The Forex Market isn't Inefficient anymore

To be Forex traders should beware that the market is at its efficient best Foreign exchange trading is becoming fashionable among retail investors. For those who are thinking on the lines joining the trend another warning in order is the fact that the FX markets are unpredictable nowadays and hence aren't the best options for easy money making.Confirming the very same fact one can opt to check an efficient market by volatility ratios.

The process involved is basic. If markets are to be efficient, past price movements shouldn't predict future movements, but this is just one of the conditions. If we multiply the weekly volatility by the square root of two we shall get the fortnightly volatility, since in this case the two are related by the square root of time.

Prices following the random walk can be tested by comparing the actual volatility to the random walk volatility. Rises in a period can follow falls if there is a prices mean revert, this happens when random walk volatility is higher than actual volatility.

The three main exchange rates' ratio of actual to random walk volatility is visible in my chart. Few weeks of rising in the Pound would consequently lead to its fall is the trend suggested here.

Still one should not ignore that the ratios are near one, in the range of 12 per cent. One could easily lose fortunes bettinf on the inefficiency since it is so little. The diminishing profit making became staple of Forex trading in the 1990s since investors started wising up to the momentum effects.

In terms of very short period one would not see consistency with a random walk. For anyone capable of expecting surprises better than the market, making money from a random walk is also possible. Compared over a 17 year period, one can see from our data that exchange rate moves are roughly random. There are certain short periods when the market isn't as efficient as its average.

Consider the situation where traders would get a sign that the US dollar would become absolutley worthless the very next year. It looks as if one could have made money if they had invested in the dollar at its lower point since it over reacted and then mean reverted.

However this is an efficient market. When one purchases dollar at its low point, he isn't making a risk free profit, but instead is being rewarded for taking that crash risk. Variation in the crash risk is one of the likely character in the exchange rates in the recent years.

The point here is simple. It is understood that banks can do it since they have an upper hand compared to ordinary retail investors. For one thing, they have proprietary knowledge about clients FX orders and this can predict future exchange rate moves. Secondly they have the ability to trade at practically no cost and hoovering up pennies can churn profit only if one has a cheap hoover. For those aware of these edges, forex trading is a safe game.

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