Short term
Trade view / 20 May 2016 at 11:29 GMT

Trading the Fed's bluff

Trader / Saxo Capital Markets Pte Ltd


The “music" of the forex markets today is the fresh assertion from the Fed that a June rate hike is still possible. But the CME Fed Watch tool is only pricing in a 30% chance of that happening.

Looking at the US dollar index futures (DXM6), we can clearly see the upward momentum of the USD decreasing. Stochastics are within striking distance of a bearish crossover, while simple price action, the purest form of any analysis, indicate a lower dollar index today (95.245 at the time of writing versus a close of 95.294 on May 19).

Remember, momentum changes direction before price, so it is a leading indicator for directional changes, an early warning of sorts.

Management and risk description

We can trade the USD via the DXM6 (US dollar index - Jun 2016) contract, which is now the front-month contract with the highest open interest.  The directional changes in USD futures are between 1-2 weeks in between, so the timeframe for this trade is 1-2 weeks.

In addition, we can minimise the risk of this trade with an entry trailing stop sell order. The SaxoTrader 2 is possibly the only trading platform on Earth with this amazing functionality. With the entry trailing stop order, we can place a sell at a preset distance from the current market price. If the USD goes against this technical analysis piece and starts to strengthen, the sell trailing stop trails the market upwards, following behind the market price by the preset distance (known as “Distance to Market” on the platform). 

At some point later, when the US dollar index turns down, the trailing stop stays where it is, and then gets executed when the USD index falls below the stop price. And what happens if the USD index keeps rising? The trailing stop order keeps following behind the market, allowing you to sell at a higher price in the future. All this is for free, how amazing is that?


Sell DXM6 via an entry trailing stop sell order, GTC

Distance to market*: 0.45

Trailing step**: 0.01

NOTE: You only need to set the above two parameters for a trailing stop. The distance to market will determine the initial stop price. So assuming DXM6 is at 95.29 bid and 95.295 offered, a distance to market of 0.45 will cause the stop to be set at (95.29 – 0.45 = 94.84)

* - The Average True Range (ATR) of DXM6 as of today is about 0.45. This means that, using the data over the past 10 days, DXM6 moves about 0.45, on average, on a day-to-day basis. We can use this as the “Distance to Market “ for our entry trailing stop order.

** - The trailing step is the minimum amount the underlying must move for the trailing stop level to be updated. You can just set it to 0.01.

Stop: Once the above entry trailing stop sell order is executed, you can then set a buy stop on the position. Again this can be ATR-derived. So if your stop trailed up and you sold DXM6 at 96.00, you can set the stop at (Sell Entry Price + 1 x ATR) or (Sell Entry Price + 2 x ATR), for example. Do ensure that these are within your risk management rules, for example the maximum loss you can tolerate for this trade,

Target: When the Stochastics next exhibit a bullish crossover

Time horizon: 1-2 weeks

Alternate Entry

If you do not have access to a Saxo account (where the SaxoTrader 2 platform offers you entry trailing stop orders), you can also trade the USD index using the Slow Stochastics (10,3,3) indicator. As mentioned, the Stochastics are within striking distance of a bearish crossover, and you can consider shorting the USD index at the open tomorrow after confirmation of the crossover at the market close today. Alternatively, you should open a Saxo account.

— Edited by John Acher

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US Dollar Index Futures


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