Vampires need love, too. Many traders regarded currencies as dead capital for most of 2014 because global central banks were printing more and more money. From the Federal Reserve’s latest iteration of quantitative easing (QE), to the Bank of Japan’s (BoJ) pedal-to-the-metal approach to monetary policy, the result was compression in currency volatility going back to Q4 2013. But as of late 2014, currencies have come back to life in a big way thanks in part to a structural set-up in the U.S. Dollar Index Futures (/DX), and a run on black capes.
The /DX is an example of a useful futures contract because it’s a basket of six foreign currencies weighted against the U.S. dollar. These six foreign currencies include the euro, Japanese yen, British pound, Canadian dollar, Swedish krona, and Swiss franc. Think of the /DX as the Dow Jones of the currency market.
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Currency volatility compression can be seen on a daily chart of the U.S. Dollar Index Futures (/DX) using a simple measure of volatility—Average True Range (ATR). The chart in Figure 1 uses a 14-day ATR to show the steady decline in volatility through August 2014.
A falling ATR can sometimes signal that a market is in a range-bound mode, meaning the market is likely to trade sideways between well-defined support and resistance levels. In contrast, a rising ATR tends to signal a market that is in trending mode. In the case of currencies, these trending modes can be up or down trends, and can last for a long time. The chart in Figure 1 reflects these signals in the ATR as the /DX transitioned from range-bound mode to up-trending mode in Q4 2014.
The Volume Profile indicator plots volume totals at specific prices over the time period specified on the chart. For example, the price at which the most volume traded in Figure 1 was 80.35. Volume totals for each price are plotted horizontally and typically form a bell curve rotated on its side. This view gives traders a new perspective on support and resistance and where breakouts might occur.
You can see in Figure 1 the /DX broke out above its year-long trading range in late August with a move above 81.50. Note that the Volume Profile was thin above 81.50 and this is the structural set-up that set the stage for a return of volatility and trends in the currency market. By “thin,” I mean there was minimal resistance because there was little historical volume above this price. This structural setup cleared the way for the /DX to shift into trending mode. And trend it did.
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When looking for potential breakouts in currency futures, take a look at the Volume Profile. Whether it’s in the /DX or in any of the individual currency futures examples like the euro (/6E), pound (/6B), or yen (/6J), checking traditional support and resistance levels against the Volume Profile can help you determine if a breakout might have follow through. Look for thin Volume Profiles beyond breakout points and match these moments with a rising ATR in your search for trending bliss.
Open a Futures Account. For qualified accounts, you’ll need Level 3 options approval to trade Futures. Log in to your account at tdameritrade.com. Under the Trade tab, go to Futures & Forex for more information.