Traders in the currency market make one of two choices: pro-dollar or anti-dollar. As a component of more than 85% of all currency transactions, the U.S. dollar has long been the primary driver of fluctuations in exchange rates. Most traders analyze the future direction of the dollar using either fundamental or technical analysis or a combination of both.
However, the time of year could also play a role in how the U.S. dollar behaves against various currencies. Technical analysis analyzes past price activity using indicators. There are many technical indicators that help analysts to consider price in different ways.
- Traders in any market look to identify patterns or cycles to take advantage of, but often when such patterns are identified they quickly disappear.
- In foreign exchange (forex) markets, however, macroeconomic forces can create cycles in currency rates that are sustainable even if they are known.
- Understanding forex seasonality can help forex traders time entry and exits from positions in various months based on patterns that have emerged.
- Even though patterns have emerged in the past and may be driven by powerful economic drivers, there is no guarantee that they will return in the future.
Filtering Out Noise
A clear way to analyze past price behavior is to examine the price activity itself without the noise of indicators. When only price is examined, seasonality patterns often emerge. Seasonality is a predictable change that repeats every year at the same period. There are no guarantees that historical patterns will repeat themselves, but whenever a pattern has been repeated 80% to 90% of the time, it becomes statistically significant—and that is valuable information for traders. In this article, we explain why seasonality is an important concept in the forex market and why it should not be ignored.
July: A Positive Month for USD/JPY
One of the strongest examples of seasonality is the USD/JPY shown in Figure 1 below. In 68% of the samples, USD/JPY ended the month of July higher than where it started. It is difficult to pinpoint an exact reason why USD/JPY tends to behave this way in the month of October, but this instance of seasonality is strong and worth keeping in mind for short USD/JPY trades during the month of October. The presence of seasonality may encourage traders to take a smaller-than-usual short position or to avoid a longer term short USD/JPY trade during this period.
August: USD/JPY Gains Made in July Are Often Erased
There is also a strong case of seasonality in USD/JPY during the month of August. As you can see in Figure 1, below, a good portion of the gains earned in July were erased in August. In fact, a look at other yen crosses quickly reveals that in a calendar year, August tends to be the strongest month for the Japanese yen across the board. In other words, other currencies such as the U.S. dollar, euro and British pound have a strong tendency to fall against the yen in August.
May: A Negative Month for the USD/CAD
For USD/CAD, the strongest case of seasonality is in the months of October and November.
Implications for Traders
As traders, there are many ways that you can apply the knowledge of seasonality to improve your trading. For example, if you are trading the GBP/USD in the month of September, as a longer-term trader you can look for opportunities using fundamentals or technicals to buy the GBP/USD or to go in the direction of the seasonal trend. As a shorter term trader, you can reduce your holding period if you are taking a trade that is against the seasonal trend or, like longer-term traders, you can focus on primarily looking for long GBP/USD trades. Although seasonal patterns do not duplicate themselves 100% of the time, following seasonality rather than fading it may improve your ability to find high probability trades.
Although instances of seasonality in the forex market are rare, being aware of them can help traders become more in-tune with the outlook for their currency trades. Seasonal patterns will not always be repeated as the data suggests, but being aware of the trends can help forex traders understand where the probabilities lie. If there is a strong case of seasonality in a given month, it may help to support a trade idea or provide a reason to avoid it.