Why such strong correlation of pairs? -
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thread: Why such strong correlation of pairs?

  1. #21
    Flotsom:

    I hope you're correct that it is not just a lucky streak.
    The unsettling Archie Karas story brings itself to bear for me here. He started with $50, turned it to $40 million in eight months, and he was back to sleeping in his car again (broke) just 3 weeks afterwards:
    http://pokerworks.com/poker-news/201...hie-karas.html

    (Granted, it is not currency trading.)

  2. #22
    Thanks for stopping the flood Timevalue.

    Why was Trade Weighted Index even mentioned in this thread?
    .

  3. #23
    My question was concerning the mechanisms of why/how other pairs would also move although the buying or selling was taking place at another pair. If there is heavy selling at the EURJPY pair, why would the EURUSD, EURCHF, the USDCHF move with no direct selling in these pairs? And the answer was given to me at the reply regarding the trade weighted index.
    I know that your question was answered, but to move a step further to the mechanisms, it's mostly from Basket Orders.

  4. #24
    Member Fuark's Avatar
    41
    Some things simply stick with me, since I read it, and this thread was among these and was bothering me. From what I have read a lot of the inadequate OP's time was wasted being lead down the garden path, such as usual on forums.

    trade weighted index.... wtf? This answer is crap to the highest level, if my googling has edued me enough on this subject then! If I'm right the trade weighted index is derived from the currency rates. It had been stated, or suggested, that it was another way round and currency rates are derived from this index. So wrong.

    It is like some other'index' on any exchange. It is one value to generalize the great number of values within the exchange to provide a view on the workings. Share prices aren't derived from the sp500 are they? of course not! That's stupid to suggest! That the sp500 is derived from the best 500 performing symbols around the market (or something to that purpose. I'm not particularly familiar with the specifics of this sp index).

    So, forget trade weighted index. That has been a waste of everybody's time.

    So how can you answer your question? You reduce and try it to it's simplest form. Inside my mind this complex problem could be reduced to some simple fanciful scenario...

    envision you own a lot of bowls on a table. Each bowl is one kind of currency. One bowl includes euro's, one has aussie dollars, another has american dollars, another has pounds, another dmarks, etc etc.. You can make it as complicated or as simple as you like by adding or subtracting currencies (but no less than 3 else that the example gets pointless).

    Let us keep it simple. There are 3 bowls. Euros, american dollars, and british pounds. They have an equal quantity of their respective currency in their bowls. You have a stash of euros. You visit the euro bowl and set it all and then take an equal amount of GBP's in the GBP bowl.

    If you stop and take a peek at the bowls you'll understand that all of a sudden there is an imbalance involving all 3 meals. There are more euros than any other currency, less gbp's than any other currency, and also the usd are in the middle of the two. It makes sense that because there are so gbp's accessible that they are now a rarity and if you want to take any gbp's it'll cost you more of the other currencies to be able to shoot any gbp's. Like something which becomes scarce the cost of buying those increases. The rarer something has the more costly it gets. The something that is accessible is the more economical.

    In this case the euro's are aplenty and aren't particularly worth that much, however, the gbp's are infrequent and cost a whole lot greater than the euro's or even usd's.

    Now you decide you're going to spend a portion of your gbp's to buy some usd's. You will get usd's per gbp since gbp's are rarer than the usd's.

    You're able to keep swapping in and out different amounts of money in the bowls.... You take somewhat from one using the currency you have on hand you use this to buy some of the additional currency, and round and round you go. The balance of rarity to plentiful for every currency changes as you alter the equilibrium around together with the continuous exchanging of one currency for another.

    So after this example what does it mean when you make gbp's uncommon by buying them together with euro's like in the very start of this example? It usually means that the cost of gbp's in terms of euro's has increased. Similarly, gbp's' expense in terms of usd's has increased. That the usd's had no part in this market and was sitting on the sideline minding it's own organization, but on account of the reversal of equilibrium between gbp's and euro's that the usd relationship between the 2 currencies has changed.

    There is your significance.

    Now this was a shitty and simplistic illustration. Considerably more realistic is if you took those 3 meals and added a whole lot of additional bowls too containing other currencies... then think about the whole mountain of bowls as being a bank. You have to imagine that there are other banks using stashes of various currencies.

    Eventually, you need to see that every bank won't actually have equivalent quantities of different currencies when compared with all other banks, but the interrelationship between all banks as they go about consolidating one currency for another generates the pure market mechanic of producing a balance point at which there is an agreed and suggested correct price of one currency versus another. If one bank happens to be redeemed something noticeably different to all other banks then somebody somewhere will probably be smart enough to immediately buy or sell the out-of-balance currency from this bank, and then offload it to among the other banks that are all otherwise in agreement with everything the price should be.... This really is arbitrage. Finding a misquote somewhere and benefiting from how this singular mistake stands against the horde of others who all stand in solidarity and arrangement. All swim but maintain a solidarity although much like a school of fish swimming together, and any fish which happens to drift from the total movement of the bunch is picking for predators.

