Deja Vu

As the old saying goes, 'it does not matter....until it does!'

This is very apre peau for traders especially. While many academics will argue that markets are efficient, scenarios over the years like WorldCom, Enron, Tesla and 2018's spectacular blowup of short volatility traders reminds us that the markets can be very inefficient. Ultimately complacency will take a trader(s) out....sometimes permanently.

That is why I find it so interesting that just over a year later where we witnessed the carnage of the 'short volatility trader' we might be seeing Round #2. As the chart below shows, large speculators, mostly hedge funds, were net short about 178,000 VIX futures contracts on April 23, the largest such position on record...Source: Bloomberg

VIX

The logic of this trade actually makes a lot of sense. The Fed's about-face in terms of rate hikes for 2019 signaled to the market that they were willing to keep the party alive. Since then, the S&P's are back to record highs, bond yields have fallen, the US dollar has risen and volatility has resumed the grind lower.

Adding to this bullish environment is the narrowing of credit spreads again. The two charts below are very supportive of a sustained move higher in stocks and thus lower volatility.

G7

Credit

Source: Nautilus Research

Why wouldn't you let the Fed take care of your back and simply go with the flow? Tough to argue. But following the crowd typically results in everyone trying to get through the same door when fortunes change.

My article today is not designed to be a forecast piece on 'when' this low volatility market will end and what the implications will be. Any smart trader will know that playing with fire can result in getting burned. What's more important, is how we navigate this low volatility environment within the FX market. 

In my update last week, I highlighted some of the challenges faced by traders in this low volatility environment. But I was also very clear that lower volatility simply means fewer trades; not lower quality trades. I maintain a near-term outlook that points to a higher Dollar Index (DXY), USD/CHF and thus lower levels in EUR/USD. That is playing out by and large at this time.

I maintain that over the next several days/weeks we are likely to see a continuation higher in the Dollar Index (DXY) as forecast here last week. The break back above the 98 level should allow for a continuation move higher. Like all moves, it will not be a linear moonshot, there will be plenty of rallies and corrections along the way, but we should ultimately see prices move towards 100.86+

Under that scenario, sustained moves lower in EUR/USD, AUD/USD and NZD/USD will be expected. On a near-term basis (next 1-4 weeks) the FX options market is pricing lower moves in as well. I have only highlighted AUD/USD below, but you will see a nearly identical pattern in EUR/USD and NZD/USD. The options market is simply pricing 10 delta puts at a higher price than the 10 delta calls. It points to the market leaning bearish. This is simply one of several inputs that traders can use to determine price direction.

AUDUSD

What If?

To avoid becoming complacent, let's take a look at what happened in FX markets back in Feb 2018 and December 2018 when the low volatility trade blew up. The most obvious impact of the spike higher in the VIX was the damage done to JPY. A quick look at JPY shows very clearly a flight to safety (i.e. stronger JPY). Simply look at the big moves in USD/JPY, EUR/JPY, AUD/JPY, NZD/JPY and CAD/JPY. All of them were nearly perfectly correlated (inversely) to the spike higher in VIX.

I have only illustrated USD/JPY below, but all the other crosses show a similar pattern. 

USDJPY

For now, stay the course, but always be mindful and on the lookout for factors that could potentially disrupt the trend....that is where you not only protect yourself but also stand to place some very robust trades.

Aspen Trading Group´s FX Commentary, including any content or information contained within it or Aspen Trading Group´s web site, any site-related service, is provided “as is”, with all faults, with no representations or warranties of any kind, either expressed or implied, including, but not limited to, the implied warranties of merchantability, fitness for a particular purpose, and noninfringement. You assume total responsibility and risk for your use of Aspen Trading Group´s commentary/website, site-related services, and hyperlinked websites.

Recommended Content


Recommended Content

Editors’ Picks

AUD/USD: A tough barrier remains around 0.6800

AUD/USD: A tough barrier remains around 0.6800

AUD/USD failed to maintain the earlier surpass of the 0.6800 barrier, eventually succumbing to the late rebound in the Greenback following the Fed’s decision to lower its interest rates by50 bps.

AUD/USD News
EUR/USD still targets the 2024 peaks around 1.1200

EUR/USD still targets the 2024 peaks around 1.1200

EUR/USD added to Tuesday’s losses after the post-FOMC rebound in the US Dollar prompted the pair to give away earlier gains to three-week highs in the 1.1185-1.1190 band.

EUR/USD News
Gold surrenders gains and drops to weekly lows near $2,550

Gold surrenders gains and drops to weekly lows near $2,550

Gold prices reverses the initial uptick to record highs around the $$2,600 per ounce troy, coming under renewed downside pressure and revisiting the $2,550 zone amidst the late recovery in the US Dollar.

Gold News
Australian Unemployment Rate expected to hold steady at 4.2% in August

Australian Unemployment Rate expected to hold steady at 4.2% in August

The Australian Bureau of Statistics will release the monthly employment report at 1:30 GMT on Thursday. The country is expected to have added 25K new positions in August, while the Unemployment Rate is foreseen to remain steady at 4.2%.

Read more
Ethereum could rally to $2,817 following Fed's 50 bps rate cut

Ethereum could rally to $2,817 following Fed's 50 bps rate cut

Ethereum (ETH) is trading above $2,330 on Wednesday as the market is recovering following the Federal Reserve's (Fed) decision to cut interest rates by 50 basis points. Meanwhile, Ethereum exchange-traded funds (ETF) recorded $15.1 million in outflows.

Read more
Moneta Markets review 2024: All you need to know

Moneta Markets review 2024: All you need to know

VERIFIED In this review, the FXStreet team provides an independent and thorough analysis based on direct testing and real experiences with Moneta Markets – an excellent broker for novice to intermediate forex traders who want to broaden their knowledge base.

Read More

Majors

Cryptocurrencies

Signatures