When currency pairs constantly vary in price against each other, the resultant effect creates multiple entries and exit points for traders. The gaps or imbalance in the market can be considered as fractional disparity.
Before we explore the concept of fractional disparity in Forex trading, it is important to understand how the Forex market works and who the major influencers are.
As we know, the foreign exchange market stays active for 24 hours, 5 days of the week (from Sunday 17:00 EST till Friday 16:00 EST).
Trading activities evolve within the three main trading sessions.
- Europe session (London),
- Unites States session (New York)
- Asian session (Tokyo)
With these basics in mind, traders of varying skill level and financial capacity trade the FX market in any or all of the trading sessions.
As offers and bids stimulate activities in the market, a few sets of players call the shots through price setting. This is done obviously through massive fund injection into a currency pair or a set of pairs. These players are known as market makers.
The activities of market makers cause fractional disparity in the Forex market.
Market makers are usually institutions like the big banks who set currency prices because of the two-way quote approach to setting prices of currency pairs thereby making a market.
What do market makers do?
- Market markets set bids and offers of a certain currency pair, usually, the major currency pairs. They do this after evaluating if they will profit from the deal.
- They commit to deals within certain constraints or pricing agreement of a currency pair.
- This being said, they commit to accepting the resulting exposure of loss to their book if the trade goes south.
But one way a market marker earns a profit is by taking advantage of a two-way quote. This happens when an upside is spotted at the two ends of the quote. They quickly accept the bid-offer spread and net off their exposure.
How do market makers cause fractional disparity?
For the market to move considerably, there must be an injection of liquidity.
Irrespective of the huge number of traders actively buying and selling in the market, when a heavyweight injects huge sums of money through a Buy or withdraws huge funds from the market through a Sell deal in a currency pair, the market witnesses a surge or crash in prices depending on the action of the market maker.
If market makers want to move every pair, that means they will need a lot of liquidity injection for the pairs to move. The whole essence of this trading approach is to take control by dictating the prices and making a profit.
As a regular trader, if you see yourself in profit during trades, it means that you are trading in line with the market maker, it is not that you are very smart, but you have understood how to follow market makers.
Fractional disparity and how it works
For there to be a movement in one currency pair, a few things must change with other currency pairs.
Let’s examine this fractional disparity chart with these currencies: the euro (EUR), Great Britain pound (GBP), and US dollar (USD).
Let’s examine the direction indicators.
Green Arrow: Currency pair is gaining and trending upwards.
Amber Arrow: Currency pair is consolidating and is neither gaining nor losing.
Red Arrow: Currency pair is losing and trending downwards.
Identify the major pairs and the cross pairs.
Major currency pairs: EUR/USD, GBP/USD.
Cross currency pair: EUR/GBP (A cross pair is a combination of two major pairs that does not involve the US dollar).
Market makers watch out for these market movements and ensure that every trade is profitable to them.
If you decide to trade the EUR/USD which is a major currency pair and the pair stalls with weak or no volatility at all, it means that the activities of market makers favor other currency pairs aside from the EUR/USD at that particular time frame. Possibly, there may be a price action in the cross pairs that were being overlooked.
Let look at these scenarios.
Scenario 1: If the market makers decide to move EUR/USD and GBP/USD upwards, this will cause the cross pair (EUR/GBP) to consolidate.
This means an imminent price action and an opportunity to trade the cross pair are probable. So, if there is a movement in the cross pairs, it, therefore, means that the majors are witnessing certain price movements.
Scenario 2: If EUR/USD is going up and GBP/USD is consolidating, so there is a possibility that the cross pair will be going up and it could signal a good time to buy.
Scenario 3: If EUR/USD is consolidating and GBP/USD is going up, then EUR/GBP will fall signaling a sell position.
If market makers move EUR/USD and GBP/USD upwards today, you can look for a buying opportunity in EUR/GBP tomorrow or if they move EUR/USD and GBP/USD during the London trading session, EUR/GBP could be influenced in the New York trading session.
Scenario 4: If EUR/USD is trending downwards and GBP/USD is consolidating, there is a high chance that the cross pair (EUR/GBP) will go downwards, signaling a good time to sell.
The key point is that currency pairs don’t move at the same time frame or trading session. So, stick to your market analysis and avoid altering it unnecessarily. Analyze your charts the same way you do, mark your levels, set your stop or trailing stops as you do.
Studying currency pairs and their behavior is important so that you understand the correlation between them and what to expect.
It is important to clarify that these scenarios do happen but there could be a break in the correlation of these currency pairs. This means that there could be an unconventional pattern playing out to negate these scenarios.
You must have all these possibilities on your fractional disparity Forex chart so they can help you anticipate trading opportunities even before they appear.
Final thoughts
Since we have ascertained that all currency pairs don’t move at once, with your fractional disparity chart, you can spot opportunities in the major or cross pairs.
Your fractional disparity chart should help you anticipate the direction of the currency pairs in the current trading session and the next.