    That the interbank relationship is obviously a great deal more complicated than that, but imagine that is well-enough to paint a picture.

    Hopefully this wasn't all a total load of crap too. When it is I hope somebody comes along and corrects it.

  5. #25
    , thank you for coming back to the thread and trying to answer my question. It is nice to see somebody on the forum attempt to supply an alternative rather than notifying everyone that replies are bollocks without explaining why and coming in, and to highlight other answer's are incorrect. Thank you.

    With more research, I am slowly coming to a clearer understanding in my own head about the almost immediate term correlation between currency quotes on pairs that at first glance are unrelated to one another.

    My question might have seemed overly simplistic to many people, hence the cause of so many simplistic and vague answers which didn't address my issue.

    The trade weighted index isn't the reply to this question, although I'm sure something similar can be used by traders (banks) to ascertain their quotes. My perception is that the vast majority of the huge volume transacted in the Currency Market market is due to traders trading with other traders , back and forth and round in circles in quick succession in order to gauge where each other is in regard to their estimate of real value. In an opaque market like Currency Market, this is one of the ways for each dealer to be in a position to accurately quote in line with the traders and stay competitive and profitable.

    Logic would suggest to me that when a massive transaction happens with one dealer in 1 currency pair, because the other traders are continuously asking for quotes from one another, all of them see the massive shift in the very first traders quoted bid and offer and adapt their own so for that pair. As you quite rightly pointed out, on account of this inter-relationship between all the currencies, a change in value of one currency, will impact the cost of buying and selling each of others with that 1 currency, hence each of the quotes are corrected in quick succession (some more than others based on the importance of it is relationship with the currency). Although this isn't the trade weighted index as explained by the initial reply it's from what I could observe a weighted value. There has to be a measure of each currency is valued and the burden of value given to each currency in comparison to another, in order to assist each dealer in valuing the currencies in response to an excess or deficit in another currency.

    Likewise, with each dealer constantly monitoring each other's quotes across the board, also with informed traders monitoring the authentic value of currencies, any discrepancy between quotes from different dealers will open an arbitrage situation that other traders or particularly fast traders will exploit. This will immediately have the effect of contributing to prices coming back in line across the board.

    I think that it's too simplistic to suggest that it is merely arbitrage which accounts for correlation (I understand that is not what you promised ). 2 seconds later there is a similar but less striking spike in the USDCHF, and if there is a massive spike up at the EURJPY, this can't be from arbitrage trades. For an arbitrage situation to appear, there has to be a discrepancy between quotes from other dealers, and for that to happen, there has to be a quote from some traders as well as an quote from others. It is how traders determine the bids and offers that I am curious about.

    I'm sure with more research I will eventually get to the proper definitive answer, but that is no doubt a very complex situation with many, many variables and contributing variables.

  6. #26
    Junior Member hugominola1's Avatar
    15
    flotsom:

    I expect you're correct that it is not just a lucky streak.
    The unsettling Archie Karas story brings itself to bear for me here. He started with $50, turned it to $40 million in eight months, and he was back to sleeping in his car again (broke) just three weeks later:
    http://pokerworks.com/poker-news/201...hie-karas.html

    (Granted, it is not currency trading.)
    Wow! What an wonderful man. Do not know if I should, but I hold respect for him if the story is true.

  7. #27
    Member Fuark's Avatar
    41
    , thank you for coming back to this thread and attempting to answer my question. It is wonderful to see somebody on the forum make an effort to highlight other answer's are incorrect, and to offer an alternative instead of merely coming in and informing everyone that previous answers are bollocks without describing. Thank you.
    No issue. Think about it my own personal vaion in my regular trollery. Got ta change things to keep it all fresh.

    The trade weighted index is not the reply to the question, although I am sure something similar is used by traders (banks) to determine their quotes. My understanding is that the huge majority of the massive volume transacted in the Currency Market market is because of traders trading with different traders , back and forth and round in circles in quick succession in order to gauge where each other is in regard to their estimate of true worth. In an opaque market like Currency Market, this is one of the only ways for each dealer to truly be in a position to accurately quote in line with...
    honestly, I would encourage you to forget you ever heard the term'trade weighted index'. What I do know is it has nothing to do with what you want to know, although I know about it.

    The trade weighted index is merely a metric to signify where a single currency is in relation to a bunch of others, instead of being compared to a currency. We are used to looking at things just like EUR/USD.... Well consider the trade weighted index to be something such as (EUR,GBP,CHF,JPY,AUD,ABC,XYZ)/USD. The purpose of it is to signify a currency in relation to whom it TRADES with'TRADE weighted index'. It is to gauge the import / export situation for the currency.

