FOREX QUANT

March 26, 2007

Less Volatility

Filed under: Uncategorized — by TraderMade @ 4:24 pm
Tags: , , , , ,

I’ve witnessed a decreasing volatility in all forex pairs. This was observed when I put a long term ATR indicator into several forex pairs on all time frames. During the last 7 years, the volatility have been declining by more than 40%. I thought that was only me who observe such a shift in market behavior. But then I found this article on FXCM’s website:

Why the Forex Market Changed

Through the 1980s and 1990s, and even into the new century, the distinctive characteristic of the foreign exchange market was its volatility—a volatility that was a reflection of major imbalances between national economies.
When a country over-spent or over-borrowed, or when its external trade went wildly out of balance, its interest rates were forced up and its economic growth slowed down. In the forex market, the country’s currency also paid the price—usually by sudden and sometimes drastic devaluation. In short, economic imbalance generated currency volatility.

Increasing globalization has changed all that. In today’s world of tightening economic interdependency, it is in every country’s interest to maintain economic and financial stability—even if it costs. And trade surplus countries (in particular China) now effectively underwrite trade deficit countries (in particular the US) in the name of stability and an orderly market. As one result, interest rate differences are compressed. As another, currency volatility is minimized.

The New Range-Bound Forex Market

The forex market has undergone a profound change. In past years, a trade imbalance or an interest rate shift could suddenly move a currency price hundreds of pips. For that reason, success in the forex market followed a traditional formula: Cut your losses short, but let your profits run. Traders took small losses quickly, but rode big trends for big wins. A volatile forex market rewarded breakout traders.

Using that formula, professional traders were disciplined enough (or their black boxes were disciplined enough) to absorb several small losing trades, because their one, very large win more than made up for them. Using a breakout trading system, only 30% of the trades had to be winners, because the payoff on a breakout trade could be six times the total of the losses. The risk/reward ratio and the mathematical probabilities were in their favor.

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