On Thursday night as I was having drinks atop the beautiful Jumeirah Beach hotel in Dubai, Patti Domm from CNBC called me. It was still day time in New York and the euro was going crazy, having first traded to 1.32 and then dropped to 1.27 in a period of a few hours. What’s going on? She wanted to know. What was the reason for such tremendous volatility?

Instead of fabricating some fundamental excuse, I decided to level with her. The fact of the matter was that there was nothing major happening news wise. The Fed had cut rates the day before as expected. Euro skyrocketed on a massive short covering rally and then collapsed just as quickly when it reached resistance at 1.3200. Algorithmic trading, I told her, has really exaggerated the recent moves in the FX market.

Algorithmic trading is simply a fancy way of saying computer driven trading. Much like the equity market, the FX market has seen a vast increase in computer based model trading over the past several years. The advent of electronic hubs like Currinex has made it much easier to run computer based models that often trade 200-300 times per day.

Most computer algorithms are moment based - they buy when prices are rising and sell when they are falling. The net effect is that volatility, which is already extremely high in today’s markets is amplified even more by the action of the robots. Ironically enough, the cold, calculating machines are now actually exaggerating rather than tempering the human emotion behind the price flow.

As I noted last week, this dynamic is unlikely to change anytime soon. Price ranges will remain wide, especially next week with the US election and US unemployment numbers due to report. Although an Obama win looks increasing likely, a McCain upset cannot be ruled out and should it occur the price reaction might be quite violent as markets generally hate surprises. In this environment there are only three strategies to use.

1. Stay out of the market and let the volatility compress as it eventually will
2. Trade very small and very wide using almost no leverage and enormously large stops
3. Trade frequently, staying glued to the screen while keeping your risk/reward ratio no worse than 1:1 and hope than when the dust settles your winners will outnumber the losers

Whatever you choose, be careful out there, its likely to be another historic week of incredible volatility.

Boris Schlossberg serves as director of currency research at GFT, and runs bktraderfx.com.