subject: Intricacies Of Forex Trading [print this page] Beware to all future forex traders, the market is at its efficiency's peak Retail investors have shifted to trading foreign exchange If you're thinking of joining the bandwagon, though, be careful because the FX market is not so predictable that easy money can be made.To see this, consider one test of an efficient market which is volatility ratios.
The idea here is meek. When past price movements influence future fluctuations, the markets cannot become efficient. If this is the case, then the volatility of price moves rises with the square root of time so the volatility of fortnightly changes is equal to weekly volatility, multiplied by the square root of two.
Prices consistency with random walk can be checked by comparing the actual to random walk volatility. If actual volatility is below random walk volatility, then prices mean revert, with falls in one period leading to rises the next.
The ratio of actual to random walk volaitility for three main exchange rates can be seen in my chart. The pound's eventual fall is predicted after a few weeks of rise by the reversion suggested here.
The ratios do touch one nevertheless, almost 12 per cent of it. One could easily lose fortunes bettinf on the inefficiency since it is so little. This is consistent with a finding that the ability to make good profits from forex trading diminished in the 1990s, as investors wised up to momentum effects.
On a timeline of very small periods, one can notice deviations from random walk. Even a random walk can be used to make money of the anticipation of surprise is better than the market. Our data shows clearly how exchange rate moves are random over a 17 year period. It is also true that there are periods even shorter in length as to when the market's efficeincy is low.
Information of the loss of value by US Dollar in an years time can mean a lot to any trader. It would look as if the dollar has over reacted and then mean reverted, and if you'd bought it at its low point, you'd have made money.
But this is not an inefficient market. If one makes money from purchasing the dollar at its low point, they aren't making a risk-free profit, instead they are being rewarded for taking on that crash risk. It is possible that many of the moves in exchange rates are rich in the character of variation in crash risk.
The point here is simple. The retail investors in general lag behind the banks in two points, hence allowing banks to do it. Firstly, Banks can predict future exchange rate moves because of their knowledge of FX orders. Banks virtually pay zero amount for trading, thereby making hoovering a profitable venture since they have a cheap hoover. For investors without these edges, forex trading is a risky game.
