As intra-day traders, it would be better for us if the trends had minimal countertrends (price action in the opposite direction of the trend; also referred to as retracements) and consolidations (sideways price action; also referred to as range trading). It would be much easier to trade with the intra-day trend and not get spooked out of our trend trades due to periods of adverse or stagnant price action.
In Forex there are many valid reasons why these intra-day retracements and consolidations occur. If you familiarize yourself with the many reasons for these interruptions, then you will be less prone to misinterpret these bumps in the road as likely trend changes and reclassify them as unlikely trend changes. In other words, you will be less prone to “bottom and top fishing”.
While bottom and top fishing feels comfortable (it’s too low so I will buy it; it’s too high so I will sell it), the fact is intra-day currency pair trends persist and sustain more often than not. And therefore you would be better off assuming the trend will persist than assuming the trend will reverse.
Short List of Reasons Why Intra-Day Trends Have Interruptions
3. Option traders
4. News events
5. Time of day
6. Technical condition
7. Currency pair
When an importing company purchase goods or services across international borders it needs to exchange its local currency for the foreign currency so that it can make the payment in the local currency of the exporter. If large enough, these types of transactions can impact the exchange rate. These transactions occur all day, every day.
Central banks are always in the process of tweaking interest rates. Central bank comments about possible changes in interest rates have a direct impact on exchange rates. Higher interest rate chatter causes a currency to increase and lower interest rate chatter cause a currency to decrease. The impact might not be large in terms of the longer term price chart but in terms of intra-day trading, the impact can be relatively large.
An option trader sells the right but not the obligation to buy or sell a currency pair at a specific price for a specific amount of time; and receives a fee upfront for giving the buyer this right. In so doing the option trader incurs risk and will buy or sell the currency pair he has given the right to in order to lower his risk. This buying and selling for hedging purchases is substantial and impacts exchange rates on an ongoing basis.
Exchange rates are continually nudged higher and lower based upon economic news events. The Tier 1 scheduled (on economic calendars so traders know when they will be released) news events, such as Central bank interest rate announcements, press conferences, testimonies, meeting minutes, inflation reports, employment, GDP, retail sales and CPI are the ones that create the big short term price spikes. The Tier 2 scheduled news events (economic news events not included in Tier 1) cause the small short term price spikes.
Besides scheduled economic news there is also unscheduled news. This can be economic news or other news. For example, a key Central bank official (economic news) might speak to the press unexpectedly (not on economic calendar). Or the Ebola news (other news) will impact exchange rates in the country or countries that get the latest press about Ebola and how it is impacting their country.
The impact of news events will cause movements in favor or against the trend and sometimes even cause a period of indecision. Sometimes there is good and bad news for a currency just minutes or hours apart. Sometimes both currencies in the pair have news on the same day – sometimes in the same direction and sometimes in opposite directions. All of this gets reflected in the charts. And most of the immediate price action after the news is of a temporary (not changing the big trend) nature.
Time of Day
Forex trading is a 24 hour a day market with three distinct trading sessions: Asia, Europe, and America. In Asia, the JPY, AUD, and NZD are actively traded and the price action in these currencies reflects enough buying and selling to assume the movements have a legitimate basis (more buyers than sellers). However, the price action in other currencies such as the EUR, GBP, and CHF is much less reliable because the liquidity is low and at times even a smaller order to buy or sell can move these currencies quite a bit. Perhaps as much as 10 times as far as a similar order placed during the European trading session.
There are also official exchange rate fixings at various times throughout the day. These fixings are the basis of large international payments and oftentimes the price action leading up to these fixings is manipulated by large players who stand to profit from a particular price fixing. We are not talking about moving the market 100s of points; more like 20-30-40 points; enough to derail an intra-day trade.
Other times of day, such as when the European traders are going home (approximately 16:00GMT) and squaring up (closing out) their intra-day positions, also experience temporary price distortions.
Oftentimes the market gets ahead of itself and too many traders are on the same side of the market. This causes a temporary imbalance (not enough current buyers or sellers) and a sudden, somewhat significant countermove occurs; followed by a subsequent return to trend.
The fact that an exchange rate can be impacted by one or both currencies on an ongoing basis makes the exchange rate particularly vulnerable to two way price action. For example, good news for the UK could drive GBPUSD higher and if followed later in the day by good US news that could drive the GBPUSD back down. An unchanged exchange rate based upon good news for both of the currencies in the pair makes sense; as does the two way intra-day price action when you consider the finer details (the timing of the news releases).
This article is making two key points
1. Intra-day price action is prone to be choppy.
2. Try not to misinterpret trend interruption for trend change.