(see blog on influences on FX rates)
Pricing is at heart of FX trading. It’s precisely due to the different pricing decisions of various players that speculation opportunities exist. There are pricing needs in pre/post trade, and pricing timeframes of long term or short term
For mark to market and unrealized PnL, real time market trade/quote prices are probably best, since FX is an extremely liquid and transparent market, except the NDF markets.
That’s post trade pricer. For the rest of this write-up let’s focus on pre-trade pricer of term instruments. Incoming quotes from major electronic markets are an obvious data source, but for less liquid products you need a way to independently derive a fair value, as the market might be overpriced or underpriced.
For a market maker or dealer bank responding to RFQ,
– IRS, bond data from Bloomberg
– yield spread between government bonds of the 2 countries. Prime example – 2-year Bund vs T-note
– Libor, government bond yield. See http://www.investopedia.com/articles/forex/08/forex-concepts.asp#axzz1SzK7LbkS
– Depth of market
– volume of _limit_orders_ and trades (It’s possible to detect trends and patterns)
– dealer’s own inventory of each currency
– cftc COT report. See http://www.investopedia.com/articles/forex/05/COTreport.asp#axzz1SzK7LbkS
– risk reversal data on FXCM. See http://olesiafx.com/Kathy-Lien-Day-Trading-The-Currency-Market/Fundamental-Trading-Strategy-Risk-Reversals.html
For short term trading, interest rate is the most important input to FX forward pricing — There’s a separate blog post. Other significant drivers must be selected and re-selected from the following pool of drivers periodically, since one set of drivers may work for a few days and become *obsolete*, to be replaced by another set of drivers.
– yield spread
– T yields of 3 month, 2 year and 10 year
– Libor and ED futures
– price of oil (usually quoted in USD). Oil up, USD down.
– price of gold
For a buy-and-hold trader interested in multi-hear long term “fair value”, pricers need
– balance of trade?
– inflation forecast?
– GDP forecast?