What is the cause of sudden price spikes in the FOREX market?

Question

I just started trading currencies on the FOREX market and notice that, sometimes out of the blue, there is a spike of massive PIPS in an instant. Who has the power to do that and why would anyone buy or sell like that?

Answer 1

If you do not understand the volatility of the fx market, you need to stop trading it, immediately. There are many reasons that fx is riskier than other types of investing, and you bear those risks whether you understand them or not. Below are a number of reasons why fx trading has high levels of risk:

1) FX trades on the relative exchange rate between currencies. That means it is a zero-sum game. Over time, the global fx market cannot 'grow'. If the US economy doubles in size, and the European economy doubles in size, then the exchange rate between the USD and the EUR will be the same as it is today (in an extreme example, all else being equal, yes I know that value of currency /= value of total economy, but the general point stands).

Compare that with the stock market - if the US economy doubles in size, then effectively the value of your stock investments will double in size. That means that stocks, bonds, etc. tied to real world economies generally increase when the global economy increases - it is a positive sum game, where many players can be winners. On the long term, on average, most people earn value, without needing to get into 'timing' of trades. This allows many people to consider long-term equity investing to be lower risk than 'day-trading'. With FX, because the value of a currency is in its relative position compared with another currency, 1 player is a winner, 1 player is a loser. By this token, most fx trading is necessarily short-term 'day-trading', which by itself carries inherent risk.

2) Fx markets are insanely efficient (I will lightly state that this is my opinion, but one that I am not alone in holding firmly). This means that public information about a currency [ie: economic news, political news, etc.] is nearly immediately acted upon by many, many people, so that the revised fx price of that currency will quickly adjust. The more efficient a market is, the harder it is to 'time a trade'. As an example, if you see on a news feed that the head of a central bank authority made an announcement about interest rates in that country [a common driver of fx prices], you have only moments to make a trade before the large institutional investors already factor it into their bid/ask prices. Keep in mind that the large fx players are dealing with millions and billions of dollars; markets can move very quickly because of this.

Note that some currencies trade more frequently than others. The main currency 'pairs' are typically between USD and / or other G10 country-currencies [JPY, EUR, etc.]. As you get into currencies of smaller countries, trading of those currencies happens less frequently. This means that there may be some additional time before public information is 'priced in' to the market value of that currency, making that currency 'less efficient'. On the flip side, if something is infrequently traded, pricing can be more volatile, as a few relatively smaller trades can have a big impact on the market.

3) Uncertainty of political news. If you make an fx trade based on what you believe will happen after an expected political event, you are taking risk that the event actually happens. Politics and world events can be very hard to predict, and there is a high element of chance involved [see recent 'expected' election results across the world for evidence of this]. For something like the stock market, a particular industry may get hit every once in a while with unexpected news, but the fx market is inherently tied to politics in a way that may impact exchange rates multiple times a day.

4) Leveraging. It is very common for fx traders to borrow money to invest in fx. This creates additional risk because it amplifies the impact of your (positive or negative) returns. This applies to other investments as well, but I mention it because high degrees of debt leveraging is extremely common in FX.

To answer your direct question: There are no single individual traders who spike fx prices - that is the impact you see of a very efficient market, with large value traders, reacting to frequent, surprising news.

I reiterate: If you do not understand the risks associated with fx trade, I recommend that you stop this activity immediately, at least until you understand it better [and I would recommend personally that any amateur investor never get involved in fx at all, regardless of how informed you believe you are].

Answer 2

Who has the power to do that?

It depends on the currency pair since it is much harder to move a liquid market like Fiber (EURUSD) or Cable (GBPUSD) than it is to move illiquid markets such as USDTRY, however, it will mostly be big banks and big hedge funds adjusting their positions or speculating (not just on the currency or market making but also speculating in foreign instruments). I once was involved in a one-off USD 56 million FX trade without which the hedge fund could not trade as its subscriptions were in a different currency to the fund currency. Although it was big by their standards it was small compared with the volumes we expected from other clients. Governments and big companies who need to pay costs in a foreign currency or receive income in one will also do this but less frequently and will almost always do this through a nominated bank (in the case of large firms).

Why would they do that?

Because they need the foreign currency immediately; if you've ever tried to pay a bill in the US denominated in Dollars using Euros you'll know that they aren't widely accepted. So if I need to pay a large bill to a supplier in Dollars and all I have is Euros I may move the market. Similarly if I am trying to buy a large number of shares in a US company and all I have is Euros I'll lose the opportunity.

Answer 3

Forex is really not that volatile compared to other major asset classes like stocks and commodities. But still markets are generally unencumbered in the major pairs and therefore spikes in volatility can happen. Take what happened with the Swiss Franc a few years ago for example, or GBPUSD recently with news of Brexit. This is less the case with highly regulated currencies like the Chinese Yuan (CNY)

Volatility is caused by excessive buy or sell pressure in relation to the available liquidity at the current price. This is usually caused by large buy or sell orders placed with interbank desks by institutions (often including other banks) and central banks. News can also sometimes have a dramatic impact and cause traders to adjust their prices significantly and very quickly.