To be Forex traders should beware that the market is at its efficient best Retail investors find it fashionable to invest in foreign exchange For those who are thinking on the lines joining the trend another warning in order is the fact that the FX markets are unpredictable nowadays and hence aren’t the best options for easy money making.Confirming the very same fact one can opt to check an efficient market by volatility ratios.
The thought here isn’t complex. 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.
The comparision between actual and random walk volatility can be used as a test of whether prices follow a random walk. When actual volatility is lower than random walk volatility, then prices would revert leading to periods of alternating rise and fall.
The three main exchange rates’ ratio of actual to random walk volatility is visible in my chart. The pound would eventually fall after a few weeks of rising, this reversion is suggested here.
Still one should not ignore that the ratios are near one, in the range of 12 per cent. One could easily lose fortunes bettinf on the inefficiency since it is so little. One would see that this is true to the findings that profit making has hit the lows since 1990s because of the realization of momentum effects.
Over extremely short time periods there can be deviations from a random walk. And it’s possible that you can make money even in a random walk if you can anticipate surprises better than the market. The fact that exchange rate moves are usually random on average over 17 years is shown by our data. Periods when the market isn’t very effective can be very short too.
Information of the loss of value by US Dollar in an years time can mean a lot to any trader. It looks as if one could have made money if they had invested in the dollar at its lower point since it over reacted and then mean reverted.
Nevertheless the market’s efficiency is still there. When one purchases dollar at its low point, he isn’t making a risk free profit, but instead is being rewarded for taking that crash risk. One thing that we can be pretty certain of is that certain moves in the recent year in exchange rates have had a variation in crash risk.
The concept here is plain. It comes as no surprise that banks can do this since they have two vital advantages over ordinary retail investors. In the first place, banks have the advantage of being aware of client FX orders, this can foretell the future exchange moves. Since only a cheap hoover can generate profits while hoovering, the second point here is the fact that banks can trade at zero cost. For those aware of these edges, forex trading is a safe game.