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Lessons from the Pros - Forex

Strategies For Identifying Potential Breakouts in Low Volatility Forex Markets

Tue, Jul 28 2009, 12:31 GMT
by Steve Misic

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There are many strategies for trading volatile markets. During periods of high volatility in the Forex markets, price often moves large distances without resting or retracing. Many times these moves happen in different time zones as reactions to economic data or global headlines cause changes in trader’s sentiment. This means that on certain days, the entire daily move might happen in the Asian session or in the European session while the US Forex trader is asleep. In order to participate in this type of swing trade, a Forex trader needs to have a volatility expansion strategy to take advantage of the larger trend moves. Before high volatility, many times there will be an opportunity to enter a breakout from a period of low volatility. Today’s newsletter will focus on using a few indicators as tools to identify ideal conditions for a low volatility breakout. The key to being successful with this strategy or any other strategy is to apply consistent rules.

The first tool that can be used to construct a volatility expansion system is the Bollinger Band indicator. When the Bollinger Bands are narrow, a currency pair is likely to break out into a trend move. Narrow Bollinger Bands indicate low volatility, but each currency will be different as to how narrow the bands become. Applying this system to periods of minimal involvement in the currency markets will usually produce small range bars indicating very low volatility. Since the currency markets become quiet after Noon EST, using the highest hourly high, and the lowest hourly low, from 12:00 PM EST until the daily rollover, can be used as boundaries to filter out false breakouts. Adding an oscillator such as the momentum indicator will further filter the number of false breakouts, as well as only taking entries in the direction of the primary trend.

The 5 minute chart of the GBPJPY cross pair shows extremely narrow Bollinger bands on 7-22-09 between 19:00 and 20:00 hours ahead of the start of the Asian trading session. The Japanese Yen had recently tested weekly resistance, and most of the cross pairs were benefiting from the selling in the Yen. The Cable had been rallying against other pairs due to the recent rebound in oil prices which was putting additional pressure on the Yen. Japan needs to import all of the oil it uses.

The rules for entry with this system are if the close of this bar is above the upper Bollinger Band, and the momentum indicator is above the zero line, then, buy the next bar at the open. Place a protective stop loss below the lowest 60 minute low from the 12:00 PM to 16:00 PM range. Since this system is a trend following system, drawing an uptrend line on the 60 minute bar lows is a good way to let this trade run rather than using the 20 MA which may exit the trade prematurely.

If the trader is looking for fewer trading opportunities, then a slightly larger time frame for entry such as a 30 or a 45 minute chart should work.

If the trader is a position trader, then this strategy can be applied on a daily chart. The trend on the daily chart will lead to longer holding periods, and it will allow the trader to enter a well established trend with measured risk.

Published on  Tue, Jul 28 2009, 12:34 GMT

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