Forex Investment and Currency Trading

Swimming in deep liquidity

Liquidity in EUR/USD is unmatched by other major currency pairs. This is most evident in the narrower trading spreads regularly available in EUR/USD. Normal market spreads are typically around 2 to 3 pips versus 3 to 5 pips in other major currency pairs.

In terms of concrete numbers, EUR/USD accounted for 28 percent of global daily trading volume, according to the 2004 Bank for International Settlements (BIS) survey of the foreign exchange markets. That’s more than one and a half times the volume of the net most liquid currency pair (USD/JPY).

Liquidity in EUR/USD is based on a variety of fundamental sources, such as

• Global trade and asset allocation: The Eurozone constitutes the second largest economic bloc after the United States. Not only does this create tremendous commercial trade flows, but it also makes Eurozone financial markets, and the euro, the destination for massive amounts of international investment flows. In April 2007, overall European stock market valuations surpassed the value of U.S. equity markets for the first time ever.
• Central bank credibility: The ECB has established itself in the eyes of global investors as an effective institution in fighting inflation and maintaining currency stability.
• Enhanced status as a reserve currency: Central banks around the world hold foreign currency reserves to support their own currencies and improve market stability. The euro is increasing in importance as an alternative global reserve currency to the U.S. dollar.

The euro also serves as the primary foil to the U.S. dollar when it comes to speculating on the overall direction of the U.S. dollar in response to U.S. news or economic data. If weak U.S. economic data is reported, traders are typically going to sell the dollar, which begs the question, “Against what?” The euro is the first choice for many, simply because it’s there. T also helps that it’s the most liquid alternative, allowing for easy entry and exit.

This is not to say that EUR/USD only reacts to U.S. economic data or news. On the contrary, Eurozone news and data can move EUR/USD as much as U.S. data moves the pair. But the overall tendency still favors U.S. data and news as the driving force of short-term price movements.

This situation is partly a function of geography and daily trading rhythms, because European data is released about four hour to eight hours before U.S. economic reports are typically issued. On any given day, traders will respond to European news and data and adjust prices accordingly for several hours until U.S. data is released.

Watching the data reports

Country-specific economic reports, such as Dutch retail sales or Italian industrial production, are increasingly disregarded by the forex market in favor of Eurozone aggregate economic data. However, German and French national economic reports can still register with markets as they represent the two largest Eurozone economies. Here is a list of the major European data reports and events to keep an eye on:

• European Central Bank (ECB) interest rate decisions and press conferences after ECB Central Council meetings: This is when the ECB president explains the ECB’s thinking and offers guidance on the future course of interest rates.
• Speeches by ECB officials and individual European finance ministers.
• EU-harmonized Consumer Price Index (CPI), as well as national CPI and Producer Price Index (PPI) reports.
• EU Commission economic sector confidence indicators.
• Consumer and investor sentiment surveys separately issued by three private economic research firms known by their acronyms: Ifo, ZEW and GfK.
• Industrial Production
• Retail sales
• Unemployment rate