Chapter 4
A Deeper Look at the FX Market

The next three chapters cover some of the unique studies that I have done on the FX market that provide some telling details for both the novice and advanced trader. This includes the following:

1. What are the best times to trade for individual currency pairs?
2. What are the most market moving economic data?
3. What are currency correlations, and how can we use them?

What Are the Best Times to Trade for Individual Currency Pairs?

The Foreign Exchange market operates 24 hours a day, making it nearly impossible for a single trader to track every market movement and respond immediately at all times. Timing is everything in currency trading. In order to devise an effective and time-efficient investment strategy, it is important to understand how much liquidity there is around the clock to maximize the number of trading opportunities during a trader's own market hours. Besides liquidity, a currency pair's trading range is also heavily dependent on geographical location and macroeconomic factors. Knowing what time of day a currency pair has the widest or narrowest trading range will undoubtedly help traders improve their investment utility due to better capital allocation. This section outlines the typical trading activity of major currency pairs in different time zones to see when they are the most volatile. Figure 4.1 tabulates the average pip range for the different currency pairs during various time frames between 2013 and 2014.

Currency	Asian Session	European Session	U.S. Session	Europe	U.S.-Europe Overlap	Europe-Asian Overlap
Pairs	7pm-4am	2am-12pm	8am-5pm	3am-12pm	8am-12pm	2am-4am
EURUSD	51	87	78	84	65	32
USDJPY	78	79	69	77	58	29
GBPUSD	65	112	94	109	78	43
USDCHF	68	117	107	114	88	43
EURCHF	53	53	49	52	40	24
AUDUSD	38	53	47	51	39	20
USDCAD	47	94	84	93	74	28
NZDUSD	42	52	46	50	38	20
EURGBP	25	40	34	39	27	16
GBPJPY	112	145	119	140	99	60
GBPCHF	96	150	129	146	105	62
AUDJPY	55	63	56	62	47	26

Figure 4.1 Currency Pair Ranges

The FX market is broken into three primary trading sessions.

Asian Session (Tokyo): 7pm to 4am EST

Trading begins on Sunday in Asia at 5pm NY Time, but the Tokyo session begins around 7pm NY Time. During the Asian trading session, the largest volume is transacted in Tokyo, followed by Hong Kong and Singapore. Trading in Tokyo can be thin from time to time; but large investment banks and hedge funds are known to try to use the Asian session to run important stop and option barrier levels, especially during Sunday trade. Figure 4.2 provides a ranking of the different currency pairs and their ranges during the Asian trading session.

Figure 4.2 Asian Session Volatility

More risk-tolerant traders may choose to trade USDJPY, GBPCHF, and GBPJPY because their broad ranges provide short-term traders with lucrative profit potentials, with an average daily range of 90 pips. Foreign investment banks and institutional investors who hold mostly dollar-dominated assets also contribute to the daily flow in USDJPY through their Japanese equity and bond markets transactions. The Bank of Japan, who holds over $1.2 trillion of U.S. Treasury debt, is an active player with their open market operations impacting the value of the currency. Last but not least, large Japanese exporters may choose to repatriate their foreign earnings during the Tokyo trading session, adding to the fluctuations of the currency pair. A pair like GBPJPY is especially volatile because large market participants may start to scale into or out of positions ahead of the European market open.

More risk-averse participants may prefer to trade EURGBP, AUDUSD or NZDUSD because they generally have less volatility, which can help to shield traders and their investment strategies from irregular market movements caused by aggressive intraday speculation.

U.S. Session (New York): 8am to 5pm EST

According to the Bank of International Settlements' 2013 Triennial Central Bank Survey of Foreign Exchange and Derivatives Market Activity, New York is the second largest FX marketplace, accounting for 19% of total forex market volume. The majority of the transactions during the U.S. session are executed between 8am to 12pm NY Time, a period with high liquidity because the European and U.S. markets overlap. After 12pm, trading starts to wind down with ranges narrowing until the open of the Tokyo session. There can be some range expansions right before the U.S. equity market closes but generally speaking the volatility is far less than in the 8am to 12pm time period.

