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FX: Volatility Going into Year End

Last updated 10/10/2011 10:22 AM ET (GMT -5) 1 Comments

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Kathy Lien

Director of Currency Research, GFT

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The lack of U.S. economic data today gives us an opportunity to discuss other less time sensitive topics that are of interest to currency traders. With the European sovereign debt crisis in full swing, currencies trading at significant highs and lows and central banks jumping into the markets to prevent further appreciation, it is no wonder that most traders feel like volatility has increased significantly over the past year.  After examining the average daily trading range of all the major currency pairs  since the beginning of the year however, the numbers show that the daily volatility in currencies is not up across the board.  The following table compares the average daily range of currencies since January with its average daily range over the past 10 years.  Yes, volatility has increased in some currency pairs, but it has also declined in others.  In general, volatility hasn’t changed all that much for most pairs compared to their 10 year averages.  Yet, there are a few pairs worth noting.  For example, USD/JPY is this year's least volatile currency pair, having been around the middle of the pack in the past.  Much of this can be attributed to the yen floating around post-war highs and staying there as traders seek a safe haven in times of slowing economic growth. The upside is impacted by demand but the downside is limited by fear of Bank of Japan intervention.   Another pair whose volatility has changed dramatically is EUR/CHF which on a 10 year basis is the third least volatile currency pair.  This year however, with the Franc soaring against the euro due to safe haven flows and the Swiss National Bank jumping in to intervene and take the unprecedented move of pegging its currency against the euro, the average daily range of EUR/CHF is now the third highest.   The EUR/USD's average range has also increased but USD/CHF and USD/CAD have become less volatile this year.   Going forward, volatility could remain high as central banks gear up for more action before the end of the year.  The market is still waiting for the Federal Reserve to restart Quantitative Easing and for the European Central Bank to lower interest rates.  Merkel and Sarkozy's end of month plan to stabilize the region could also trigger some volatility depending upon whether their plans beats or misses expectations. 

The following charts of 1 month average option volatilities in the 3 major currencies offer some additional clues:

On a seasonality basis, the last three months of the year tend to have the highest volatility.  As the graphs indicate, trading tends to be more muted over the summer and picks up in September and October into November and December.  Traditionally volatility increases around this time of year because it is the last opportunity for investors and funds to generate alpha before their books are closed at year end.  Additionally, many international businesses repatriate their earnings in December for fiscal year end which can cause more volatility.  We expect this historical trend to hold in 2011l because of the number of uncertainties in the market - Greece is still at the brink of default and does not know whether it will receive its last bailout payment.  Investors are still waiting to see if the European Financial Stability Facility will be increased and if the ECB will lower interest rates.  And lets not forget that the Federal Reserve needs to decide if they want to reinitiate Quantitative Easing before the end of the year.   There are a lot of moving parts in this global economy that could impact volatility from now to December and for currency traders this leaves the choice of reducing your exposure to accommodate wider stops or to focus on shorter term trading to take advantage of the increase in volatility.  

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Comments (1)

Gogolando

October 11, 2011 at 08:32 PM ET

Thanks for all the hard work Kathy. This was great. Very useful. I was just thinking about what to do about wearher or not to widen my stops a bit and low and behold. Nice:)

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About The Author

Kathy Lien began her FX trading career 10 years ago at J.P. Morgan Chase. After graduating New York University’s Leonard Stern School of Business at the age of 18, Kathy joined the bank's interbank FX trading desk and eventually moved to the cross markets proprietary trading desk. In the interbank market, her ability to create solid fundamental and technical analysis from the myriad of information on the market helped her trade forex spot and options. Her experience eventually led her to be chief strategist at Daily FX where she worked until she joined GFT in 2008.

With her knowledge of forex, as well as her experience trading other products, such as interest rate derivates, bonds, equities, and futures, Lien has built a reputation as an international currency analyst. She is frequently quoted on CNBC, Bloomberg, Fox Business and Reuters. Lien has also written for publications like Active Trader, Futures, and SFO magazine. She is the author of the newly updated Day Trading the Currency Market: Technical and Fundamental Strategies to Profit from Market Moves, and the co-author of Millionaire Traders: How Everyday People Are Beating Wall Street at Its Own Game with Boris Schlossberg.

To buy Kathy’s newly updated Day Trading and Swing Trading the Currency Market: Technical and Fundamental Strategies to Profit from Market Moves, click here.