To begin, it is useful to examine the general characteristics of the forex market. This will facilitate understanding of the related time series. Most of our discussions will center around the spot forex market as this is the most important segment of the forex market.
The spot market has the following characteristics:
- Among all the financial markets, the spot market may be regarded as the most technically efficient. This attribute makes it difficult to apply conventional modelling techniques to forecast the dynamic behavior of the forex time series with a view to establishing profitable trading positions.
- Spot transactions in the forex markets are carried out 24 hours per day using an electronic network such as the dedicated dealing system offered by Reuters. The absence of any formal exchange makes it very easy to trade on the spot market. Transactions on the futures market, by contrast, are made via the exchanges.
- Ignoring credit related issues, another important reason for the very high trading volume on this market is the possibility of high leverage. This feature attracts even small time speculators and investors to enter and trade currencies. The low barrier to entry to trade forex has been facilitated by the financial companies, brokers, and investment banks all over the world. Broker bonus offers are commonplace, and enable trading with minimal capital.
- The Forex market is perhaps the only market which is open virtually 24 hours a day, five days a week. The market opens early in New Zealand and Australia, followed by Japan. A little later several trading centers in the Far East such as Singapore and Hong Kong enter the global market and provide further liquidity. As the market closes in Japan, trading begins in the Middle East and Europe, closely followed by the United Kingdom. While the UK is still actively trading, North America begins to trade, and when it is time for the US close the 24 hour cycle starts over in New Zealand. On Saturday and Sunday very limited trading is reported from the Middle East markets.
- Trading volumes are substantial, particularly in the major currency pairs. Therefore the market is considered very deep and liquid for the purpose of initiating and closing positions at any time of day or night. In general, forex market trades are executed in a fraction of a second, as a counter-party is quickly found by any reputable broker under normal market conditions.
- Funding costs for overnight forex positions are based on the interest differentials of the two currencies involved in the trading position. These are normally low unless a high interest rate currency is sold against a low interest rate currency. Therefore, in general, it does not cost much in terms of position funding to hold trading positions in the forex market.
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