How to Trade Volatility Breakouts in the Forex Markets
Over the forthcoming days and weeks we will take a look at some of the most effective and powerful ways to capitalize on huge outsized moves in the financial markets… and we would like to tell you upfront: it does NOT involve day trading!
Today we are going to look at Weekly Volatility Breakouts which are an incredible strategy for catching wide range weekly moves off the Monday ‘open’ long and / or short.
Weekly Volatility Breakouts: System Rules
1. Volatility Stretch = (Last weeks high – Last weeks low) * .30
2. Add the Volatility Stretch to Mondays Open (1AM EST) for long entry, subtract to Mondays Open for short entry
3. Stop loss = (Last weeks range * .1) added to Mondays open for short exit, subtracted to Mondays open for long exit.
4. Exit all trades the following Monday 1AM EST at market if not stopped out.
Example Trade Setup on XAGUSD (Silver) 3rd September 2012
Previous weeks range XAGUSD = 31.753 (previous weeks high) – 30.24 (previous weeks low) = 1.513
30% of last weeks range = 1.513 *.3 = .4539
This week XAGUSD opened at 31.8275 at 1AM EST (pre London open)
We add .4539 to Mondays Open for Long entry (Long Entry @ 32.281), and subtract .4539 to Mondays Open for Short entry (Short entry @ 31.374). Which ever fills first is our trade, we cancel the other pending order.
Our stop is 10% of last weeks range (1.513*.1 = .1513) added to Mondays open for our short exit (31.8275+.1513 = 31.979), or subtracted from Mondays open for Long exit (31.8275 – .1513 = 31.676).
We exit the trade the following Monday 1AM EST open if not stopped out before.
Weekly volatility breakout performs incredibly well when there is an explosive continuation move in the markets, other times when markets are range bound our losses are contained to a small percentage of our account equity.
Why do volatility breakout strategies work so well when the markets trend?
Often a ‘big range bar’, defined as a bar whose range is two times greater than the 70 bar average range, will open and close at opposite extremes. The bigger the range, the more extreme the close. Profit is a function of time, the longer the holding period the greater the profit potential. By staying with the position for up to 5 full trading days we are giving ourselves a time opportunity for catching some supercharged moves when they present themselves.
Take a look at the weekly bars on silver below and notice how often the open and close are at opposite extremes (normally within the most extreme 15-20%) on big range weeks.
Silver weekly bars
One of the problems with volatility breakout strategies is that markets can go extended periods without any trend, and these periods can cause whipsaw losses for traders. We will discuss some robust filters which work around these issues and significantly improve volatility breakout performance in our next blog update.
If you enjoyed learning about how to Trade Volatility Breakouts, make sure to check out our Forex Strategy Pages for further Updates on how you can improve your Risk Adjusted Returns in the Forex Markets.
