The Western world since the start of time was built, created, designed and grew based on interest rates. So successful was lending and borrowing monies in interest rates, markets were created to finance further the proliferation and creation of money for companies, capital projects, citizens needs, governments and pure capitalist profit motives. From Commercial Paper interest rates came Stock companies then stock indices and other financial instruments but all had money, interest rates and profit as the motivational foundation.
In order to understand money, trading money and currencies, it must be defined as an interest rate. A currency is derived from an interest rate and includes every nation’s fundamental, economic and financial orientation towards its own currency. Note the word currency as this word is specific to a nation’s money. EUR is a currency, AUD is a currency, NZD is a currency. If one nation’s currency is matched to another nation’s currency then it becomes an exchange rate. Currency and exchange rates are two vastly different yet similar concepts but the glue to meld the two methodologies are interest rates.
The competition and only competition for traders are banks because banks understand the methodologies of interest and exchange rates and execute trades in split seconds. Traders lack ability to compete against banks due to speed of execution and ability to rapidly move exchange rate prices unless a trader understands the concepts of interest and exchange rates.
Most importantly, banks deal in prices vastly different than 90% of market traders. Banks enter, exit and profit in minutes then the day is done. Rather than pips earned on a trade, more importantly is how many pips flew by without profit. Banks simply employ the age old tools of exchange rate trading, tools not known yet available to the 95% of traders to profit from every traded pip. Banks since Babylon days specialized in deposits, loans, lend, borrow, buy, sell, exit, profit and all included an interest rate. Modern day banks simply act upon information provided by the central banks in order to perform their natural and specialized functions.
Bradley Gilbert CTA and 20 year bank trader wrote a 2013 article for fxstreet titled ” Making Money in Forex is Easy if you know how the Banks Trade.” A Gilbert quote below
“Bank traders only make up 5% of the total number of forex traders with speculators accounting for the other 95%, but more importantly that 5% of bank traders account for 92% of all forex volumes. So if you don’t know how they trade, then you’re simply guessing.”
The generalized words volume and liquidity are misnomers in exchange rate trading. Actual volumes are metrics exclusive to the domain of upper elite FX professionals. Volumes are categorized by currency pair and begins from normal or average then calculated to volume extremes above and below normal. Volume is an elite science and trade able metric if actual was known. The smart in the elite FX professional category to include banks calculate volume on a forward basis. The best method exclusive to markets from 1920’s to 1970’s and valid today for the average to trade volume is by Open Interest.
Liquidity asks the question how much is the volume. The answer is never known or ever seen and is a throwaway term. The best liquidity determines is possible position sizes but volume and position sizes range widely from bank to bank therefore lacks an exact answer.
If for example volume in NZD was known. What does NZD mean? Does it mean NZD/USD, NZD/CAD, NZD/CHF, all of the above or just NZD/USD. Its not determined. Then the question how volume actually relates to an exchange rate price.
The BOE cut interest rates then GBP/USD fell 100 ish pips. The RBNZ cut interest rates and NZD/USD rose 100 ish pips. The RBA cut interest rates and AUD/USD barely dropped 60 pips, rose and continued on its path higher. Volume is to blame in AUD only to the extent traders and banks lacked interest to trade AUD. Why interest is because of the price.
Historic trading in exchange rates is the trade in deposit rates. Deposit rates vary nation to nation yet deposit rates offer price triggers. Each nation has an exclusive price trigger and its what offers each currency pair its characteristic, its ability to move and its ability to stop moving. A price trigger answers long or short and where is the end point to profit. When banks and elite Fx professionals identify the price trigger then all not only see it from miles away but all pile on the trade and seen by volumes. Price and volume however was just one moment in time. Tomorrow’s price may not account for the same interest from banks despite price movement unless a price trigger is seen therefore ask how much volume actually matters overall.
Does USD and non USD pairs drive cross pairs or does cross pairs drive USD and non USD pairs. Does an exclusion exist or do cross pairs and USD V Non USD drive each other. Historically, cross pairs drive USD and Non USD pairs because cross pairs are always priced above USD and Non USD counterparts. Cross pairs are always priced to move. In the past 3 months however, cross pairs were priced 1 to 2 pips higher or equal to USD V Non pairs.
Much exists to FX knowledge yet much has been lost over the past few years. Myths and realities in exchange rate trading after 1000 years of practice is an endless topic in the modern day. Part of the problem is the knowledge and skills lack the overall foundation for proper understanding.
Brian Twomey, Inside the Currency Market, btwomey.com