4 findings about forex that may surprise traders

column earlier this week
investigated over 70 years of market history to show
how trending and volatility have declined in the S&P 500 Index. Many
readers wrote to me to confirm these findings with their personal trading
experiences. Some asked my advice about alternate markets. The most
common query concerned the currency markets. Aren’t these markets more
promising to trade, since they’re more volatile and trending than stock indexes?

If the growing number of advertisements for forex brokerage houses is any
indication, currency trading has certainly picked up its share of interested
participants. My stance is that one market is not inherently better or
worse than another. What makes a market good for you as a trader are two

1) Whether that market offers you a distinctive, non-random edge with
respect to directional movement; and

2) Whether the personality of the market fits your own personality and
your trading style.

Before we explore the personality of the Euro/Dollar currency market, allow
me to expand on these two points. First, it is not true that a market that
moves is a good trading market. Volatility is only a positive if you have
a valid edge in the market that allows you to exploit supply/demand imbalances
in auction process. If you lack such an edge, volatility merely confers

Second, each market moves differently in its “trendiness” and
volatility. A market that is trendy and volatile is wonderful for a trend
follower; not necessarily good market for a market maker selling offers and
buying bids. A risk-seeking individual might love high beta stocks; a
risk-averse trader would likely avoid them altogether. It is the fit
between a market, a trading style, and a trader’s talents and personality that
makes for success or failure.

Because many traders begin their careers schooled in technical trading
methods that boil down to buying strength and selling weakness (moving average
crossovers, breakouts from ranges, rising/falling oscillator readings, etc.),
they naturally assume that trending, volatile markets are good ones. Hence
the interest in currencies, which are perceived as both.

My readers’ queries led me to take a detailed look at forex by focusing on
the most popular contract: the Euro/Dollar, which is traded as an emini contract
on the CME (6E). The instrument trades in pips (the equivalent of ticks in
stock indexes), with one pip equaling $.0001 per Euro or $12.50 per
contract. I went back to January, 1999 (N = 1845 trading days) and
investigated closing prices in the cash market (which is very tightly correlated
to the futures markets).

Here are a few of my conclusions:

1) Median market movement in the Euro is higher than in the
S&P 500
. Over the seven year period, the average price change
from day to day in the Euro was 52.6 pips. The median price change,
however, was 42 pips. In a normal distribution, the mean and median should
be the same. Price changes in the Euro are not normal. Given that a
pip in the emini Euro is functionally equivalent to a tick in the S&P emini
contract–both worth $12.50–the median day to day movement of the Euro is
equivalent to a daily change of 10.5 ES points. By comparison, the average
daily change in the S&P 500 since 1999 has been 40.3 ticks (median =
30.8). While volatility has declined in the Euro over the past two years,
it has declined far more in the S&P 500.

2) Volatility in the Euro is less consistent than you might
. Over the period since 1999, the Euro traveled a total of
97080 pips. The most volatile 25% of days accounted for 54% of this total
movement. The least volatile 25% of days accounted for only 4.2% of the
movement. This highlights the unusually non-normal distribution of price
changes in the currency market. There are many time periods in which the
market does not move, interspersed with other periods in which there are extreme
movements. The most volatile 10% of days moved by an average of 145
pips–the equivalent of 38 S&P points in the current market. The least
volatile 10% of days moved by an average of only 3.26 pips–less than a single
S&P point. It’s not exactly accurate to call this a volatile
market. More precisely, it’s a market of volatility extremes, with mixed
periods of very low and very high volatility.

3) Intraday trading patterns appear to mimic daily ones.
I’ve examined 30 minute data in the Euro and find the same pattern of volatility
extremes. During certain times of day, the contract is extremely quiet and
at other times, especially around economic releases, it can be extremely
wild. The distribution of price changes is more peaked (more periods of
little change), with fatter tails (more extreme changes) than the distribution
in the stock indexes. This leptokurtic distribution gives the currency
market much of its personality, especially on an intraday basis.

4) Trending in the Euro is lower than you might expect.
In fact, I detect no evidence of trending in the Euro contract. Out of
1845 two-day sequences, I found 875 occasions of trending (up day followed by up
day; down day followed by down day). There were 969 sequences of
non-trending. This is actually slightly worse than we would expect by
chance, suggesting a mild tendency to reverse prior strength or weakness.
Interestingly, this reversal pattern was even more noticeable in the 30 minute

I’ll editorialize a bit about these findings on my
research site
. For now, let me suggest that the presence of occasional
huge market runs so dominates the price landscape (and charts) of the currencies
that they appear to be consistently volatile, trending instruments.
In reality, however, trading from period one to period two, volatility is highly
irregular (though elevated relative to stocks overall) and trending is the
exception–at least on the 30 minute and daily bases that I investigated.

Again I stress that this is neither good nor bad in itself; it is the fit
with the trading methods and personality of the trader that is crucial. To
the extent that traders are thinking of fleeing the stock indexes and finding
trending and volatility in currencies, they might want to think twice.
Risk and reward are highly variable in this market. Trying to catch
frequent short-term movements places one potentially in the path of occasional
violent moves, and trying to catch those big moves will probably necessitate
sitting through many time periods of little price change and directional

If you’re contemplating a person as a future spouse, you would want to know
their personality intimately. Before marrying any market, make sure you do
the same.

Brett N. Steenbarger, Ph.D. is Associate Clinical
Professor of Psychiatry and Behavioral Sciences at SUNY Upstate Medical
University in Syracuse, NY and author of
Psychology of Trading
(Wiley, 2003). As Director of Trader Development
for Kingstree Trading, LLC in Chicago, he has mentored numerous professional
traders and coordinated a training program for traders. An active trader of the
stock indexes, Brett utilizes statistically-based pattern recognition for
intraday trading. Brett does not offer commercial services to traders, but
maintains an archive of articles and a trading blog at www.brettsteenbarger.com
and a blog of market analytics at www.traderfeed.blogspot.com.
He is currently writing a book on the topics of trader development and the
enhancement of trader performance due for publication this fall (Wiley).