Volatility Increasing in the Forex Markets, How to Profit Forex Trading

by Joe Oliver, Forex Trading-Pips

Forex Trading Strategy Update: How to Profit Forex Trading Volatile Markets

With the expansion of volatility in the Forex markets following Standard & Poor’s downgrade of US long term credit grade from AAA to AA+ our Forex Signals Program has continued to generate some impressive gains. Today we will take a look at the volatility breakout trading systems and strategies we use to profit from volatility in the Forex markets. 

Reliable Forex Broker data shows that most traders lose money when volatility starts to expand outside an established range as traders typically favour fading moves using mean reversion strategies. Mean reversion, otherwise know as counter trend strategies, involves fading the market: selling highs and buying lows in the hope that prices will revert back to the mean.

Mean reversion strategies work well most of the time and particularly well during range bound and low volatility markets, however when volatility starts to expand and markets start to make large directional moves, reversion traders can get crushed. Case in point: the large number of traders wiped out ‘buying the dips’ during the 1987 stock market crash,  Asian & LTCM crisis 1997-1998, technology stock crash 2000 and the credit crunch of 2007.  Though such crises are infrequent they tend to be far more frequent than the average trader or investor would like to assume, and it is during these periods that trend followers using volatility breakout methods can reap huge returns.

What is a breakout system?

Perhaps the most famous example of a volatility breakout system is the Donchian Channel 4 week rule, later adapted by Richard Dennis and Bill Eckhardt in their extremely successful Turtle Trading program.

How to Profit Forex Trading Donchian Channel Breakouts

The Donchian 4 week Rules are as follows:

  • Cover short positions and buy long whenever the price exceeds the highest high of the previous 4 calendar weeks.
  • Liquidate long positions and sell short whenever the price falls below the lowest low of the previous 4 calendar weeks.

As simple as the system sounds it is profitable over a large sequence of trades and has been since it was first developed by Donchian over 40 years ago! Back-test results using the above parameters from January 2000 to August 2011 on a single Euro Futures contract show a win ratio of 43%, an average win 1.94 times the size of the average loss, largest win $15K, largest loss $12.6K and profit factor of 1.51. $25 commission and $50 slippage were assumed in the back test. These parameters are by no means the best ones: performance can be improved using trend filters, optimizing the channel width, using profit targets, increasing the number of markets traded etc, the point is that trend following is still as viable today as it was when Donchian developed the system back in the 1970’s.

Below is a chart showing recent trades on EUR futures using Donchian’s 4 week rule. Long entry is the green up arrow, short entry is the red down arrow. Note the frequent small losses and occasional large wins.

Forex Trading Update How to Profit Forex Trading, EUR Donchian System

Forex Trading, EUR Donchian System

 Below is a chart displaying the historic equity curve on one lot Euro futures contract from January 2000 to August 2011 using Donchian 4 week rule.

Forex Trading, EUR Equity Curve Donchian

Forex Trading, EUR Equity Curve Donchian

 

If you would like to learn more about how to profit Forex trading robust and statistically proven methods get started today on a risk free trial of our proven Forex Signals Program.

More reading