They say there is no such thing as a stupid question. This I do not agree with. I mean, just browse through the trading system section and you will be exposed to useless banter on repetitive subjects which offer little to no direction for success whatsoever. However, it is my belief that to find the right answers you first need to ask the right questions. That is what I have done and found success.
So you want to know what influences the market. Let's talk a little about participants and the consequential discovery of price. In a nutshell, information drives the FX market, so first you need to understand how information is factored into price.
It all begins with people who demand the need to exchange currencies, and therefore they seek to participate in the FX market. These people are called customers. Why they enter is important, but the exact reasons why they enter vary enormously. Obvious reasons could be anything like news, events, politics, investments, technical levels, risk management, entertainment, business, whatever! The point is that customers, for one reason or another, need to move money from one currency to another. Just so you know, small retail traders count as customers in this equation, though seeing as how they represent roughly two percent of the entire traded volume, any impact they have is insignificant. Regardless, it is the institutional customers I refer to who actually do make a difference.
So at this point, how does a customer go about participating in this exchange? Well, first off they need access to the market, which means they need a dealer. That is simply put the main role of the dealer; to grant access, offer participation, or by all other means sell liquidity to a customer. So all day long customers place orders with their dealers who are obediently buying and selling the opposite side of what their customers are demanding or supplying. This has been commonly referred to as tier two and three trading. Liquidity is the product; spreads or commissions are the cost.
Now, what have the dealers gained? Well, in addition to gaining spread or commission for their service, they have also taken on the unwanted risk of accumulating inventory from the unbalanced trades with their customers. However, more importantly than either of these, dealers have also gained information based on order flow. That is, information telling them how their customers are reacting to the public information (stated above) through signed transactions. Now, based on the customer who signs these transactions, the dealers determine if the information contained in the order flow is informative or not. In general, the larger the bank, the more customers it has and the bigger the orders are. This leads to more informative order flow.
Either way, the bank responds to this newly acquired information by participating in the interbank market, referred to as tier one. Therefore order flow is a dealers main medium of information. It is what banks use as their primary reason for participating in the interbank market; to either offset the risk they have accumulated, obtain insight into other banks order flow status, or to profit from knowledge gained from informed customers (among other reasons). Consequently, price discovery occurs on the interbank level because the best bid and the best offer prices are supplied and demanded by the largest participating banks who offer the most competitive (and informative) prices. Therefore, response to order flow directly, if not completely, drives and determines how price moves in the FX market.
Thus the flow of orders is formed: Public info drives customers to the dealers, who then view order flow and participate with other banks, which leads to shifts in price on the interbank market as dealers accommodate the incoming flow, which is then mapped out on a chart, which is the average retail traders medium of information. This process is why I always stress and encourage that new traders develop a deep understanding of how the FX market works, how dealers manage inventory, what techniques they use to speculate from their own order flow, how they gather information on the order flow from other large banks, etc, etc, etc.
So the next logical question is: what does all this mean for a retail trader like me? As mentioned above, information drives the markets. He who has the most information has the greatest potential, but he who understands and utilizes the information given to him has gained knowledge, wisdom, and most importantly, an edge. Low level retail traders are at an immediate disadvantage due not only to lack of good information, but to overexposure to bad information as well. This means that a retail trader must learn to filter out the rubbish. This does not necessarily mean looking to exotic sources of information on markets, but instead discerning how information is really being discounted into price.
Ask the right questions. What is the market thinking right now? Are we at an important level of historical support or resistance, or did an unexpected news event just get released? Is today a holiday in some other country, or did Gaston just take the day off? Did the U.S. just elect a new president, is a central bank intervening, or are options expiring soon? Are conditions volatile, deep, steady, trendy, consolidated? Is this a reversal or just a pullback to interest more buyers?
Information can be gathered from everywhere. What information is the most important RIGHT NOW? Don't know what the market is thinking right now? Don't trade.
Ask the right questions with the filter of how price will react based on the internal boundaries of our FX market. We do not have access to the banks order flow. In fact, they do not even have access to each others. But that does not make us incapable of speculating on exchange rate returns. Charts are not bad, and they are a great way to interpret information. But we should never forget that it is what lays behind that chart that gives insight into what the intentions of the market really are. Charts show us what already happened. Fundamental info tells us what might happen. Understanding why price is behaving like it is according to how it fits into the structure of the market will make finding ways to profit from every day events clear.
