The Forex Three-Session System

One of the greatest features of the foreign exchange market is that it is open 24 hours a day. This allows investors from around the world to trade during normal business hours, after work or even in the middle of the night. However, not all times are created equal. Although there is always a market for this most liquid of asset classes, there are times when price action is consistently volatile and periods when it is muted. What's more, different currency pairs exhibit varying activity over certain times of the trading day due to the general demographic of those market participants that are online at the time. In this article, we will cover the major trading sessions, explore what kind of market activity can be expected over the different periods and show how this knowledge can be adapted into a trading plan.

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Breaking A 24-Hour Market Into Manageable Trading Sessions
While a 24-hour market offers a considerable advantage for many institutional and individual traders because it guarantees liquidity and the opportunity to trade at any conceivable time, it also has its drawbacks. Although currencies can be traded any time, a trader can only monitor a position for so long. This means that there will be times of missed opportunities, or worse, when a jump in volatility will lead the spot to move against an established position when the trader isn't around. To minimize this risk, a trader needs to be aware of when the market is typically volatile and decide what times are best for his or her strategy and trading style. (For more, see Trade To Your Taste.)

Traditionally, the market is separated into three sessions during which activity peaks: the Asian; European; and North American sessions. More casually, these three periods are also referred to as the Tokyo, London and New York sessions. These names are used interchangeably as the three cities represent the major financial centers for each of the regions. The markets are most active when these three powerhouses are conducting business as most banks and corporations make their day-to-day transactions and there is a greater concentration of speculators online. Now let's take a closer look at each of these sessions. (For more, see how does the foreign-exchange market trade 24 hours a day?)

Asian Session (Tokyo)
When liquidity is restored to the forex (or, FX) market after the weekend passes, the Asian markets are naturally the first to see action. Unofficially, activity from this part of the world is represented by the Tokyo capital markets, which are live from midnight to 6am Greenwich Mean Time. However, there are many other countries with considerable pull that are present during this period including China, Australia, New Zealand and Russia, among others. Considering how scattered these markets are, it stands to reason that the beginning and end of the Asian session are stretched beyond the standard Tokyo hours. Allowing for these different markets' activity, Asian hours are often considered to run between 11pm and 8am GMT.

European Session (London)
Later in the trading day, just before the Asian trading hours come to a close, the European session takes over in keeping the currency market active. This FX time zone is very dense and includes a number of major financial markets that could stand in as the symbolic capital. However, London ultimately takes the honors in defining the parameters for the European session. Official business hours in London run between 7:30am and 3:30pm GMT. Once again though, this trading period is expanded due to other capital markets' presence (including Germany and France) before the official open in the U.K.; while the end of the session is pushed back as volatility holds until the London fix after the close. Therefore, European hours are typically seen as running from 7am to 4pm GMT.

North American Session (New York)
By the time the North American session comes on line, the Asian markets have already been closed for a number of hours, but the day is only half through for European traders. The Western session is dominated by activity in the U.S. with few contributions from Canada, Mexico and a number of countries in South America. As such, it comes as little surprise that activity in New York City marks the high in volatility and participation for the session. Taking into account the early activity in financial futures, commodity trading and the concentration of economic releases the North American hours unofficially begin at noon GMT. With a considerable gap between the close of the U.S. markets and open of the Asian trading, a lull in liquidity sets the close of New York exchange trading at 8pm GMT as the North American session close.

Session Major Market Hours (GMT)
Asian Session Tokyo 11pm to 8am
European Session London 7am to 4pm
North American Session New York noon to 10pm
Figure 1: Major market session hours

Figure 2: Three-market session overlap
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Measuring Market Activity
Now that we know when the Asian, European and North American sessions are and what markets comprise each, we should discuss how time and participation affect price action for different currencies.

As logic would suggest, a currency is typically most active when its own markets are open. For example, the euro, British pound and Swiss franc see higher volatility on average when the European session is active. This is the case because banks, businesses and traders from any specific country will use their domestic currency in the majority of their foreign exchange transactions. What's more, it is more difficult for a market participant to buy or sell a currency from a region where all the major banks are closed. To illustrate, if a U.S. bank wants to make a multibillion dollar currency exchange for euros, it would likely do so when European banks are online and there is a greater pool of liquidity. Otherwise, large orders in a thin market would result in prices moving away from the ideal entry point as the order is processed.

