Traders in the currency market makeone 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 can also play a role in how the U.S. dollar behaves against various currencies. Technical analysis analyzespast price activity usingindicators. There are many technical indicators thathelp analysts to consider price in different ways.
Key Takeaways
- Traders in any market aim to identify patterns or cycles that they can take advantage of, but these patterns tend to disappear as soon as they are identified.
- 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 entries and exits from positions based on patterns that have emerged.
- Such patterns may be driven by powerful economic drivers, but there is no guarantee that they will return.
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, seasonalitypatterns may emerge.
Seasonality is a predictable change that repeats every year at the same period of time. There is no guarantee that a historical pattern will repeat itself, but whenever a pattern has been repeated 80% to 90% of the time, it becomes statistically significant. That isvaluable information fora trader.
October: A Positive Month for USD/JPY
One of the strongest examples of seasonality is theUSD/JPYshown in Figure 1 below. In 68% of thesamples,USD/JPY ended the month of October 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.
It's worth keeping in mind forshort 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 tradeduring this period.
Figure 1
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August: USD/JPY Gains Are Often Erased in August
There is also a strong case of seasonality in USD/JPY during the month of August. As you can see in Figure 1, above, 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.
Figure 2
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Implications for Traders
There are many ways that traders can apply the knowledge of seasonality to improve their results.
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 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.
The Bottom Line
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 notalways be repeated as the data suggests, but being aware of the trend's stage 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.
Correction—Jan. 22, 2022: In 68% of thesamples,USD/JPY ended the month of October (not July) higher than where it started.