Have a great weekend,
Gaston
So you want to know what influences the market. Let's talk a little about participants and the consequential discovery of price. In a nutshell, information drives the FX market, so first you need to understand how information is factored into price.
It all begins with people who demand the need to exchange currencies, and therefore they seek to participate in the FX market. These people are called customers. Why they enter is important, but the exact reasons why they enter vary enormously. Obvious reasons could be anything like news, events, politics, investments, technical levels, risk management, entertainment, business, whatever! The point is that customers, for one reason or another, need to move money from one currency to another. Just so you know, small retail traders count as customers in this equation, though seeing as how they represent roughly two percent of the entire traded volume, any impact they have is insignificant. Regardless, it is the institutional customers I refer to who actually do make a difference.
So at this point, how does a customer go about participating in this exchange? Well, first off they need access to the market, which means they need a dealer. That is simply put the main role of the dealer; to grant access, offer participation, or by all other means sell liquidity to a customer. So all day long customers place orders with their dealers who are obediently buying and selling the opposite side of what their customers are demanding or supplying. This has been commonly referred to as tier two and three trading. Liquidity is the product; spreads or commissions are the cost.
Now, what have the dealers gained? Well, in addition to gaining spread or commission for their service, they have also taken on the unwanted risk of accumulating inventory from the unbalanced trades with their customers. However, more importantly than either of these, dealers have also gained information based on order flow. That is, information telling them how their customers are reacting to the public information (stated above) through signed transactions. Now, based on the customer who signs these transactions, the dealers determine if the information contained in the order flow is informative or not. In general, the larger the bank, the more customers it has and the bigger the orders are. This leads to more informative order flow.
Either way, the bank responds to this newly acquired information by participating in the interbank market, referred to as tier one. Therefore order flow is a dealers main medium of information. It is what banks use as their primary reason for participating in the interbank market; to either offset the risk they have accumulated, obtain insight into other banks order flow status, or to profit from knowledge gained from informed customers (among other reasons). Consequently, price discovery occurs on the interbank level because the best bid and the best offer prices are supplied and demanded by the largest participating banks who offer the most competitive (and informative) prices. Therefore, response to order flow directly, if not completely, drives and determines how price moves in the FX market.
Thus the flow of orders is formed: Public info drives customers to the dealers, who then view order flow and participate with other banks, which leads to shifts in price on the interbank market as dealers accommodate the incoming flow, which is then mapped out on a chart, which is the average retail traders medium of information. This process is why I always stress and encourage that new traders develop a deep understanding of how the FX market works, how dealers manage inventory, what techniques they use to speculate from their own order flow, how they gather information on the order flow from other large banks, etc, etc, etc.
So the next logical question is: what does all this mean for a retail trader like me? As mentioned above, information drives the markets. He who has the most information has the greatest potential, but he who understands and utilizes the information given to him has gained knowledge, wisdom, and most importantly, an edge. Low level retail traders are at an immediate disadvantage due not only to lack of good information, but to overexposure to bad information as well. This means that a retail trader must learn to filter out the rubbish. This does not necessarily mean looking to exotic sources of information on markets, but instead discerning how information is really being discounted into price.
Ask the right questions. What is the market thinking right now? Are we at an important level of historical support or resistance, or did an unexpected news event just get released? Is today a holiday in some other country, or did Gaston just take the day off? Did the U.S. just elect a new president, is a central bank intervening, or are options expiring soon? Are conditions volatile, deep, steady, trendy, consolidated? Is this a reversal or just a pullback to interest more buyers?
Information can be gathered from everywhere. What information is the most important RIGHT NOW? Don't know what the market is thinking right now? Don't trade.
Ask the right questions with the filter of how price will react based on the internal boundaries of our FX market. We do not have access to the banks order flow. In fact, they do not even have access to each others. But that does not make us incapable of speculating on exchange rate returns. Charts are not bad, and they are a great way to interpret information. But we should never forget that it is what lays behind that chart that gives insight into what the intentions of the market really are. Charts show us what already happened. Fundamental info tells us what might happen. Understanding why price is behaving like it is according to how it fits into the structure of the market will make finding ways to profit from every day events clear.
Have a great weekend,
Gaston
http://www.forexfactory.com/search.php?do=finduser&u=84703
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