03 May 2011

Forex and Equity Market Process

Can one examine the market and gain insight into whether the market is moving because of company growth or money flow. In a well functioning market what would one expect to predominate. What happens if it is only company growth.

That is the equity market is entirely composed of advocates of Graham financial analysis, finding well engineered companies to grow, in a growing economy.

This would mean very stable valuations of USD, or would it. I think it might be the reverse. For a day trading environment, the random input of money flow is highly necessary to bring stability.

I suspect as well that companies would not grow in such an environment and a kind of least quality would prevail. In fact if QE2 is well founded, it may be laying the groundwork for high quality companies, already existing, growing to fruition.

That is the sea of forex is a way to optimize, it is highly adaptive, in the way static statements are not. Companies do try and adapt to their environment, but it is a very coarse grained process.

In fact successful companies tend to adapt their environment to them. The markets may play a role in this process. So forex is about a process in the economy to successfully adapt ? This is an idea of markets as meta-processes.

Generally the economy is taken note of, but this does not seem to work as a causal analytical tool. It does not tell you what individual companies share prices will do and it does not usually help you with the movement of a currency pair. However it most certainly does exist.

So what is it doing. Well, if the markets are causally inputting into it, by looking for the effect in the markets, one is looking at the effect and assuming it is the cause. The question is to what extent, as it is sensible to expect that the assumed causality has particular explanatory weight.

So what is market causality. That is the question which confronts one if one does exactly what a trader or short term investor does and trades in the market for profit, that is to ride directionality.

I have suggested that the mind may be able to follow in some sense the underlying causality, but actually capturing this in models or describing it is extremely hard and trading with your intuition is extremely risky.

It was my observation from the crisis that causality is an input of functionality into markets from other markets, which is of a different kind of action than from the effect of external events.

That is there is a greater coherence of action from cross market infusions than from external economic events. This might not be entirely unsurprising as affecting the function of structure with structure needs some symmetry.

The assumption here is there is less structural symmetry between linear events such as interest rate changes and changes in the equity market, referenced to the forex market.

That is the interesting proposition that interest rate changes do not work well, without structural symmetry, which one might conjecture semi-stabilized differentials over time may have provided, except they collapsed at the end.

The collapse may have been related to the growth of the forex market and the lack of symmetry between forex and equities, in fact this is another way of looking at asset re-valuation to true valuations, the assumption that forex and equities need to be in congruence for accurate valuations.

The fact that the forex market continued to function, albeit with volume drops, may suggest that this market achieved a functional move towards greater importance in the markets as a whole.

Essentially for the market to function to grow equity, functionality has to be hidden, because the market works in a competitive manner. Its functionality is partly to hide process.

One might conjecture that it is harder to note the effects of growth versus money flow in forex than in equities, long term, and hence it is very hard to trade long term in forex. It is perhaps though easier to note the effects of growth in short term trades in forex than in equities.

Why, well because process is less hidden in forex day trading than in equities. Because forex is the process of valuation in a fine grained manner. Because this has much less linear directionality than equities, or forced directionality than equities (which the market rejects), potentially one can process trade.

But as well one exposes oneself to great risks, and the outcome of linear trading, a zero sum game (because process is not linear here, and the market does not even try to force it to be).

© 2011 Guy Barry - All Rights Reserved.