Trader Mindset

Economic data and financial news are an important component in understanding why markets make moves in certain directions, but it’s not the only reason why FX rates change. To get a better understanding of FX, it is equally important to know the people who make up and influence the market.

The name “FX Market” is a way to describe the vast multitude of people who engage in FX operations. Every single publicly recorded currency exchange transaction makes up what we call the market. Some traders are individuals who buy and sell FX for themselves. Other traders belong to large banks. Individually, they all have a very small impact on the overall market, but when put together, they exert a force that moves the currency pairs in a specific direction. The size of the FX market averages more than $5 trillion per day, according to a 2016 survey by the Bank of International Settlements.

Some of these transactions are “algorithmic”, meaning that they follow a set of automated parameters such as timing, price and quantity that determine when a clever computer programme will execute a trade. Even though trading algorithms are computerised, rules that govern them and tell them what to buy and sell are still set by people who are subject to typical human drivers and motivations.

Seasonality in FX Markets

What influences FX traders? How do they make trading decisions, both on a daily basis, and over a longer period?

All traders listen to the news and try to parse announcements from influential economists, corporate decision makers and political leaders. They look at the state of the economy and try to understand how key economic indicators would strengthen or weaken one currency in relation to others.

But even on a more basic level, traders follow typical seasonal life patterns. As the saying goes on London financial trading floors: “Sell in May and Go Away”. There is a commonly held belief that trading activity decreases during summer months and that the year can be roughly divided into two major halves: November to April, and then May to October.

According to this view, November to April is a part of the year that is rife with trading activity. With exception of a small window of inactivity around late December (due to Christmas), the rest of the period sees big trading volumes. Trading is believed by some to be more predictable, the patterns more easily discovered and less chance for uncertainty to affect investments.

Pattern Recognition

Examining the charts, FX traders can spot certain quarterly patterns in volatility throughout the recent years. GBP/USD pair in 2015 has seen an uptick of volatility in the March-April period, mirroring intense trading activity. Volatility dropped sharply in mid-April and increased once again in May (while the Pound strengthened in the previously discussed Spring Bounce). After that it started to steadily decline throughout the summer months, culminating in very low levels of market volatility during the month of August. It once again picked up in September and remained steady for the rest of the year.

(Source: AlphaTerminal, 26.04.2018, GBP/USD, Daily Chart, 2015)

At the same time, the method of examining volatility patterns as a proxy for market trading activity has its obvious limitations. Certain political and economic events can have such an enormous effect on FX markets that they “smother” all other potential seasonal patterns. This can be observed in examining the GBP/USD 2016 chart, dominated by an “explosion” of market volatility during the summer of 2016, in the aftermath of the Brexit referendum.

(Source: AlphaTerminal, 26.04.2018, GBP/USD, Daily Chart, 2016)

Nor are these seasonal volatility patterns uniform or unchanging. Comparing the GBP/USD 2017 market volatility chart to the one from 2015, it becomes apparent that while there are observable upticks of market volatility during certain times of the year, these patterns do not repeat exactly year to year.

(Source: AlphaTerminal, 26.04.2018, GBP/USD, Daily Chart, 2017)

In 2017, there is an earlier increase in market volatility in the Q1. During Q2 2017, there is another, slightly smaller, increase in market volatility, but this time mirrored by a 4-5% strengthening of GBP/USD (more evidence of a potential Spring Bounce pattern). As in 2015, summer months show less market volatility, but it picks up once again in September, mirrored by yet more strengthening of GBP/USD.

Similar patterns can be observed while examining EUR/USD and EUR/GBP charts for 2015 and 2017, with 2016 volatility chart again dominated by the Brexit and, hence, not particularly useful for spotting any FX trading patterns. There are periods throughout the year that see marked increases in market volatility, especially in Q1 and Q2, but these periods do not match perfectly every year and are often tied to major economic events and announcements.

(Source: AlphaTerminal, 26.04.2018, EUR/USD, Daily Chart, 2015)

(Source: AlphaTerminal, 26.04.2018, EUR/GBP, Daily Chart, 2015)

There are more obvious periods of volatility downturn throughout the calendar year. These are typically observed toward the end of summer, as well as in late December, which can be traced to a decrease in market activity due to many FX traders leaving work for holidays.

(Source: AlphaTerminal, 26.04.2018, EUR/USD, Daily Chart, 2017)

(Source: AlphaTerminal, 26.04.2018, EUR/GBP, Daily Chart, 2017)

Looking for patterns in market data can be time-consuming. British businesses and households require a reliable partner that can help them chart their way through financial markets and support their needs with innovative FX solutions.