FOREX: Santa Claus Rally and the Potential for a Breakout
By Kathy Lien
The past week has been a quiet one in the foreign exchange market with the dollar consolidating against the euro and Japanese yen. The only currencies that really moved were the Swiss franc, which rose to a record high against the euro, and the British pound which fell to a three-month low against the dollar.
Despite the lack of a big move in the greenback against most pairs, quite a bit of U.S. economic data was released. The only problem was that the data confirmed what investors already knew—the U.S. economy is improving at a sluggish pace.
Next week’s economic reports are not expected to help because data is limited. The only potentially market-moving reports will be the Consumer Confidence report on Tuesday and the release of Chicago PMI and Pending Home Sales on Thursday.
Although most traders will be off enjoying their holidays, leaving only their juniors dealers on the desk, it will not be a shortened trading week as it has been in years past because the equity markets will be open for trading on Dec. 31. There is no New Year holiday this year because Dec. 31 falls on the last Friday of the year.
DON’T RULE OUT A BREAKOUT IN FX AFTER CHRISTMAS
However, just because there are only a handful of noteworthy events on the U.S. calendar does not mean currencies will continue to consolidate in the coming week. Friday is the month, quarter and year end for many companies, which mean that there could be a great deal of position adjustments.
We have also found that over the past 10 years, the odds are skewed towards a breakout or expansion in volatility in the forex market the week after Christmas. According to our study, the weekly trading range in the EUR/USD the week after the holiday increased by an average of 80 percent seven out of the past ten years. In USD/JPY, there was an expansion in the trading range eight out of the past 10 years the week after Christmas with the range increasing by an average of 78 percent.
In 2009, for example, USD/JPY fluctuated within a 170-pip trading range during Christmas week and the week after the holiday there was a breakout that caused the trading range to expand by 289 pips. This suggests that thin trading conditions at the year end fuels unusual volatility that lead to breakouts in currencies. As for the potential direction of the breakout, let us consider how the Santa Claus Rally could affect the dollar.
HOW COULD THE SANTA CLAUS RALLY AFFECT THE DOLLAR?
The Santa Claus Rally is a price pattern identified by Jeff Hirsch, the founder of Stock Trader’s Almanac. According to his findings, stocks tend to rally in the week between Christmas and New Years Day. The holiday spirit, reinvestment of bonuses and tax considerations are all reasons investors like to buy stocks at the end of the year.
Since currencies tend to have a strong correlation with equities, we decided to take this same idea and see how it applies to forex. We looked at how the dollar traded between Christmas Eve and the first two days of January and found that the dollar weakened against the euro eight out of the last 10 years during this period with an average rally of 1.1 percent.
Against the Japanese yen, the data is less statistically significant with the dollar weakening only six out of the last 10 years. This means that a rally in equities next week could boost risk appetite, which in turn should help to lift the EUR/USD.
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