Here’s an indicator with an interesting story to tell…
Ok, I admit it’s not the most glamorous trading tool.
It won’t give you a big flashing arrow telling you it’s time to buy the Yen or anything like that. But as you are about to see most Forex pairs are giving a similar reading with this indicator at the moment – which is quite intriguing and offers us some potential trading opportunities.
I’ve got some charts lined up for us to look at and we’ll go through them in a moment. But first, let me tell you a bit more about this thing I’ve been using to get an insight into the current state of play in the currency markets…
I’m talking about the Average True Range (ATR) indicator.
What the ATR can help you see
Its job is to measure volatility in the market and just now almost all liquid currency markets are trading at very low levels of volatility. This doesn’t mean directional moves cannot take place – they can – it’s just showing us there’s no real momentum in play at the moment.
If you’d like to take a look, you don’t need to go to the trouble of calculating the ATR yourself – it’s a standard feature on most charting software. It basically plots the value taken from the average range of the latest specified set of price bars. It’s usually a 14 period default setting, so that’ll be 14 days worth of data, or 14 hours worth of data etc… depending which timeframe you are charting.
And you can use this indicator to help steer your higher level trading decisions.
Like I mentioned earlier, it’s not really something to use for precise timing of trade entries. But the Average True Range CAN give you insight into what’s going on ‘under the bonnet’ of the markets:
Schoolboy physics tells us an object in motion tends to stay in motion (i.e. a strongly trending market will tend to extend that directional bias) so if there’s a reduced level of motion the opposite is likely to apply – there’s a higher probability of the market chopping around or forming an area of consolidation rather than trending strongly.
And being aware of these conditions can help you adapt your trading outlook accordingly. There’s no need to be spooked out of the markets. Just take on board what the market is showing you and change your approach to suit.
Use the Average True Range tool with a bit of common sense and it can help you:
- Calculate and place trailing stop loss orders that self-adjust organically.For example, if you’re holding a long position you could take a multiple of the current ATR – two and a half times ATR or three times ATR – and project that value downwards off the most recent highs.Your stop is now placed beyond what you could reasonably expect to happen over the next two bars of price action. This can help you avoid stop-running activities targeting the obvious stop-loss placements in choppy markets. Trail your stop upwards as the market extends its run and update your calculations with the new daily ATR value.
- Locate provisional profit targets for your trade exits. If a trade you took on the intraday charts (e.g. 15 min) really takes off to the upside you can plot a target level by adding the current daily ATR to the lows of the day. This will give you an upside level at which the market may start to lose intraday momentum.Sure, it may continue higher but why take the risk of giving back your gains? The market will already have covered the range of price you could reasonably expect on the day. Use your ‘insider’ information to keep the probability of a highly profitable exit firmly on your side
- Choose the right overall strategy for current conditions. Break-out entries might be prone to more false signals in low-volatility conditions so buying and selling against the tops and bottoms of the current trading range – “fading” the breakout – may be a better strategy.
And you can also use the measure of volatility to help you select a higher-probability timeframe to trade off in the first place. If the weekly ATR is low it’ll tend to have a throttling effect on the range of the daily charts. You might find richer pickings by dropping down a timeframe. Under those circumstances trading the 8 hour or 4 hour charts may offer a better risk to reward scenario.
But of course, with trading there’s always a paradox. We need to consider the other side of the coin too…
Yes, the ATR indicator is showing us CURRENT low levels of volatility and we should trade with that in mind. But we also need to keep an eye out for a rapid change in volatility.
The markets are cyclical by nature and a period of low volatility is likely to be followed eventually by a period of high volatility. So are we simply seeing the calm before the storm?
Yes, big money can be made by catching the turn just right, but it can be an expensive hobby to keep (unsuccessfully) trying!
Let’s have a look at those charts now…
I’ll show you the ATR on the weekly charts for a range of Forex pairs. This will give you an idea of how volatility is low in most markets. You could expect it to be lower during the summer months anyway but this situation has been brewing for a while.
EUR/USD: The Euro/Dollar is down at the lowest levels of weekly volatility since 2007. It’s been trading in the 1.3000 to 1.4000 for twelve months now.
GBP/USD: Similar to the Euro, volatility in Cable is back down on its lowest lows since 2007 after spending a bit of time down here early in 2013. We’ve see that stuttering rally up from 1.5000 so you can see how volatility doesn’t outright preclude directional moves. It would have been a bumpy ride to effectively manage position trades on the daily charts from this price action though. Here’s where you might look to slightly lower timeframes to participate in the smoother flowing momentum moves.
USD/JPY: The Yen looks like it’s gone to sleep. We had that explosive up-move beginning in autumn 2012, a pause, a continuation of bullish activity at the end of 2013 and then… nothing. This market has been doing little more than bouncing along support at 101.50 for months now.
USD/CHF: The Swissie falls in line too – down on lowest volatility since 2007. That spike low mid-2011 keeps a bullish slant on things but recent movement is tight.
So that’s four big markets covered. But is this just a US Dollar thing?
Let’s have a look at a couple of the other British pound crosses and see if we fare any better.
EUR/GBP: Not much free flowing movement here either. We’ve seen that stuttering down-move over the last eighteen months but again, it’s been a choppy, bumpy ride day-to-day.
GBP/JPY: Similar price action to the US Dollar v Yen market. The up-move beginning in 2012 has stopped for a breather. This market has been range bound between 168.00 and 173.70 for most of the year to date. It took a quick stab to the downside in Feb but soon got dragged back into the current range. N.B. GBP/JPY is currently testing the highs of the range – might be worth keeping an eye on.
So if you’ve not paid it much attention before, have a play around with the ATR tool yourself. See if you can use it to uncover freer flowing opportunities in other markets (just be careful of the wide bid/ask spread on the more exotic pairs) or find freer flowing timeframes in the main markets.
Look out for a climbing ATR indicator line…
An up-ticking ATR might indicate an opportunity to ride smoother flowing momentum.
I hope you find it useful and do let me know how you get on.
Be Prepared: Market Moving Data Coming This Week (London Time):
Wednesday 2nd July 2014:
13:15 USD Non-farm employment change
16:00 USD Yellen speaks
Thursday 3rd July 2014:
09:30 GBP Services PMI
12:45 EUR Interest Rate Decision
13:30 EUR ECB Press Conference
13:30 USD US Employment numbers
15:00 USD ISM Non Manufacturing PMI
Friday 4th July 2014:
All Day USD Independence day holiday
Monday 7th July 2014:
No big reports
Tuesday 8th July 2014:
09:30 GBP Manufacturing production
Keep your wits about you if you’re trading on Thursday. There are a cluster of big data releases right ahead of a US holiday – it could get a bit lively on the day!
I hope you enjoyed this week’s material. Let me know what you think of the ATR tool and I’ll catch up with you again soon.