Lesson 1: Short-term fluctuations in the foreign exchange market

The daily volatility of foreign exchange prices in the international foreign exchange market is roughly between 0.8% and 1.5% (one to two cents, 100 to 200 points in foreign exchange market terms). It can reach more than 5% when the significant volatility (Ie, 700 to 1000 points). The frequent fluctuations of exchange rates in the foreign exchange market illustrate two essential characteristics of the foreign exchange market:

First, the risk is significant;

Second, the possibility of huge profits from investing in the foreign exchange market exists. For the short-term violent fluctuations that often occur in the foreign exchange market, economics calls it overshooting to information.

What is the overreaction of the foreign exchange market has always been debated in the economics community? There are roughly three explanations as follows.

First, the spot price of foreign exchange deviates from the long-term equilibrium price of the foreign exchange rate. People often talk in newspapers that the “exchange rate of a certain currency is currently overvalued” or that “the current exchange rate of a certain currency is far below its reasonable price.” These words refer to this phenomenon.

The excessive deviation of the spot price of foreign exchange from the long-term equilibrium price of foreign exchange can also be explained by various reasons. It may be that the spot price is too low or too high, or the long-term equilibrium price is estimated too low or too high. From the perspective of the market operation itself, when speculative capital is insufficient (the trading volume in the market is small), or when speculative capital is excessive in the foreign exchange market (the market is overheated), the fluctuation of the spot price exceeds its long-term equilibrium. Price is not an incomprehensible phenomenon.

Second, the volatility of the short-term equilibrium price of foreign exchange will always exceed the volatility of its long-term equilibrium price. This explanation assumes that all factors that affect the foreign exchange market will affect the price fluctuations of foreign exchange. Still, this effect's adequate time and channels are different, causing the short-term equilibrium price to deviate from the long-term equilibrium price.

For the phenomenon that the short-term equilibrium price of foreign exchange deviates from the long-term equilibrium price, the currently popular explanation in economics is that when the government expands the money supply or reduces the interest rate, the market price will not rise immediately, increasing the actual money supply. The market reacted quickly. The exchange rate of the domestic currency fell sharply, making the short-term equilibrium price of foreign exchange excessively lower than the long-term equilibrium price. And when prices rise when the money supply growth factor is fully digested, the actual money supply will drop, and the short-term equilibrium price of foreign exchange will gradually return to be consistent with the long-term equilibrium price.

Third, the foreign exchange market is not efficient; that is, the fluctuation of foreign exchange prices cannot fully reflect all the information in the market in a certain period, resulting in the actual cost of foreign exchange often deviating excessively from the equilibrium price.

The short-term violent fluctuations in the foreign exchange market may be due to the personal rejection of certain information by market participants, one-sided or excessive acceptance of certain information, which distorts the foreign exchange price excessively; it may also be that certain information that affects foreign exchange fluctuations obscures others. Equally, important information has caused great ups and downs in foreign exchange prices. Second, suppose the foreign exchange market is not profitable. In that case, some corrective behaviors will appear in the market, such as profit-motivated speculators intervening, the need to accurately release information that affects the market, and government intervention. These corrective actions sometimes make the actual price, and the equilibrium price converges and further distort the market price fluctuations.

Judging from the actual fluctuations in the foreign exchange market, it may be information-efficient in the long run, but it is far from proof in the short run. At present, the most significant impact on the daily volatility of the foreign exchange market is news, which includes two major categories: economics and politics. In addition, the willingness and psychological factors of market investors often further expand the impact of this news on the foreign exchange market.

Continue to study the following article: Forex intermediate Course: Lesson 2