Table of Contents
1. Introduction to the Forex Market
The basic operation of the foreign exchange market consists of buying or selling a currency at a moment (t), hoping to sell or buy it later at the next (t + 1) moment at a higher price,price, and making a profit. In forex, rates or exchange rates between pairs of currencies (such as dollars and euros) are traded, which are treated in established places wherewhere commissions are calculated. The result of the balance of these tradestrades in several countries is the set of operational marketsmarkets for the buying and selling of currencies abroad. Each country is represented by a central bank of foreign exchange, which monitors and supervises the activity performed in the market of their country’s currency. Mainly, the supervision is focused on the exchange operations of the country’s total exchange,the maintenance the maintenance of the international reserves, and the exchange market in case it is organized inside the country. The forex rate increases and decreases due to several factors,factors, such as the supply and demand of currencies, relative purchasing power, the balance of payments, and risk and volatility.
The forex market owes its name to the expression “Foreign Exchange Market,Market,” and it is one of the most democratic markets. This market has captured the attention of many investors because of its large volume of operations and because it admits short sales at any time. The logic of foreign exchange is based on the purchase transaction of a currency pair under the forecast of rising quotes and the sale under the forecast of their decline. In this case, it is advisable to negotiate exchange rate quotes because the smallest price movement is profitable. The basic operation of the foreign exchange market consists of buying or selling a currency at a time (t), hoping to sell or buy it later at the next (t + 1) moment at a higher price,price, and making a profit. The forex market is the biggest and most liquid.
1.1. What is forexforex tradingtrading?
Today, thanks to the work of intermediaries or brokers, trading in foreign exchange has proliferated, offering clients greater leverage. Forex trading is no different from the stock trading market. Its incredible liquidity and modern technology have contributed to the growth of forex trading. Traders can now place transactions with a click of the mouse and with a lot of confidence. Among all the strategies to earn money from investing in forex, retail traders invest through a forex broker,broker, whowho, in this market, traders hashas the right to demand very high funds and earn commission on each investor’s trade (between purchase and sale prices) and sale. Brokers are regulated by national or international entities so that traders have confidence based on these regulations. With the introduction of the online trading system, the power of large investment houses and financial facilities has been spread over the individual investor.
It is open 24 hours a day, five days a week. From the point of view of trading volume, it is by far the largest market. It has an average daily trading volume exceedingexceeding 5 trillion dollars. Forex is the market wherewherethe most the most money moves in the world and the most popular for all traders. In this market, a currency is exchanged for another currency. The buy and sell of aa currency is based on knowing which will be the behavior or variation of a currency with respect to another currency. Up to a few years agoyears ago, only forex traders, large companies, and currency exchange houses participated in forex.
The forex market, or forex (from the English Foreign Exchange, literally “foreign exchange”), is a global decentralized or over-the-counter (OTC) market for the trading of currencies. This market determines the foreign exchange rate. It includes all aspects of buying, selling, and exchanging currencies at current or determined prices. In terms of volume of trading, it is by far the largest market in the world. The main participants in this market are larger international banks. The financial centers of the world, such as Sydney, New York, Tokyo, London, and institutions, capital, and Qatar, respectively.
1.2. Importance of Data Analysis
The Forex market is influenced by various factors, and it’s important to analyze these factors for more accurate transactions. The most important data that mediatesmediates these transactions are the prices. Defining the direction of price movements and the extent of a predetermined period oftime of time of price change is one of the most important functions that can be performedperformed to realize these benefits. However, transactions made with only price data can be risky. Therefore, the investor frequently uses different data alone and in a combined manner to capture more accurate results.
In order to trade more powerfully in this $6 trillion market, predicting the Forex market accurately must be well understood. Accuracy depends onthe available the available news and data. However, it is not possible to reach all of the events in all time periods. Knowing only significant events is important forfor achieving high estimates. Knowing the data and the relationship between the market variations helps the investor step on a confident path.
