The Forex Three-Session System

Measuring Market Activity

Now that we know when the Asian, European and North American sessions are and what markets comprise each, we should discuss how time and participation affect price action for different currencies.

As logic would suggest, a currency is typically most active when its own markets are open. For example, the euro, British pound and Swiss franc see higher volatility on average when the European session is active. This is the case because banks, businesses and traders from any specific country will use their domestic currency in the majority of their foreign exchange transactions. What's more, it is more difficult for a market participant to buy or sell a currency from a region where all the major banks are closed. To illustrate, if a U.S. bank wants to make a multibillion dollar currency exchange for euros, it would likely do so when European banks are online and there is a greater pool of liquidity. Otherwise, large orders in a thin market would result in prices moving away from the ideal entry point as the order is processed.

The above example further highlights another truism for the currency markets: price action is usually greatest when the sessions overlap. When traders, banks and business from two different sessions are online, there are more participants in the market and, therefore, a greater level of liquidity is available. Figure 3 below charts the average hourly range for the seven majors in the two years through 2007. A quick glance at this graph reveals what we would expect - two notable peaks in price action. The first rise in price action occurs around the closing hours of the Asian session and open of the European session (around 7am GMT). Before this peak, the markets in the Far East are carrying currency volatility alone. After the Japanese session closes, there is a clear drop in the ranges for most of the majors as Asian liquidity quickly evaporates and leaves traders in Europe to keep the fires of volatility stoked.

The second and larger jump in activity is seen when the North American and European sessions converge (between noon and 4pm GMT). This four-hour overlap is far greater than the Asian/European sessions' own union, and volatility clearly benefits from the greater period of liquidity. However, from this period we can see there is another factor at work in driving price action - otherwise there would not be a consistent dip across the majors at 1pm GMT. This particular influence is the presence of fundamental releases. Most of the top market moving indicators for the U.S. cross the wires at either noon or 2pm GMT and thereby boost the average range for those times. And, while the influence of the U.S. data is the clearest example here, fundamentals from other key markets certainly influence price action as well. Another obvious instance of this dynamic is the typical release time for U.K. data (around 8am GMT), which coincides with a sharp peak in GBP/USD activity that goes beyond the Asian/European session overlap and cooling of the other major pairs.

Figure 3: Currency market volatility

Copyright Ó 2008

Another aspect to take into consideration is that while broad market activity typically follows the same trend as seen across the majors (a peak in volatility during the two session overlaps), each pair is unique depending on its two component currencies and which underlying sessions they belong to. For example, when a pair is made up of two currencies from the same session (let's say USD/CAD), there will likely be a relatively greater level of volatility during that session (the U.S. session) while price action is subsequently more muted during the market's other high points (the Asian/European session overlap).

In contrast, if the pair is a cross made of currencies that are most actively traded during Asian and European hours (like EUR/JPY and GBP/JPY), there will be a greater response to the Asian/European session overlaps and a less dramatic increase in price action during the European/U.S. sessions' concurrence. Of course, the presence of scheduled event risk for each currency will still have a substantial influence on activity regardless of the pair or its components' respective sessions.

Figure 4: A greater response to Asian/European session overlaps is shown in pairs that are actively traded during Asian and European hours.

Copyright Ó 2008

How To Weave This Into a Trading Strategy
There are few things more important to successful trading than market activity. Even the best strategy could fall apart if it is applied during the wrong session. For long-term or fundamental traders, trying to establish a position during a pair's most active hours could lead to a poor entry price, a missed entry or a trade that counters the strategy's rules. On the other hand, for short-term traders who do not hold a position over night, volatility is vital.