open as of this writing. 

GOLD DAILY CHART                                         

ON AUSTRALIAN DOLLAR TRADES :

Since the EUR/USD earleir trade was a small busted trade the subsequent Australian dollar trade executed on the 25th day of August at the price of 0.8347 AUD/USD and settled at 0.8448 AUD/USD. As this was simply a support if the prices on the Aussie should continue its breakout pattern from is previous resistance price of 0.8330. As this currency was not affected like Gold in the heavily cross-traded currency like the GBP/USD versus the GBP/JPY and the EUR/JPY rates.

AUSTRALIAN DOLLAR DAILY CHART          

IN CONCLUSION :

The transactions have been quite rigid in nature as the market conditions changed due to unexpected cross-trades between major particpants in the market. As the majority of buyers for the GBP/USD had been boxed-in as the overwhelming long positions capitulated as th edirectional movement of the prices headed lower compared with the EUR/USD. Although, this kind of situations do exist sometimes but more often the market is in a normal pace. A lot of position maneuvering and strategy must always be on the alert when similar conditions may happen. In essence, the end result justified the means and a net positive in dollar amount has been achieved successfully.

The importance of presenting this case study is to familiarize investors and traders that there are always some room for improvement in trading the Foreign Exchange Market. Furthermore, with proper guidance and due diligence such techniques applied in these transactions are openly available as informational reference if and when similar instances may or may not happen again.