The foreign exchange market is the largest market in the world and has a trading volume of more than 6 trillion dollars a day. National banks, commercial and investment banks, fund management organizations, brokerage houses, central markets, multinational corporations, and small investors are participants in this market. As seen, participants who are dominant in the economy are involved in this system, and in today’s world, all cash and capital movements are made in these markets.
Data analysis is an important part of almost all fields of life. However, when it comes to investing in the forexforex market, its importance starts to increase.
2. Fundamental Analysis in Forex
Economic reports contain a lot of unexpected information that is used to gauge the future direction of the national economy. Several key reports are used in this analysis. Gross domestic domestic product (GDP) measures the output of the nation’s goods and services and, therefore, its economy; it also reflects growth. Retail sales is a timelier report. It measures the total sales value of all goods and services sold by these and is a key sign of consumer spending. The Producer Price Index measures average changes in wholesale prices and is the most commonly used indication of general price trends at the consumer level. Employment data shows changes in the number of employed individuals, and the unemployment rate shows the percentage of the workforce that is unemployed and actively seeking work. These key reports are used to gauge trends in the business cycle.
Fundamental analysis is an essential tool for strategic decision-making in the forex market. Fundamental analysis studies anything that may have an effect on the nation’s economy. This includes, but is not limited to, economic indicators, monetary and fiscal policies, trade figures, and national debt. Understanding what moves the economy is important because the currency is the direct representation of the economy. Therefore, the current market price is a reflection of the aggregate of all knowledge concerning all aspects of the currency. The forex market is integrated and can reflect changes in economies due to a combination of factors.
2.1. Economic Indicators and Their Impact
Nothing is more useful than planning for future expansion with prior knowledge when, in a competitive economic world, the difference between a successful company and a company that goes into liquidation is due to the correct interpretation of the data beforehand, which signifies the maximization of profits at the lowest available level of risk, which is the ultimate goal of every company. Through the correct interpretation of the key indicators, and particularly the most important one that this theme proposes, a company can provide timely corrective action and thus not be exposed to very high levels of risk. In essence, the use of this type of information can be seen as an anticipation of future events. This approach can foresee factors such as recessions, unemployment rates, bankruptcies, trade balances, etc. and set up all the strategies required for the appropriate time for application in accordance with a flexible strategic plan adapted to the respective sector. There are indicators that are highly subjective and can only be evaluated subjectively; however, statistical indicators are on the edge of the economy, with mechanical production being high-density concrete, which is available for practically all periods. This approach is, therefore, imposing, since it supports an abundant amount of knowledge about changes in economic systems.
There are several economic indicators that have a quick and often significant impact on financial markets. All are macroeconomic indicators, since they refer to activity in a certain sector of the economy or in the economy as a whole. They can be merged into three main groups. The first group is composed of indicators related to the real sector, to the goods sector, and to the services sector. The second group is made up of indicators, which are used to assess cyclical prospects or reflect changes in the cost of living, changes in employment, or factors that may influence employment, as well as certain changes in economic agents’ capacity for debt repayment. The third group contains indicators aiming to bring to light the influence factors have on price stability. In addition to these indicators, there are several others, referred to as non-economic and composite indicators, that measure financial developments in general.
Economic indicators are an important source for forex markets to analyze the behavior of currencies. The reason behind this relationship is the reaction that the release of economic figures arouses in the forex market. The stronger the discrepancy between the reported and forecast values for the economic figure, the stronger the response will be. In this way, positive economic data about a country is a plus for its currency value, and vice versa. The largest impact of the economic indicators publication is just after they have been reported, after which the impact fades. However, many reports have consistently displayed that currency returns do respond to some macroeconomic announcements in predictable interval returns. The financial media play a crucial role in reporting this kind of information, leading to the signaling effect that is so present in empirical tests. Economic new releases generally have two important types of impact. It is not sufficient to have just one without a proper forecast from one of the major survey institutions or from the economic reports forecasting companies, which for the forex market are said to have economic and financial importance in general, called consensus. Another set of particular economic indicators with forecasting power, which is the correlation with the business cycle, is also synthesized by these consensus release reports. These consensus reports are monthly or weekly publications, since the time that passed since the last report has forecasting power for the next.