    If I am in the US and the US exports to australia, europe, and switzerland, then the US trade weighted index would be a metric representing the value of their US versus every one of those countries. It would be (AUD,EUR,CHF)/USD. By calculating this one value, one is immediately given metric to demonstrate how the economy is in terms of being able to import/export.

    So, again, forget ishii ever mentioned transaction weighted index. You have wasted a lot time on the path that was totally wrong. You can thank ishii for that.

    I think that it is too simplistic to suggest it is merely arbitrage which accounts for significance (I know that is not what you claimed). When there's a massive spike upward at the EURJPY, and 2 seconds later there's a similar but less dramatic spike in the USDCHF, this can't be from arbitrage trades. For an arbitrage situation to appear, there has to be a discrepancy between quotes from other dealers, and for that to occur, there has to be a quote from several traders and an incorrect quote from others. It's how traders determine...
    you have it somewhat backward. Arbitrage is not what generates spikes or misquotes and anything.... Arbitrage is the incentive to NOT be out of line with what's deemed fair or accurate by the masses. It is not what causes price IMBALANCES, it is what keeps everything IN LINE. If you go into a single shop and buy a box of chocolates and then go next door and sell it to them in a greater price, wash, rinse, repeat, you will eventually place one or both companies out of business (the one that you buy from because you bought all their stock and they can't buy it any cheaper anywhere else to regain their losses, and also the one you sell too because they can't sell it any more costly and profit from this stock they're overloaded with).

    Everything you have to understand is this... when somebody wishes to convert a metric buttload of a single currency for another and they call their guide line to Mr Joe Bank, Mr Joe Bank must perform a ring-around to additional banks to find out what they are all quoting and just how much they're willing to shoot indefinitely. Mr Joe Bank understands a fantastic perspective on how he can spread the risk amongst his banks and at what rates. Mr Joe Bank then quotes his customer a worse price for a commission for doing business (pads the spread), takes the currency that the customer is supplying and gives the customer the currency s/he requirements. Currently Mr Joe Bank can offload some or all this currency he simply received by giving portions of it to all those willing different banks, and in return he can regain some or all the currency he simply gave to the customer in a profit.

    In this way the customer hasn't really exchanged with Mr Joe Bank, s/he has actually done the deal with a bunch of banks but only via his connection with Mr Joe Bank. The customer has actually taken the bought currency from the market in large, while dispersing what s/he was supplying to the market at large. The deal was done with Mr Joe Bank, but this transaction was then distributed amongst the market in the large by Mr Joe Bank, and Mr Joe Bank must pocket some commission from you buy quoting you a worse price than the interbank rates were actually at.

    Edit: see link in next post

  8. #28
    , we are on the same page. I am obviously not very good at describing myself. Everything you've said in the above post is pretty much precisely what I have also found and what I had been attempting to articulate. It is the relationship between traders quoting each other that determines the price.

    My reference to arbitrage was a point of saying I didn't believe arbitrage was the main reason for the correlation as many posters in this thread was asserting. I totally realize that arbitrage will make the most of mis-quotes and force prices back into an accurate value. Arbitrage traders punish traders for getting their quotes wrong, but they do not influence the initial price quotes. It was what decided a correct price quote I had been interested in.

    I've been reading Larry Harris and he is going a very long way to describing this connection between traders which influences the prices and correlation. I am simply not skilled enough to place it in to a concise explanation on newspaper, although I am understanding it clearly in my own head.

  9. #29
    Member Fuark's Avatar
    41
    , we are on precisely the same page. I am not so good at explaining myself. Everything you have said in the above post is pretty much precisely what I also have found and what I had been attempting to pronounce. It's the association between traders quoting each other which determines the price.

    My reference arbitrage was a point of stating I did not believe arbitrage was the main reason for the correlation as many posters in this thread was claiming. I completely realize that arbitrage will make the most of mis-quotes and induce prices...
    cool cool.

    Edit: crap all that... just read here: http://www.investopedia.com/articles...#axzz1ezhXypGU

    the bottom-line to your query as to how can a pair get any amount as it is quote comes back to any market where you have some people who are prepared to buy, plus a few prepared to sell. The point at which the are facing each other is the bid/ask. Market orders out of there swallow this and move the line forward and back which will then be filled by new limit orders and whatnot as price gyrates around. In this case the order book just happens to be split to separate books amongst the banks.

    I know it is not really that easy and there are different things occurring every minute, but that's the easy way to look at it.

  10. #30
    Member Fuark's Avatar
    41
    No longer edits.

    Further for this... did some light reading to refresh the memory. It appears you're right about the visitors being from inside the market itself since they risk their own funds to make further profits. Market manufacturers trying to reap the spread in addition to prop moves yadda yadda yadda blended in with some real customers that are outside needing to get in to the action.

    So if it turns into the event of who is quoting what and who is getting bumped into being long or short a currency taking on risk they would otherwise prefer to be flat on just earning spread costs.

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