Year-End Forex Trading Conditions

Twice each year, over the northern hemisphere summer months and again during the Christmas and New Year holidays, commercial and institutional forex traders take their vacations. Almost all of them square their positions prior to departure, selling their long positions and covering their short ones, leaving themselves flat in the market and with nothing to worry about until their return.

The effect of all these closed positions on the individual currency pairs is two-fold:

1) First, closing such large positions can drive a currency pair in the direction opposite the current trend, causing short-term retracements or even large movements, depending upon the pair’s general liquidity, that don’t respect the current technical or fundamental picture. This can confuse retail forex traders unaware of the tendency and tempt them into contrary and often losing trades.

2) Second, once the large positions are closed and their effects on the market have faded, the various currency pairs are left with much less liquidity than normal. This causes a new raft of issues, including:
•    Increased volatility, with even the most staid currency pair, EUR/USD, suffering an increase in price jumps. Both buying and selling pressures become lower than usual, but cause outsized effects on the price action. Traders should therefore expect less testing and re-testing of technical levels, with less time to consider positions prior to entering the market.
•    Trends and breakouts unsupported by increased volume and therefore liable to change direction without warning. Retail forex traders should seek to profit from price moves but without trusting them and without attempting to call their tops or bottoms.
•    Trend extensions to ridiculous levels, as the bulls or bears remaining in the forex trading market push the currency pair well past any sensible level.
•    Ranges less likely to respect their boundaries, with the price action spiking through support and resistance levels and sometimes even closing beyond them, only to retrace back to where it belongs once the forex trader’s stop loss has been triggered.
•    Increased chop. By now, we’re all experts on this topic.

Over the next two weeks, volume will continue to diminish and trading conditions are likely to worsen. However, most commercial and institutional forex traders return from their holidays on Monday, 3 January 2011. Retail traders should expect a welcome surge of volume at that time, with increasing liquidity supporting new trends and returning currency pairs to appropriate levels.

This January is also likely to see further effects from the ongoing Eurozone sovereign debt crisis. This is no longer confined to the periphery, with German and French swap rates rising as well as those from Belgium, Greece, Portugal, et al., and the New Year is likely to see renewed depreciation pressure on the Euro crosses.