2.2. News Events and Market Reactions
There is also a series of important economic reports, or events, that are released at regular intervals during the month. Other events may also be registered and included in the database. For the purpose of this study, i.e., to carry out micro-structure analysis, only the reports concerning the EUR/USD currency pair received attention; nevertheless, other economic indicators have a different relevance and an impact on the FX market.
2.2 News Announcements
The interest rates are the main determinant factors of the foreign exchange market dynamics; however, the situation may change and the market can start considering other themes. The central banks commonly schedule regular monetary policy meetings, so these decisions and central bank statements usually move the EUR/USD market. In fact, typically 7–14 times per year, the FOMC members meet to decide the direction of interest rates, so these decisions and press conferences are very important events for forex market participants. The ECB conducts eleven regular meetings to set the key interest rates.
2.1 Interest Rate Decisions
Research has shown that new information conveys a significant part of the EUR/USD intraday volatility. Two types of events that are released in economic calendars were considered in this proposal: interest rate decisions and non-scheduled messages.
3. Technical Analysis in Forex
Technical analysis in forex, in addition to being the most popular type of analysis, examines the historical prices of the security to make predictions about the future behavior of these prices. Technical analysts always examine the price and volume of their chosen security. Now, you can say, then how does fundamental analysis make sense in the forex market? Since the only data in the forex market is price-related data, the answer to this question is that technical analysis should be given priority in the forex market. Foreign exchange is an extremely dynamic and fast market. Money constantly passes from one currency to another. It is necessary to make quick decisions in this fast market. In order for the investor to earn from these fast movements, there are no transactions that need to be stable in the long term. This makes forex a dynamic market. In the forex market, there are about 1 trillion dollars of money per day. This trading volume is much higher than in most other financial markets. Since forex prices can be shaped both by economic developments and by big investors, “technical analysis” should certainly be given priority.
3.1. Chart Patterns and Trends
In the concept of trend or trend series, which has a very special place in economics, the definition, qualification, classification, and determination of its form and value remain controversial. Economists use the concept of trend to separate and analyze short-term and long-term time and macroeconomic series. Theories and data methods related to patterns increase when technological developments develop. Graphic and statistical methods start to become popular for determining the characteristics of patterns and their durations. Even the graphs are prepared in consideration of the characteristics of these patterns. Wave theory, Elliott theory, and window analysis are formed over time to explain the patterns frequently observed in the market due to positive or negative investment bubbles, short-term price movements, and long-term cyclical patterns. Although the credibility of the theories is not proven by mathematical models, traders trying to predict the future behaviors of the market benefit from the fact that they are widely accepted since they are based on long-term data-based experimental travel.
In forex analysis, since countries cannot be analyzed with predetermined economic parameters, it is only by taking the behavioral patterns of the markets as data and analyzing them in terms of past experiences that possible outcomes can be projected. The currency graphs and analyses obtained on a current and past basis can be used in financial decisions. Methods of data collection through interpretation from the graphics on price and volume points give valuable information to investors and large fund managers, although the methods based on these data have not been proven by statistical data. One of these is a data pattern called a trend. The market system develops in accordance with the conditions of demand and supply. Thus, the chart on demand and supply is used as a pricing criterion, and trends give us signals about the nature of demand and supply in the market throughout the forex market.
3.2. Indicators and Oscillators
3.2.1. Main indicators
The moving averages, also called MA, are one of the main indicators and are used to visualize the pattern of the market variables. One thing about moving averages is that they highlight market risk. The moving averages help to ease the understanding of the market. As a result, a trader or a technical analyst can detect the volatility and the market trend. The EMA refers to the average value of the series using the most current data, so the EMA uses more recent information than the simple average. It is often used to create the MACD. In the real market, more traders use the EMA in the short term.
