Thursday, April 21, 2011
Forex Becomes A Mass Movement
The process involved is basic. If markets are to be efficient, past price movements shouldn’t predict future movements, but this is just one of the conditions. For this scenario the rise in volatility is proportionate to the square root of time, hence the volatility of fortnightly change is the same as the square root of two multiplied by the weekly volatility.
If we test the volatility of actual to random walk, we can see whether a price follows random walk or not. A higher random walk volatility than actual volatility translates into falls in one period leading to rises in the eventual period.
The ratio of actual to random walk volaitility for three main exchange rates can be seen in my chart. The pound may rise for a few weeks but would fall because of reversion is the suggestion here Further your knowledge on foreign exchange at currency conversion calculator.
Nevertheless, the ratios touch one, as close as 12 percent of it. One could easily lose fortunes bettinf on the inefficiency since it is so little. The diminishing profit making became staple of Forex trading in the 1990s since investors started wising up to the momentum effects.
One can see deviations over a short period of time from the random walk. Anticipating surprises better than the market can lead to a person making money even from a random walk. Our data findings show a roughly random rate move for foreign exchange over a 17 year period. The efficiency of a market would be brought down in extremely short periods.
For traders, knowing news like the US dollar turning absolutlely worthless in an years time would be priceless. It would have been possible to make money by purchasing the dollar at its lower point because it over reacted and then mean reverted.
But this is not an inefficient market. The profits made from purchasing dollar at its low point aren’t risk free ones but instead a reward for taking the crash risk. The predominant character in exchange rates over the years is the variation in crash risk.
It is obvious that the message is plain. It is but obvious that banks can do this because of their advantages over ordinary retail investors. Since banks have proprietary information about the FX orders placed by a client they can successfully predict the flow of the market. Trading costs are virtually zero for banks, this makes it profitable for them since their hoover is cheaper now. Trading in Foreign Exchange is safe only if one is aware of these edges.