An investigation of customer order flow in the foreign exchange market

This paper examines the effect that heterogeneous customer orders flows have on exchange rates by using a new propreitary dataset of weekly net order flow segmented by customer type across nine of the most liquid currency pairs. We make three contributions. First, we investigate the extent to which order flow can help to explain exchange rate movements over and above the influence of macroeconomic variables. Second, we look at the usefulness of order flow in forecasting exchange rate movements at longer horizons than those generally considered in the microstructure literature. Finally we address the question of whether the out-of-sample exchange rate forecasts generated by order flows can be employed profitably in the foreign exchange markets.

[1]  Mark P. Taylor,et al.  The Obstinate Passion of Foreign Exchange Professionals: Technical Analysis , 2007 .

[2]  F. Diebold,et al.  Comparing Predictive Accuracy , 1994, Business Cycles.

[3]  Andrew N. Carpenter,et al.  Sources of Private Information in FX Trading , 2003 .

[4]  Martin D. D. Evans,et al.  Order Flow and Exchange Rate Dynamics , 1999, Journal of Political Economy.

[5]  Daniel Friedman,et al.  Partial Revelation of Information in Experimental Asset Markets , 1991 .

[6]  Yin-Wong Cheung,et al.  Empirical Exchange Rate Models of the Nineties: Are Any Fit to Survive? , 2002 .

[7]  Kenneth S. Rogoff,et al.  Exchange rate models of the seventies. Do they fit out of sample , 1983 .

[8]  Mark P. Taylor,et al.  Charts, Noise and Fundamentals in the London Foreign Exchange Market , 1990 .

[9]  Richard K. Lyons,et al.  Profits and Position Control: A Week of FX Dealing , 1998 .

[10]  Jack L. Treynor,et al.  MUTUAL FUND PERFORMANCE* , 2007 .

[11]  Dagfinn Rime,et al.  Exchange Rate Forecasting, Order Flow and Macroeconomic Information , 2009 .

[12]  A. Kyle.  Continuous Auctions and Insider Trading , 1985 .

[13]  T. Bollerslev,et al.  Deutsche Mark–Dollar Volatility: Intraday Activity Patterns, Macroeconomic Announcements, and Longer Run Dependencies , 1998 .

[14]  Jonathan H. Wright,et al.  Order Flow and Exchange Rate Dynamics in Electronic Brokerage System Data , 2005 .

[15]  Bettina Peiers,et al.  Informed Traders, Intervention and Price Leadership: A Deeper View of the Microstructure of the Foreign Exchange Market , 1997 .

[16]  Mark P. Taylor,et al.  Commercially Available Order Flow Data and Exchange Rate Movements: "Caveat Emptor" , 2008 .

[17]  R. Lyons.  Foreign exchange: macro puzzles, micro tools , 2001 .

[18]  R. Lyons,et al.  Tests of Microstructural Hypotheses in the Foreign Exchange Market , 1993 .

[19]  Mark P. Taylor,et al.  The Obstinate Passion of Foreign Exchange Professionals : , 2006 .

[20]  Richard K. Lyons,et al.  A simultaneous trade model of the foreign exchange hot potato , 1997 .

[21]  Ekkehart Boehmer,et al.  Order Flow and Prices , 2008 .

[22]  Exchange Rate Fundamentals and Order Flow , 2012 .

[23]  S. Sapp.  Price Leadership in the Spot Foreign Exchange Market , 2002 .

[24]  Ronald MacDonald,et al.  On Fundamentals and Exchange Rates: A Casselian Perspective , 1997, Review of Economics and Statistics.

[25]  Menzie David Chinn,et al.  Banking on currency forecasts: How predictable is change in money? , 1995 .

[26]  Dagfinn Rime,et al.  Liquidity provision in the overnight foreign exchange market , 2005 .

[27]  Dagfinn Rime,et al.  Volume and Volatility in the Fx-Market: Does it Matter Who You are? , 2002, SSRN Electronic Journal.

[28]  Nicholas Sarantis,et al.  On the short-term predictability of exchange rates: A BVAR time-varying parameters approach , 2006 .

[29]  Kenneth J. Singleton,et al.  On Unit Roots and the Empirical Modeling of Exchange Rates , 1982 .

[30]  Richard K. Lyons,et al.  The Microstructure Approach to Exchange Rates , 2001 .

[31]  D. Rime,et al.  Dealer Behavior and Trading Systems in Foreign Exchange Markets , 2005 .

[32]  P. Newbold,et al.  Tests for Forecast Encompassing , 1998 .

[33]  A. Shleifer,et al.  Inefficient Markets: An Introduction to Behavioral Finance , 2002 .

[34]  Takatoshi Ito,et al.  Is There Private Information in the FX Market? The Tokyo Experiment , 1997 .

[35]  I. Marsh,et al.  Customer Order Flow and Exchange Rate Movements: Is There Really Information Content? , 2005 .