As explained in the previous section, obtaining forecasts for exchange rate movements is very important to being a profitable operator in the forex market. Many types of fundamental and technical analysis are used to make these predictions. Among the types of technical analysis, we can distinguish the leading indicators to which we will refer with the term “indicators,” and “oscillators” are some of these leading indicators that are most distinguished. In this section that is to follow, we will expose various indicators and oscillators, as well as the forms of use that have made them gain acceptance in the forex market.
4. Sentiment Analysis in Forex
Bai et al. took four different data sources, including keywords used by traders, watched for their repeat, and then dissected the data. Sentiment scores were then extracted to see if trading decisions could be inferred from them. His calculator provided a somewhat challenging metric, but by using sentiment data about different pairs of money, he was able to gain more insight when there was nothing in that money that day and the sentiment score could not be auto-correlated back to the previous day. When a facial expression was found, a trader appeared to be interested in a pair of dollars. Facial expressions were even better when backed up by trading data. These findings could be equally leveraged for judgment-free data feeds. People could use PAMMs (Percentage Allocation Management Module) to limit an open market of data in real-time. It floats a real-time representation of a trader’s intent in the world, whispering tips right into the trader’s EA ear. In this other case, the real-time trader generator can identify an impending emotional flash of the trader based on a tweet-based watchlist and apply a filter to avoid overexposure to certain currency pairs.
In financial markets, lag times and low visibility are key problems. When considering the forex market, this is even worse, as many developing nations have virtually no market transparency at all. Some countries have very tight capital controls or do not allow currency trading at all. Developed nations have financial regulation and work towards transparency, but as visibility falls off the edge of the market, the public, or even the most highly regulated market, tumbles. Twitter is one form of reference that has information on a constant timeframe (albeit at a data sampling cost) and has shown in a portfolio of United States-based stocks that it can deliver real value in information about the market. Market reports, successful rate alerts, and the Hedge Fund Enigma Blogspot have provided added insights into market behavior and signals. In contrast, certainly during a United States holiday, Google can inundate the market with spamdexing signals. Sentiment—sometimes called near-term price movements—seems to have a say in the outcome of this data signal struggle. In attempting to extract data signals from such noise, the publication of this work will examine the Forex data continuum from the two-week election motion until the market is satisfied and moves on to other events.
4.1. Market Sentiment Indicators
I also use Jason Alan Jankovsky’s method for assessing market sentiment over time and historical data. However, in addition to the indicators mentioned above, we consider two new sentiment indicators: the ratio of the number of “buy” orders to the number of “sell” orders and the net position of the smoothing speculators.
1. 99-line method
- Consensus Position
- CTA Position Index
- Ratio of Bullish Consensus to Bearish Consensus
- Monthly change in trader position
- Participation ratio
- Leg ratio
- Ads index: pcr ratio
- Commitment index
- Swing traders step values
- Open Interest
Most forex traders use technical analysis to trade; however, there is another key consideration: market sentiment. Market sentiment is the current mood of the market and its instruments. It manifests itself in trading positions, which are opened and not closed. Moreover, market sentiment is colored by psychology (mass fears and predilections). To assess market sentiment, time and historical series of the following indicators are used: According to Jason Alan Jankovsky, there are some methods for using market sentiment in trading strategies:
4.2. Retail Trader Sentiment
Not everything is gloomy. Of course, the market price of any traded good incorporates disagreement among the participants. The divergent opinions of the participants in the Forex market, both institutional and retail, coexist on the very existence of the new equilibrium prices. Given the evidence of the persistent failure of commercial Forex operators to achieve long-run gains, many trader participants in Forex are biased and trade, one way or another, against the institutional leaders. And they are potentially profitable in the long run. Carry traders are long-term investors who focus on long-term indicators. They consider an exchange rate to be fundamentally overvalued when it appreciates to the extent that it
exceeds the potential increase in interest rate differentials implied by future inflation and the expected risky exchange rate change. Carry traders expect the fundamentals in the exchange rate to weaken and realize the risk that a carry trade runs from the increasing imbalance caused by the growth difference between the expectations of the price and curve spreads due to long-term reflexive economic fundamentals.In recent years, some leverage has been
provided to retail traders to realize and commercialize strongly descriptive field characters. Specifically, the fact that retail traders are small-sized accounts allows brokers to discriminate and isolate positions from this particular category. The performance of small retail traders is poor. This is a consequence of many considerations. Let us briefly list the most evident ones according to the empirical findings reported in the present study. Many retail traders do not have deep pockets and are so concerned with timely short-term gains that they neglect to apply a careful assessment of the fundamental and technical macroeconomic motives that are at the heart of Forex activities. As a result, retail traders are incompletely and imperfectly informed and/or motivated.
