RRR,
This is an excellent question that I had to think long and hard about before answering.
First off, I would suggest reading the post on the ‘Structure of Forex Brokers’ by Darkstar on the Forex Factory forum.
Much of what I have to say is based on the excellent insight provided by him.
In order to answer your question, I think it worth taking a step back and examining how the FX market works.
The primary role that the banks play is one of facilitating the actual exchange of currencies around the world(eg business, Expats in Dubai sending money home to support family, etc). The banks make money out of charging you a markup on the spread and commission…but they have found that they can make extra profit by holding on to your transfer for a day or two(ever wondered why it takes 2 days to do a transfer when we can perform medical operations via broadband from halfway across the planet). Unfortunately, an undesirable by-product of holding onto your funds is that liquidity is affected and that is where the retail FX trader was born. Whats better than getting the noobs to come play in your deep end of the pool and they provide you with liquidity at the same time.
The bank uploads its FX deals into one big computer system known as the ECB(also referred to as Interbank), and this data is distributed to all banks in the network…think of this as a really big version of BidorBuy. Here any of the other banks can immediately see what price they can get for their dollars/yen/gbp, etc…it goes without saying that they will always try and get the best price, just like an auction.
Think of this ECB as a big electrical power grid(FX grid)…each bank is either going to supply liquidity to the grid(pending orders) or they are going take liquidity from the grid(market orders). Obviously, the more banks that are actively using the grid, the better the liquidity(think volume = spreads & execution). Unfortunately banks only work the grid when they are open…ie office hours.
You should also note that you can only access the ECB through a bank…your broker will sign up with one or more of these banks as liquidity providers. Amongst other things, one of the things that will determine how good your broker is will be which banks he gets signed up…and what kind of deal he can negotiate with them. Next time you complain about your broker, remember that he is at the mercy of his liquidity providers.
Any 1 bank can power the whole grid just like 1 generator can power a whole city…the grid is powered but the flow is weak. The more units that are plugged in, the better the flow. When the grid is powered, I can trade on the grid via my own bank, even though they are not open and they are not an active participant. You could argue that they are providing liquidity to the market via my participation but the fact is the speculative retail traders are miniscule in the big picture.
With the above in mind, lets look at what happens when Monday morning breaks in New Zealand(Sunday evening in the USA). The Bank of Wellington(or whatever) plugs into the grid and effectively switches it on. There are only a handful of New Zealand banks active and volume is low with big spreads. As the sun moves west and more banks open for normal business, the situation improves with peak volume being sometime after New York opens as this is when most of the banks are open, given the office hours overlap of Europe and Eastern USA.
As the sun hits New Zealand and Tokyo again on Tuesday morning, the banks in that part of the world wake up and can start actively providing liquidity…however, the Europe and USA banks are now closed or closing. Once again volume starts to drop off and we hit the Asian session. Contrary to popular belief, widened spreads during this period are not caused by FAPTurbo but it is a natural consequence of low volumes.
rhodytrader made an interesting point about the overlap in the asian session with the time differences…I wasn’t aware of this.
You asked about FX trading and its relationship to the NYSE…when they talk about New York opening, this is simply more co-incidental to the relationship of banking hours and the various stock exchange trading hours, rather than the forex trading taking place on any of these markets. There are some derivative products that are traded on the exchanges, but the forex market is a bank product.
Another interesting point is that many of the exotic currencies are not available 24/5.5 Some of these currencies might only be traded by a handful of banks in one market(eg London). This means that when London is closed, you cannot trade that currency pair anymore until the next day. Anyway, I digress…
When the weekend comes up and the last bank in the USA closes, they effectively switch off the grid…no banks are open, so there is no-one to power the grid.
I understand that there are one or two brokers that offer trading over a week-end, but that can only be in-house as I am sure they cannot be doing it on the Interbank system. They charge massive spreads to cover themselves for any Sunday night price gaps. I don’t know why anyone would trade with these spreads in a market that is hardly going to move but each to their own.
I hope that I have not sprouted too much nonsense here as I have simply tried to put this as I understand it. Feel free to correct any errors or misconceptions I may have.