Global Trading Blog

Do businesses exchange currencies in predictable ways that forex traders can exploit? This post explores an intraday EUR.USD strategy based on the hypothesis that businesses cause currencies to depreciate during local business hours and appreciate during foreign business hours.

Business patterns in foreign exchange

Source paper: Breedon, Francis and Ranaldo, Angelo, Intraday Patterns in FX Returns and Order Flow (April 3, 2012). Queen Mary, University of London, School of Economics and Finance WP 694. Available at SSRN: https://ssrn.com/abstract=2099321

Academic research shows that currencies tend to depreciate during local business hours and appreciate during foreign business hours. Researchers postulate that businesses are net buyers of foreign currencies, and since businesses are primarily active during their local business hours, they cause foreign currencies to rise against the local currency. Later, when foreign businesses are open, the process is reversed.

Example 1: European importer of US goods

You are a European company that imports goods from the US and sells them in Europe. Your predominantly European customers pay you in euros, while your US suppliers invoice you in US dollars. Therefore you must regularly exchange EUR for USD. This creates downward pressure on the euro during European business hours, the time of day when you are most likely to convert your currency.

Example 2: US-based international investment fund

You are a US-based investment fund that buys international stocks including European ones. When new customers give you their US dollars to invest, you must exchange them for euros in order to buy more European stocks for your fund. This creates upward pressure on the euro during US business hours, the time of day when you transact.

EUR.USD returns by time of day

Using hourly data for EUR.USD from 2005 to the present from Interactive Brokers, I calculate EUR.USD's mean return by hour of day in order to compare the return during European vs US business hours.

On average, the euro depreciates against the US dollar during the European business day (3 AM to 11 AM New York time), then appreciates against the dollar through the close of the US business day.

The source paper provides a similar figure for the period 1997-2007. Thus, the time-of-day pattern observed by the researchers has persisted in later years.

EUR.USD trading strategy

Next, I create a trading strategy that sells EUR.USD from 3 AM to 11 AM New York time (9 AM to 5 PM Europe time), then buys EUR.USD from 11 AM to 4 PM New York time. The key section of Pandas code looks like this:

closes = prices.loc["Close"]

# Get a DataFrame of times
times = closes.index.get_level_values("Time")
times = closes.apply(lambda x: times)

# Sell EUR.USD when Europe is open
sell_eur = (times >= "03:00:00") & (times < "11:00:00")

# Buy EUR.USD when Europe is closed and US is open
buy_eur = (times >= "11:00:00") & (times < "16:00:00")

Transaction cost analysis

To accurately model transaction costs, I collect 1-month of EUR.USD bid/ask data from Interactive Brokers aggregated to 1 minute bars. I calculate the average EUR.USD spread to be 0.15 basis points (0.1-0.2 pips) at the times of day this strategy trades. Expecting to pay half the spread, I model slippage at 0.1 basis points per trade. I also incorporate IB's forex commission rate into the backtest, which is 0.2 basis points.

Backtest performance

The strategy's compound annual growth rate is 6.2% with a Sharpe ratio of 0.70. The gross and net cumulative returns as well as commissions and slippage are shown below:

The next plot shows the strategy's returns against the benchmark returns of EUR.USD. EUR.USD itself meanders sideways, reflecting that the time-of-day effects produced by the European and US business day cycles offset one another.

Finally, a plot of the strategy's performance by year suggests that the business day effect has not substantially diminished or disappeared over time:

Conclusion

The forex market is the largest market in the world, and it is dominated not by speculative traders but by market participants exchanging currencies for reasons other than speculation. The behavior of businesses located in different time zones creates predictable upward and downward pressure on currency pairs over the course of the day.

EUR.USD is an attractive currency pair for exploiting this time-of-day pattern because it has the tightest spreads of any pair. Additionally, EUR.USD's massive liquidity reduces the likelihood that competing traders will degrade the strategy's performance.

Explore this research on your own

This research was created with QuantRocket. Clone the fx-bizday repository to get the code and perform your own analysis.

quantrocket codeload clone 'fx-bizday'

QuantRocket LLC is not a financial advisor and nothing on this website or in any materials created by QuantRocket LLC should be construed as investment advice. All results are hypothetical unless otherwise noted. Past performance is not indicative of future results.

The material on this website and any other materials created by QuantRocket LLC is provided for informational purposes only and does not constitute an offer to sell, a solicitation to buy, or a recommendation or endorsement for any security or strategy, nor does it constitute an offer to provide investment advisory services by QuantRocket LLC.

In addition, the material offers no opinion with respect to the suitability of any security or specific investment. No information contained herein should be regarded as a suggestion to engage in or refrain from any investment-related course of action. Neither QuantRocket LLC nor any of its affiliates is undertaking to provide investment advice, act as an adviser to any plan or entity subject to the Employee Retirement Income Security Act of 1974, as amended, individual retirement account or individual retirement annuity, or give advice in a fiduciary capacity with respect to the materials presented herein. If you are an individual retirement or other investor, contact your financial advisor or other fiduciary unrelated to QuantRocket LLC about whether any given investment idea, strategy, product or service described herein may be appropriate for your circumstances. All investments involve risk, including loss of principal. QuantRocket LLC makes no guarantees as to the accuracy or completeness of the views expressed in the website. The views are subject to change, and may have become unreliable for various reasons, including changes in market conditions or economic circumstances. Past performance is not indicative of future results.