5. Case Studies and Examples
To illustrate some of the points made in the last two sections, we present an analysis that involves applying classical time series methods to important and recent exchange rate data. We consider data collected right before and during a significant and surprising foreign exchange management (monetary policy) action by the central bank of Taiwan. Such an event drives millions of dollars of economic activity, and the foreign exchange market is the largest financial market in the world. Many investors and companies attempting to gain from their international investments can hedge the unknown currency returns from their assets. In this paper, we consider the effectiveness of a central bank on shocks to the forex market in the practical situation we consider here.
The models that have been described to this point do not generally have direct application to forex time series data. One reason is that those models work with relatively homogeneously spaced data. In addition, for most of these models, the data must be ideally spaced (i.e., evenly spaced, independent, identically distributed data are somewhat critical for many statistical techniques). But forex data are high-frequency, usually measured only at intervals of a few seconds (and at hundreds of ticks per second for the most active contracts). Furthermore, forex data is not evenly spaced since no data is typically available during the weekends. Plus, real price movements are not independent and identically distributed. Currencies move in relation to each other. However, these models indirectly impact currency volatility. For example, the use of Black-Scholes derivative pricing models helps influence currency traders, who (along with many other financial market participants) often use these models as part of their pricing mechanism for economic data releases.
5.1. Real-world Examples of Data Analysis in Forex
It is not clear whether the best is to simply study the raw changes of the levels of the USD per other currency or to ratio both levels in order to study the average relative change between both. The glamorous reason why one might prefer the ratio over the raw change is to control for any systematic drift that all FX rates tend to exhibit as a result of both relative price levels and relative nominal income shocks. The content of such significant shocks is all but likely to be random. Closely following Lewis (1995), however, one can build the test way to see whether the proportional change is truly better than the raw change. Just conduct the test and observe the result. We will provide an empirical answer to the above conundrum. The related content of this paper is as follows: Some studies find that shifts in the value of the USD can account for 50–80% of the total swings in the U.S. and some foreign stock markets. If valid, this would be good news for international diversification. We are interested in the short- and medium-term forecast of U.S. stock prices, however, and so we do not delve into these papers further to document further evidence in this respect.
The author’s current analysis of data is also both simple and real-world. I managed to locate some high-quality data on foreign exchange (FX) rates and the value of the U.S. stock market from a top data provider. The question asked is the following: Can one use past changes in FX rates to forecast the movement of the U.S. stock market? There are good theoretical reasons to think that the answer is indeed yes. To the best of our knowledge, most prior studies dealt with the issue of whether past FX changes could forecast the movement of the U.S. bond market or the foreign exchange rate risk of U.S. equities. I will uncover a previously discovered relationship for our case and show that this relationship has remained constant over the data collection period despite the multitude of significant real-world changes. We shall do so for the FX rates of the U.S. dollar (USD) against six major currencies, namely Australia, Canada, the European Monetary Union, Japan, Switzerland, and the United Kingdom.
