With all the talk about volatility and the dollar strengthening… it appears the dollar stalled out in January, and has gone nowhere since. On January 27, the dollar was trading at 1.13 against the Euro and it’s there again today – the dollar has essentially gone nowhere in 6 months.
What we’re seeing is an extended period of non-directional movement in the dollar. This is a situation where large dollar gains and losses are typical – with the media focusing more on the strong dollar than the weak giving us the illusion that the dollar is strengthening when it is really just drifting sideways for an extended period.
The root cause of the non-directional market is uncertainty. As traders, we understand that the only guarantee in the markets is uncertainty, but this type of uncertainty is different. For example, it’s easy to frame uncertainty during a rate decision – if the rates increase the dollar goes up. If the rates drop the dollar weakens. However, the uncertainty of having one fed meeting after another with conflicting economic data is much more difficult to forecast future movement.
And there is a lot of this type of uncertainty in our world. Among them is the uncertainty surrounding the Greek debt defaults and the Grexit from the Eurozone. An exit could bring contagion to financial markets – the extent to which no one really knows.
Geopolitical tensions (such as ISIS, South China Sea, and Ukraine) also make directional bias difficult. At any moment tensions could flare resulting in greater uncertainty.
Adding to the uncertain cauldron, is the presidential race in the US, where we have an ever-expanding pool of candidates with no candidate showing any real sign of strength. There is also the dysfunctional relationship between the Whitehouse and Congress, and their inability to settle on any meaningful fiscal policy.
All these factors make forecasting future trends foggy at best.
What do you do in markets like this? The easiest solution is to use different models. Fading the outside of the range is an effective strategy. Reversals will tend to yield better results than breakouts. Smaller timeframes will still have directional bias – albeit with smaller returns. And taking small incremental profits is better than hitting home runs.
Traders can survive periods of non-direction if we remember the rules are different and it requires a different book of play. Don’t forget the rule of volatility – the market oscillate from periods of high volatility to low. We are in a low volatility period so the next move is to an increase… Clarity on any of the issues mentioned in this article could be a catalyst for that shift and you need to be prepared!