More risk-tolerant traders will find GBPUSD, USDCHF, GBPJPY, and GBPCHF attractive currency pairs to day trade because their daily ranges average around 120 pips (Figure 4.3). Trading in these currency pairs is particularly active because they involve the U.S. dollar. When the U.S. equity and bond markets are open during the U.S. session, foreign investors have to convert their domestic currency, such as the euro, Japanese yen, and the Swiss franc into dollar-dominated assets in order to carry out their transactions. With the market overlap, GBPJPY and GBPCHF have the widest daily ranges. Most currencies in the FX market are quoted with U.S. dollar as the base and the primary instrument traded before a cross. In AUDCAD for example, for an Australian dollar to be converted into Canadian dollars, it usually has to be traded against the USD first, then CAD. This means an AUDCAD trade typically involves two different currency transactions, AUDUSD and USDCAD, and its volatility is ultimately determined by the correlations of the two derived currency pairs. Since AUDUSD and USDCAD are negatively correlated, which means they tend to move in opposite directions, the volatility of AUDCAD is amplified. Trading currency pairs with high volatility can be very lucrative, but in doing it is also important to bear in mind that the risk involved can also be high. Traders should continuously evaluate their strategies as market conditions change because big moves in exchange rates can easily nullify their long-term strategies.

Figure 4.3 U.S. Session Volatility

For the more risk-averse traders, USDJPY, EURUSD, and USDCAD can be attractive pairs because they offer a decent trading range with lower risk. The highly liquid nature of these currency pairs can also allow investor to secure profits or cut losses promptly and efficiently. The modest volatility of these pairs provides a favorable environment for traders who want to pursue long-term strategies.

European Session (London): 3am to 12pm EST

London is the largest and most important dealing center in the world, with a market share of more than 40% according to the BIS survey. Most of the dealing desks of large banks are located in London, and the majority of major FX transactions are completed during London hours due to the market's high liquidity and efficiency. The vast number of market participants and their high transaction value makes London the most volatile FX trading session. Half of the 12 major pairs surpass the 80 pips line, the benchmark that we used to identify volatile pairs from the rest, with GBPJPY and GBPCHF reaching as high as 140 pips and 146 pips, respectively, during this time period (Figure 4.4).

Figure 4.4 European Session Volatility

With an average daily range of more than 140 pips, GBPJPY and GBPCHF are two currency pairs that risk-tolerant traders love to trade. While such high volatility can create much in the way of opportunity, it is important to realize that the peak of daily trade activity in these two pairs generally happens during the London session. With the London trading session overlapping both the New York and Tokyo sessions, it is the perfect market for banks and institutional investors to reposition their portfolios, and these adjustments contribute to the volatility in the market.

Traders with moderate risk profiles will also find plenty of pairs to choose from. EURUSD, USDCAD, GBPUSD, and USDCHF have an average range of 100 pips. As mentioned earlier, trading in these pairs is active because large market participants like to adjust their portfolios before the U.S. session opens.

For the more risk-averse, the NZDUSD, AUDUSD, EURCHF, and AUDJPY, with an average of 50 pips range, are good choices as these pairs provide traders with high interest income and profit potential. These pairs allow investors to determine their direction of movements based on fundamental economic factors and tend to be less prone to losses caused by intraday speculative trades.

US–Europe Overlap: 8am to 12pm EST

The FX markets tend to be most active when the hours of the world's two largest trading centers overlap. The range of trading between 8am and 12pm EST constitutes on average 70% of the total average range of trading for all of the currency pairs during the European trading hours and 80% of the total average range of trading for all of the currency pairs during U.S. trading hours. Just these percentages alone tell day traders that if they are looking for high volatility and they don't want to sit in front of the screen all day, then the best time to trade is the U.S. and European overlap (see Figure 4.5).

Figure 4.5 U.S.–Europe Overlap

European–Asian Overlap: 2am to 4am EST

In contrast, there is far less volatility during the European and Asian market overlap because of the slow trading during the Asian morning (see Figure 4.6). Of course, the two-hour gap is also a relatively short time period. What is interesting about this period, however, is that it usually precedes a breakout at the European market open between 4am and 5am.

Figure 4.6 Europe–Asia Overlap