Order Flow and Exchange Rate Dynamics
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What they found
Where macro models failed, order flow succeeded. Using four months of interdealer trading data for the mark-dollar and yen-dollar in 1996, Evans and Lyons showed that signed order flow (buyer-initiated minus seller-initiated trades) explained over 60% of daily exchange rate changes, versus less than 5% for interest rate changes. A billion dollars of net dollar buying moved the mark-dollar rate by about half a percent. They argue order flow is how dispersed private information about fundamentals gets aggregated into prices.
What you can use
- Daily currency moves are mostly explained by who is buying and selling, not by news about fundamentals.
- Order flow is not noise; it is the mechanism by which information reaches prices, so watching flow is watching information arrive.
- Retail FX traders do not see interdealer order flow, which is a structural disadvantage against the banks that do.
Caveats
Four months of data on two currency pairs in 1996; the market structure has since changed dramatically. Explaining contemporaneous moves is not the same as forecasting them.
Tags: forex, order-flow, microstructure, price-discovery
Summaries are our own reading of the paper, not the authors' words. Educational only, not advice. Discuss it in Book Club.