Volatility can cause range breaks in all markets, but trends could be short-lived

Volatility can cause range breaks in all markets, but trends could be short-lived

As the second quarter begins, the macro environment for financial markets is characterized by persistently high inflation and an unfolding banking crisis. Will volatility continue to evolve?

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While separated, they are related. The ultra-loose monetary conditions of the pandemic era have created circumstances this allowed for a large amount of cash reserves. This led to increasing pricing pressures and excessive capital availability, allowing for risk-taking that would otherwise have been challenged by the market.

The inflation problem is well documented, but the unfolding banking crisis has created uncertainty about the viability of some institutions. The banks that have failed so far have done so for two different reasons. The first is the mismanagement of their balance sheets, which showed a mismatch between assets and liabilities. Silvergate Bank, SVB Financial and Signature Bank could fall into this category. The second is weak balance sheets, which are revealed when financial conditions tighten, making raising capital more difficult and expensive. Credit Suisse and Republic Bank could fall into this category.

How many more looming collapses there could be is the big “known unknown.” Looking at stock indices and forex, the long, protracted trends that prevailed during the pandemic era appear to be over for now.

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However, increased volatility due to this uncertainty can be observed in several asset classes. In this scenario, ranges have built up over time, often breaking out to one side before either establishing a new range or folding back within the previous range.

In these types of trading conditions, false breaks could present an opportunity. This type of trading requires robust risk management and generally features smaller position sizes and wider stop-loss parameters to allow for excessive volatility when markets cross the range.

An example of this type of market is gold. It has been in a wide range of 1,615 – 2,075 for almost 3 years. It broke below an ascending trend line and then below the previous low of the range at 1,677. It hit a new low of 1,615 in September of last year before bouncing back inside the range.

This price action is difficult to trade as many stop losses have been cleared lower and it was unclear whether or not a new range would be established.

Looking on the upside, the August 2020 peak of 2,075 in the March 2022 rally failed to eclipse. This created a double top formation.

The current price is moving towards this high and this could represent an opportunity. If you sell near the previous highs. A small position size can allow for a higher stop-loss level in the event of a false break.

However, it should be noted that past performance is not an indication of future results.

GOLD CARD

Chart created in TradingView

— Written by Daniel McCarthy, Strategist for DailyFX.com

Please contact Daniel via @DanMcCathyFX on twitter