Surreal illustration of currency symbols swirling around a speculator.

Decoding the Forex Market: How Speculators Impact Currency Predictability

Nico Varela in Business & Economy June 2025 • 4 min read.

"A deep dive into how speculator activity influences the predictability of FX returns and what it means for market efficiency."

The foreign exchange (FX) market is a vast and complex arena where currencies from around the globe are traded. Understanding the dynamics of this market is crucial for investors, policymakers, and businesses alike. One of the key aspects of the FX market is the role of speculators, who aim to profit from short-term price movements. Their activity can significantly influence how information is disseminated and how predictable currency returns become.

The gradual information diffusion hypothesis (GIDH) suggests that information doesn't immediately reach all investors and asset markets. This slow diffusion creates opportunities for return predictability. In simpler terms, if information spreads slowly, some traders can take advantage of early insights before the market fully adjusts. This paper delves into how speculators affect this process in the FX market.

This analysis will explore the role of speculator activity in cross-asset return predictability within FX markets. It examines how the presence of speculators impacts the flow of information between equity, commodity, and FX markets, ultimately affecting the predictability of FX strategies.

The Role of Speculators in FX Market Predictability

Surreal illustration of currency symbols swirling around a speculator.

The research builds on the idea that speculators play a vital role in enhancing informational efficiency. When speculators are active, they accelerate the speed at which information is incorporated into market prices. This increased efficiency, in turn, reduces the predictability of returns. The study hypothesizes that when speculators are highly engaged in the FX market, the predictability between equity and commodity markets and FX strategies weakens.

To investigate this hypothesis, the study uses econometric models to analyze historical data. The researchers examined the impact of speculator activity on the predictability of FX returns based on indicators from equity and commodity markets. Specifically, they looked at how the S&P 500 index (representing the equity market) and the CRB Spot Commodity Index (representing the commodity market) predict FX strategy returns under varying levels of speculator activity.

Key findings from the research include:

When speculators are active in the FX market, predictability from the equity market diminishes.
Similarly, predictability from the commodity market also decreases when speculators are active.
The activity of speculators increases the speed of information diffusion in the FX market.
These findings suggest that speculators play a crucial role in making the FX market more informationally efficient.

The study uses the Commitment of Traders (CoT) report data to measure speculator activity. This report, published by the U.S. Commodity Futures Trading Commission (CFTC), provides insights into the positions held by different types of traders in the futures market. The researchers focus on the positions of non-commercial traders, who are considered to be speculators. By tracking their net open positions in currency futures, the study gauges the level of speculative activity in the FX market.

Implications and Conclusion

This research provides valuable insights into the role of speculators in the FX market. By accelerating the diffusion of information, speculators contribute to market efficiency and reduce opportunities for predictable returns. This has significant implications for traders and investors, as it suggests that strategies based on lagging indicators from other asset classes may be less effective when speculative activity is high. Ultimately, understanding the dynamics of speculator behavior can lead to more informed decision-making in the complex world of foreign exchange.

About this Article -

This article was crafted using a human-AI hybrid and collaborative approach. AI assisted our team with initial drafting, research insights, identifying key questions, and image generation. Our human editors guided topic selection, defined the angle, structured the content, ensured factual accuracy and relevance, refined the tone, and conducted thorough editing to deliver helpful, high-quality information.See our About page for more information.

This article is based on research published under:

DOI-LINK: 10.2139/ssrn.3222067, Alternate LINK

Title: Speculator Activity And Cross-Asset Predictability Of Fx Returns

Journal: SSRN Electronic Journal

Publisher: Elsevier BV

Authors: Anton Hasselgren, Jarkko Peltomäki, Michael Graham

Published: 2018-01-01

Everything You Need To Know

How do speculators influence predictability in the FX market, and what does this mean for trading strategies?

Speculators in the FX market aim to profit from short-term price movements. They play a vital role in enhancing informational efficiency. When speculators are active, they accelerate the speed at which information is incorporated into market prices, reducing the predictability of returns. This means strategies based on lagging indicators from other asset classes, such as equity or commodities, may be less effective when speculative activity is high.

What is the gradual information diffusion hypothesis (GIDH), and how do speculators affect it within the FX market?

The gradual information diffusion hypothesis (GIDH) suggests that information does not immediately reach all investors and asset markets. This slow diffusion creates opportunities for return predictability. Speculators counteract GIDH by accelerating the dissemination of information, thereby reducing the time available for traders to exploit informational advantages. The increased activity of speculators diminishes the opportunities to profit from slowly spreading information.

According to the study, how does speculator activity impact the predictability of FX returns based on equity and commodity markets?

The research indicates that when speculators are active in the FX market, predictability from the equity market, represented by the S&P 500 index, diminishes. Similarly, predictability from the commodity market, represented by the CRB Spot Commodity Index, also decreases when speculators are active. This suggests that speculators play a crucial role in making the FX market more informationally efficient by swiftly incorporating information from these markets into FX prices.

How is speculator activity measured in the study, and what data source is utilized for this purpose?

The study uses the Commitment of Traders (CoT) report data, published by the U.S. Commodity Futures Trading Commission (CFTC), to measure speculator activity. Researchers focus on the positions of non-commercial traders, who are considered to be speculators. By tracking their net open positions in currency futures, the study gauges the level of speculative activity in the FX market.

What are the broader implications of the research findings on speculator behavior, and what further research could build upon these insights?

By accelerating the diffusion of information, speculators contribute to market efficiency and reduce opportunities for predictable returns. The research enhances our understanding of market dynamics, suggesting that strategies based on inter-market relationships may be less reliable during periods of high speculative activity. Further research could explore how specific trading strategies perform under varying levels of speculator activity, providing more granular insights for market participants and potentially informing regulatory decisions to maintain market stability and fairness.