Special FX: the asset class that thrives on volatility
"FX divisions are among the most profitable in the banks. Ultimately in 2008, FX was a significant contributor to profits," says Scott Wacker, managing director of foreign exchange sales at JPMorgan.
"Low volatility means a bear market for the foreign exchange industry and high volatility means a bull market," says Martin Wiedman, head of global forex sales at Credit Suisse.
"But if you still have a pulse, you are going to have the opportunity to make some serious money in FX over the next couple of years."
Full Story: 26b4d60c-f324-11dd-abe6-0000779fd2ac,dw.pdf
My Comments:
Intraday Volatility---Prices move more during certain parts of the global day.
In foreign exchange, currencies get traded more or less in the regions where they are used as currencies of account, ie. JPY in Japan, GBP in the UK, etc. USD is essentially the global currency used to measure value, with EUR becoming a closer second for this role.
FX Pairs move more when one of their currency's regions begin their day and, you get a distribution of volatility on pairs.
(Stole this from: http://i.investopedia.com/inv/articles/site/FX-3market2.gif)
Short & Long, 20pip stop / 40pip take. (meant to do 1 lot, but accidentally did 2 lots)
The market went almost straight down, $1080+, $540-, which is P/L $540+.
The risk is that the volatility drops off, and the market starts moving sideways again. Worse even, the market moves against you and you pay spread, and lose your ante'd stop loss.
Take a look at the last 3 weeks or so. Pay attention to the area under the Solid Blue (UK) boxes (and where they overlap with Solid Green boxes (US)). This is typically the most volatile time of the day. Since Lehman died, its a rare day that see daily range of less than a 100pips.
Depending on what the actual probabilities work out to be with whatever SL/TP I choose and the directionality from whatever point I initiate my trades turns out to be, the probability of working out might be less than 50% of the time. With only simple TP/SL, if the trade only works out 45% of the time, that means that the break even on the game is...
[Scenario 1 x Probability 1] + ... + [Scenario n x Probability n] = 0, (Break Even)
[(Win Scenario) x 45%] + [Losing Scenario x 55%] = 0,
[((Profit Took Side) + (Stopped Out Side) ) x 45%] + [2 x (Stopped Out Side) x 55%] = 0,
[(Take Profit - Spread) + (Stop Loss - Spread) ) x 45%] + [2 x (Stop Loss - Spread) x 55%) = 0,
[((91pips - 5pips) + (-20pips - 5pips)) x 45%] + [2 x (-20pips - 5 pips) x 55%] = 0
At 45% probability of win, 91pips is break-even,
At 50% probability of win, 80pips is break-even,
At 55% probability of win, 71pips is break-even.
Reducing loss, increasing win, and increasing winning probability are keys to any strategy.
When expecting a spurt of volatility, the fact that the trade has not won yet, indicates too little volatility for the strategy. A time-based narrowing of the exit range would probably be helpful at reducing loss. In this case, it would be good to start reducing losses by accepting a small loss on exit, which is better than waiting until the market starts moving against you and takes out the remenants of your trade.
Secondarily, there might be something to be said for a directional bias. A risk-neutral bias, based on close historical prices seems like it might be of some value. However, care needs to be taken to only make the strategy risk neutral, otherwise the strategy starts becoming a directional play, as opposed to a volatility play.
With that said, with a well timed entry where volatility typically picks up, a well devised trailing stop, and a loss reduction strategy, there might be a potential on an above average volatile day of 200-250pips, to return a maximum of 2 to 3x the break even distance of 80pips.
Since this strategy runs on volatility, another helpful ingredient might be having the program look back several days and measure the amount of volatility there was, and make it revise it's own strategy parameters to increase win probability. Even perhaps a simple implementation of a volatility model, GARCH, or something along those lines.
This leads me to thinking about a model that attempts to predict intraday volatility, and perhaps calculating win probabilities to size bets, maybe with the Kelly bet-sizing model, or a weakened form (as Kelly is known to be ultra aggresive.) Alas, I shall leave this for another day.
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