The above example further highlights another truism for the currency markets: price action is usually greatest when the sessions overlap. When traders, banks and business from two different sessions are online, there are more participants in the market and, therefore, a greater level of liquidity is available. Figure 3 below charts the average hourly range for the seven majors in the two years through 2007. A quick glance at this graph reveals what we would expect - two notable peaks in price action. The first rise in price action occurs around the closing hours of the Asian session and open of the European session (around 7am GMT). Before this peak, the markets in the Far East are carrying currency volatility alone. After the Japanese session closes, there is a clear drop in the ranges for most of the majors as Asian liquidity quickly evaporates and leaves traders in Europe to keep the fires of volatility stoked. (For more, see Getting Started In Forex.)

The second and larger jump in activity is seen when the North American and European sessions converge (between noon and 4pm GMT). This four-hour overlap is far greater than the Asian/European sessions' own union, and volatility clearly benefits from the greater period of liquidity. However, from this period we can see there is another factor at work in driving price action - otherwise there would not be a consistent dip across the majors at 1pm GMT. This particular influence is the presence of fundamental releases. Most of the top market moving indicators for the U.S. cross the wires at either noon or 2pm GMT and thereby boost the average range for those times. And, while the influence of the U.S. data is the clearest example here, fundamentals from other key markets certainly influence price action as well. Another obvious instance of this dynamic is the typical release time for U.K. data (around 8am GMT), which coincides with a sharp peak in GBP/USD activity that goes beyond the Asian/European session overlap and cooling of the other major pairs.

Figure 3: Currency market volatility
Copyright Ó 2008 Investopedia.com

Another aspect to take into consideration is that while broad market activity typically follows the same trend as seen across the majors (a peak in volatility during the two session overlaps), each pair is unique depending on its two component currencies and which underlying sessions they belong to. For example, when a pair is made up of two currencies from the same session (let's say USD/CAD), there will likely be a relatively greater level of volatility during that session (the U.S. session) while price action is subsequently more muted during the market's other high points (the Asian/European session overlap).

In contrast, if the pair is a cross made of currencies that are most actively traded during Asian and European hours (like EUR/JPY and GBP/JPY), there will be a greater response to the Asian/European session overlaps and a less dramatic increase in price action during the European/U.S. sessions' concurrence. Of course, the presence of scheduled event risk for each currency will still have a substantial influence on activity regardless of the pair or its components' respective sessions.

Figure 4: A greater response to Asian/European session overlaps is shown in pairs that are actively traded during Asian and European hours.
Copyright Ó 2008 Investopedia.com

How To Weave This Into a Trading Strategy
There are few things more important to successful trading than market activity. Even the best strategy could fall apart if it is applied during the wrong session. For long-term or fundamental traders, trying to establish a position during a pair's most active hours could lead to a poor entry price, a missed entry or a trade that counters the strategy's rules. On the other hand, for short-term traders who do not hold a position over night, volatility is vital. (For more, see The Fundamentals Of Forex Fundamentals.)

When trading currencies, a market participant must first determine whether high or low volatility will work best with their personality and trading style. If more substantial price action is desired, trading the session overlaps or typical economic release times may be the preferable option. The next step would be to decide what times are best to trade given the bias for volatility. Following with a desire for high volatility, a trader will then need to determine what time frames are most active for the pair he or she is looking to trade.

When considering the EUR/USD pair, the European/U.S. session crossover will find the most movement. However, there are usually alternatives, and a trader should balance the need for favorable market conditions with physical well-being. If a market participant from the U.S. prefers to trade the active hours for GBP/JPY, he or she will have to wake up very early in the morning to keep up with the market. If this person has a regular day job, this could lead to exhaustion and errors in judgment when trading. A better alternative for this particular trader may be trading during the European/U.S. session overlap, where volatility is still elevated even though Japanese markets are offline

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