17 May 2011

Value Pricing in Forex and Stocks

The point of a typical auction market, is that lack of knowledge makes it a market in essence out of control of the buyer, but such a market easily collapses down to one where a buyer is in control, if they do not worry about costs.

Financial Markets though do not, in fact they resist this strongly. That resistance seems to come from internal processes in the market. That is, the market most certainly does seem to take control of prices.

In fact those who buy and sell, typically market makers, once the market is made, it is out of their control. But they adjust the market dynamically.

It is why it is out of their control that makes disciplines such as technical analysis, fundamental analysis and so on. What I am interested in is the time the market takes the instrument out of the market maker, the moment the market is made.

My feeling is that this moment is highly important from a computational viewpoint, because it reflects precise valuation. An example of this which can be seen by all participants is the valuation which occurs at the moment of a news event.

That seems to me to have a significance for where the prices will return. A news event is an aggregation of market making and it is as well an example of non-technical trading.

That is, the participants are making a short term investment, having valued the asset. It is no more a gamble than an equity investment. This is perhaps why the initial direction may have some accuracy, because the forex market is at least highly connected with a market based on valuations, namely the equity market. It suggests efforts to value in forex may not be without reward.

That computational viewpoint is a way of looking at what makes the market. The market comes back to the market makers in the form of order flow, for example pricing behavior at '00'. They continually adjust pricing. But what are their criteria ?

This is generally seen as antagonism, that is large banks with a view of the order book running stops for example or simply the fact that take profits and stop loss orders are placed at these levels, as should be well know. But what is that.

It is actually logically restructuring the market. Placing stop loss and take profit orders at '00' has no internal market logic to it (or external economic logic).

The market makers price at levels highly interactive with the processes of the market itself, they have to and from a professional viewpoint they do even if they are valuing assets in terms of their own returns.

This is especially true in forex, where competition keeps pricing to pinpoint accuracy. But there is a structuring of optimization as well. However market maker pricing and re-pricing is exactly that, but is it a discrete process of optimization or is there a global optimization as well.

I suggest in effect in my blog posts that there is, in the sense there are growth processes in the Dow which work irrespective of any inputs. That market becomes fragile though if it is deluged by money flow (the crisis and post crisis). By this I mean orders made not on any inherent value of an instrument, but because circumstances dictate this.

In equities the smart money is usually seen as the money taking positions before the security becomes saturated with orders, pushing it up until the sell orders, perhaps placed by those who made the smart moves, revalue it.

This is true in forex, but the issue is the smartness is not exactly made on valuations of currency pairs, it is mostly made on technical signals, with the exception of those situations detailed above and other circumstances, such as highly fundamentalist approaches.

The issue with those is that the market turns of fundamental valuations (I mean this in both sense of the phrase), but that may be because of the complexity of valuations affecting it.

One can make it on fundamentals, but that is like skating on the thinnest of ice. In effect fundamentals become like new inputs, something to watch for, rather then something that might give one directionality.

That is all orders are in effect like large cascading orders, unless one believes technical signals are accurate. If they were, then the market would cease to exist as a market.

But the forex market does not, it just eats up any cascading money flow, in fact it came into its own during the crisis and has certainly not been damaged by the post-crisis. But the equity market arguably has, the behavior of it since the crisis is not conducive to investing.

In fact for forex a cascading equity market is content. But it may not be tradable content. So what is it. Can one say that a forex market flooded by money flow does not function. It may not globally optimize.

The effects of that are relative effects between countries in terms of their currency valuations. But that is a huge effect which feeds back to the currency markets and the equity markets. It is perhaps more instability than anything else.

It is that stability that was perhaps sought before the crisis, but finding it, does not seem effective via interventions and similar macro economic controls.

I am suggesting that it may be an emergent property of forex, despite the pricing content given it, in the sense that an emergent property of the Dow's growth processes are companies growing to their potential in their balance sheet.

This is a very good stable form of economic growth, the foundation of enormous wealth and diffused wealth throughout the economy and world especially when it happens in the United States.

If you can increase precision in the way the market values companies, it is less likely that a crisis will occur again.

That is, company growth is stable, but it has valuation issues. Cascading orders can push prices to levels out of sync with asset values. This can happen with companies, sets of companies and the market itself.

Normally this is part of the ebb and flow of markets as retracements bring equity and asset valuations back into line but this can lead to asset pricing being destabilized. That is arguably a depression. If asset pricing is itself mis-priced, a crisis can result (destabilized, mis-priced critical asset sets).

What about forex retracements. Well, forex is an inherently detabilized mis-priced asset market. That is one way of looking at why it functioned well in the crisis. But that itself is the source of its stability as a pricing mechanism. It is optimized precisely to function thus.

If the future of securities is mis-priced assets then at least forex, as least forex is there to catch it. But if the future of securities is creative moats, then forex may be a source of pricing these hard to value companies, from within the market itself.

That would possibly make securities trading like trading forex, except that it would be grounded in growth processes. But it is hard to value companies with creative moats. Would it be easier to ?

That is the question of how much is it possible to make forex a market biased towards profit rather than loss, as a trader. That is, viewing trading itself more like investing.

© 2011 Guy Barry - All Rights Reserved.