Establishing an Effective Forex trading Relationship

Establishing an Effective Forex trading Relationship

In financial markets and economics, the efficient market hypothesis (EMH) asserts that asset prices always reflect the available information. The suggestion is that beating the market consistently is impossible, as market prices should react only to new information.

The hypothesis was created by Professor Eugene Fama who postulated that, due to the exponentially increasing volume of highly sophisticated market analysis, equities will always trade at their fair value. It’s impossible for investors to either purchase undervalued stocks, or sell stocks for inflated prices as there are no secrets in the market place.

Eugene Fama was convinced it was impossible to outperform markets through expert stock selection, or through market timing. In his hypothesis the only way an investor can enjoy higher returns is by chance, or by purchasing riskier investments. In a 2012 study with analyst Kenneth French they went on to confirm the original theory; they discovered that the distribution of abnormal returns in US mutual funds was very similar to what you’d expect if the fund managers had no relevant skills.

In summary; the only method by which you could therefore beat the market is by having access to critical market moving information before it’s published (front running/insider trading), reacting in lightning quick automated fashion (by way of algorithmic high frequency trading) as the information is released, or by taking a punt; simply taking a position and getting lucky.

This EMH theory equally extends to forex trading, in fact you could argue that the findings are more relevant in a market that has an estimated $4.3 trillion turnover each trading day, according to the latest BIS (bank of international settlements) data. The activity in the FX markets is so high, so relentless, that it’s impossible for secrets to exist.

An undiscovered currency movement, that we’ll identify before our zero sum competitor (the market) beats us to it, can never happen. We can’t beat the forex market, as retail traders we can generally only trade with it and on trend, for however long that trend may last and hopefully bank pips as part of our trading plan.

It’s important to take on board these facts when you’re a novice, or who we’d term an “intermediate level” trader. Let’s use a couple of high profile examples to attempt to prove the EMH theory. We’ll use an interest rate rise and an infamous unemployment number release.

High impact news and the Forex markets

In December 2016 the FOMC (the Fed, the USA’s central bank) put up the interest rate by 0.25%. This rise was predicted by many pollsters and analysts and in many ways the rise didn’t surprise the markets, given the forward guidance (clues) the Fed had previously issued. Unless you possessed insider information (highly unlikely) then you could either: wait for the base rate decision information to be released, take a position before the publication based on all your research, or simply take a guess.

Shortly before such a high impact news release you may witness market moves in the direction of the eventual short or medium term trend. This is unlikely to be insider trading or front running, it’s more likely the weight of orders begin tipping in favour of the eventual outcome. Upon the news release and subsequent 0.25% rise, the market collectively took the view that the dollar was more valuable, consequently it rose in value versus its peers.

Once a month we receive the BLS, NFP unemployment data from the USA, or “non farm payrolls” as it’s often referred to. A data release that has the ability to move the market for the USA dollar, as analysts view this one key data release as symptomatic of the overall health of the USA economy.

The release hasn’t provided the dramatic, immediate market movements witnessed in the past, mainly as a result of the margins of change being far smaller; shortly after the 2008 crisis we’d witness the NFP data revealing a loss of 700K jobs per month. Currently (January 2017) the analyst community is predicting 175K jobs to be added, up slightly from the 156K in December.

Unless it’s a huge miss, or there’s tens of thousands of extra jobs created, it’s unlikely we’ll witness a huge movement in the dollar and it’s main currency peers. When the data is released the Forex markets react in a highly predictable fashion whether it’s considered: good, bad or indifferent.

Efficient market hypothesis

Traders have a tendency to over complicate trading, they constantly search for either patterns that don’t exist, in terms of effecting future price movements, or for a secretive ‘holy grail’ Forex trading strategies, that will surrender up significant rewards. Once they accept the theory of efficient market hypothesis, they can begin to abandon many of their pre conceptions and concentrate on trading what they see, as opposed to trading what they think.