Reader Questions Answered

Thin holiday markets and new year volume pick-up

The following two questions came in from one of my newsletter subscribers in regards to comments I made about how the markets can trade around year-end and into the new year.

1. Regarding your 2000 EUR/JPY trade: I am wondering if your success with that trade was more a function of fundamentals than the low volatility of the holiday period. Everyone knows that there was a G7 coordinated campaign to prop up the Euro. Being both a position trader and a Forex analyst, it wouldn’t be a surprise if we were told that you considered that information in your decision. Lack of offers during the holiday period may have helped, but it’s hard to get a sharp move of thousands of pips without some fundamental development that the market perceives as a game changer.

In fact, I wasn’t actually working as an analyst at that point. I was coaching volleyball full time back then. My analysis was strictly technical in nature, which is what I tend to favor in my own forex trading in any case.

The point about there being a fundamental driver is a good one, as there is almost always something underlying a directional move in the market (though Wednesday’s trading demonstrates that it isn’t always the case for short-term moves), but it’s not an either/or thing. There is no doubt in my mind that reduced volumes around the holiday period helped to accelerate that rally for the simple reason that there weren’t sufficient offers on the other side to resist it. When the volume did start coming back in after the first of the year, there was a very sharp retracement, and in fact it wasn’t until a year later that the market was able to extend the late 2000 rally into the trend that eventually topped out in 2007.

2. You make it sound as if everything will be back to normal in terms of volume on January 3rd. I have noticed (and others have commented likewise) that the first two weeks of the year are similar to the last two in terms of liquidity. Is that definitely NOT the case in your experience?

Actually, if you look at stock market volume you’ll see it snaps back very quickly. For example, in 2010 the last two weeks of the year show 105mln and 76mln shares respectively (I’m looking at an S&P 500 chart – not total market volume). The first week of 2011, however, shows 197mln, which is basically in line with the volume peaks from normal period weeks before that. There’s a similar pattern looking back to prior years.

Note that volume and volatility aren’t necessarily the same thing. There are reasons why there’s increased volume flow in the markets to start the new year – reasons which contribute to the seasonal patterns which tend to be in force. And keep in mind that volume and participation isn’t necessarily the same thing either. Just because more money flows back into the markets (or through them), it doesn’t necessarily mean there are many more traders and investors active (though certainly it’s often the case).

Trading News

I have access to forex volume data!

And you don’t! 🙂

We’re working on something in the office whereby we get access to volume data from the folks who run the Reuters forex dealing platforms so we can use it in our market analysis. Right now I can only see the current day’s data to a given point in time (we’re working on expanding that). The chart below shows Tuesday’s distribution actual traded volume by price level for GBP/USD.

Click for full-sized image

By way of comparison, here’s the price time distribution for GBP/USD on the day. You’ll notice the similarity of the two distributions, but also the differences in the upper part of the day’s range.

The Basics

Most Active Forex Currency Pairs

(Note: See Most Traded Currency Pairs for up-to-date info) The question comes up a lot as to what the most actively traded currency pairs are. A lot of forex traders end up responding based on what they think people trade most without necessarily knowing the statistics. Well, now you can be educated on the subject because I’ve got some data to share with you based on official figures (as of October 2008). This information comes from Forex volume survey, Forex volume survey, a presentation compiled by a former colleague of mine (originally posted on Kathy Lien’s website – at least that’s where I saw it).

Here are the highlights.

London is by far the most active trading center, handling something close to $1.5 trillion in flows per day on average. It does roughly twice what second place NY does, with NY being a little higher than the Sydney/Signapore combined total. (Note: Tokyo was not included in the study, nor was anything from the Europen Continent).

The spot forex market is not the largest component of forex trading, despite what you might have heard. It’s actually the swap market which is the largest part. Given that most forex trading is actually related to international trade and capital flows, this really shouldn’t come as a surprise. Interestingly, though, spot trading is by far the biggest part of forex trading in the NY market.

In NY trading, EUR/USD accounts for about a third of all forex action. USD/JPY is about 20%.  The trio of EUR/JPY, GBP/USD, and USD/CAD make up the rest of the pairs accounting for 75% of the trading activity on average.

EUR/USD is actually more like 40% of London trading. USD/JPY is still in second position, but at a lesser amount than in NY trading (call it 15%). GBP/USD is slightly less than USD/JPY. The group of EUR/JPY, EUR/GBP, and USD/CHF make up the rest of the top 75%.

Not surprisingly, AUD/USD is the biggest pair traded in Sydney (about 25% share), but EUR/USD and USD/JPY are the next two most active pairs, and in Signapore they are also 1/2 as they are in the rest of the world.

So the bottom line is that EUR/USD and USD/JPY are the two most actively traded currency pairs in the forex market. GBP/USD is third, with EUR/JPY generally forth.

I encourage you to check out the report, and if you are day trading check out the data for the trading center that’s the focal point for when you are in action. It might help you better find good trading opportunities. Of course, this isn’t to say that the lower volume pairs aren’t worth trading either. It just depends on your needs.