Some reasons behind price action and its volatility.
There are a multitude of “reasons” behind volatile moves, or “spikes” in the market and the resulting retracements that occur.
As previously mentioned/discussed – ahead of any major economic indicator the “market” will have discounted any possible move based on market estimates. So when data is released there is always a “reaction” based on actual re estimate and any adjustment from the previous release.
However, there are certain events, like we saw on Monday August 24th that are not a result of economic data/FOMC announcements etc. What we saw was a reaction to the dramatic slide in China’s stock market being mirrored on the worlds stock exchanges. This, in turn, saw massive moves in the value of currencies as investors looked to “cover” positions (take profit or loss) or enter new ones (speculate). The forces of supply and demand kick in and we see demand outstripping supply.
To the question of how large banks/market makers move markets…..
All Banks have clients that will leave take profit or stop losses with them. Normally, as the market flows freely, these orders are “triggered” and the client gets “filled” accordingly at or close to the requested “price”. However, Banks will also have much larger limit and stop orders that are, invariably, a distance away from the current market price. In times when there is increased volatility and the markets are moving directionally and spreads are widening with less volume then a Bank trader will look to “mitigate” risk by “covering” the order in the market ahead of the “price” of the order.
A Bank has a buy stop at 1.1275 for €500 MIO. EUR/USD is trading at 1.1225-26 when a significant piece of data hits the market resulting in a dollar sell off. Naturally EUR/USD starts going bid. The market starts to rally 1.1230 bid 1.1240 bid 1.1250 bid. The fear, and expectation, is that the market will continue to rally. Therefore, rather than waiting for the stop to get triggered by the market the Bank with the order will start to buy EUR. Chances are they may get €200 to €300 million in before the market goes 1.1275 bid and the stop is naturally triggered. They then cover the remainder of the order between 1.1275 and 1.1300. The market continues north and hits a high of 1.1350! Hopefully the average purchase price is close to 1.1275 so they can “fill” their client accordingly. Regardless, they will endeavor to fill the client as close to the stop order as possible. Remember that stops can be some of the hardest orders to fill. Clients regularly leave standard limit orders which can be “finessed” by the holder of the order – and in doing so Banks can, occasionally balance their P&L with a deep order book of both stops and limit orders.
If we also take the above scenario – where a large stop needs to be filled there will be times when a large sell limit is in the market. However, many traders still manually enter orders and do so as to not “show their hand” to the market. In such instances a heavy (panic) buying rout can go through levels where a Bank has a large sell order (in this example) by the time they realise their sell order needs to be filled the market has moved 20+ pips higher. Now the seller is desperate to fill his sell order so the trader will start “hitting” the market. These “corrections” or “reversals” happen a lot and are quite visible when they happen.
I am not suggesting that this is the only reason for a reversal/correction but I have seen such first hand. In addition a Bank will also have clients calling them throughout the day placing orders. So a client seeing a significant move may want to sell into it. If the order is in size then that too will cause retracements.