Forex Trading

Managing FX Risk: An Eight-Step Plan to Establish a Corporate Foreign Exchange Policy

2008-01-15T19:47:00.000-08:00

The following is an interesting article from the Wells Fargo Treasury & Risk Magazine. It was written by Dave Napalo, Senior Vice President, Foreign Exchange Division, Wells Fargo.

Following the corporate failures of recent years, the Sarbanes-Oxley Act
(SOX) has set in motion a grounds well of changes in corporate governance and
risk compliance. Corporations have been challenged to respond to the proliferation
of new standards that establish measurements for good risk management practices. The requirement for impeccable financial controls has touched virtually every area of
a company’s business. The reach of SOX has clearly extended to the practice of foreign exchange (FX) risk management, an area already thrust into the spotlight due to the market volatility
that has prevailed for some time. As a consequence, many corporations have
undertaken an assessment of whether their FX risk management practices are appropriate
for their underlying exposures, as well as whether their financial controls pass muster in a SOX environment. As part of that process, a sound formal policy for FX risk management is a major
step towards satisfying the new standards for financial controls. The policy must lay out clear mandates for action and governance with clearly defined responsibilities. To craft a policy, we recommend an eight-step approach:

STEP ONE: DEFINE CORPORATE PHILOSOPHY AND OBJECTIVES

The first step is to establish a framework for the policy. It outlines the principal business
lines and overall corporate objectives and stipulates those areas where the company
is prepared to take risk. For example, a company in the laser technology field might
recognize that risks necessary to remain at the cutting edge of research cannot be
hedged away. Conversely, most companies will identify risks that can be hedged away
– for example, foreign exchange, interest rate and commodity risks that may affect
financial performance. In most cases, companies state their intention to offset their FX
risk since it is not an area in which the company has a competitive advantage.

STEP TWO: IDENTIFY EXPOSURES

The next step involves identification of major exposures – generally, these exposures
are grouped under the headings of transactional, translational and economic
exposures. Transactional exposures wouldrelate to buying or selling in any foreign
currency. Translational exposures would relate to protecting the value of overseas
investments and reported income. Economic exposures might be the most difficult
to capture because they relate to issues that usually arise from foreign competition.
It is also useful to include as an addendum to the policy a glossary of
terms, including acronyms that are unique to a company’s practices and operations.

STEP THREE: QUANTIFY EXPOSURES

This step measures the degree of importance of the exposure. The specific measurement
technique can vary. Some companies may use sophisticated modeling techniques such as value-at-risk to measure exposures. Equally valid approaches are simpler and rely upon measuring recent historical changes of currency relationships and their impact on exposures. Whatever the approach, the objective is to define which exposures are significant. Any hedging activity should be proportional to the exposure.

STEP FOUR: DEFINE RISK MANAGEMENT POLICIES AND PROCEDURES

In this step, specific actions and responsibilities are identified. Those exposures that
present significant risks to the company are identified and designated for hedging. The chain of responsibility for making decisions and executing them is formally established. Ranges of acceptable hedging activity should also be established. For example, a company might elect to hedge no less than 50% but no more than 80% of forecasted foreign sales over a specified
time period. Each exposure must be systematically addressed. This step will necessarily be complex as it represents the heart of any hedging policy. Most companies include in this section an explicit statement that speculative activities should not be undertaken under any circumstances. Speculative activities would include any action that would add to, rather than
reduce, the financial risks of the company.

STEP FIVE: IDENTIFY STRATEGIES TO MANAGE RISK

In this step, derivative strategies to managerisk are explicitly identified. Approved
derivatives will reflect the procedures established in Step Four. In order to provide
additional flexibility, most companies will specify a range of approved derivatives,
including forward contracts, purchased options, and forward-equivalent option-combination strategies. The specific hedging technique selected will depend on the circumstances of each exposure. For example, if certainty of an outcome is the main objective, forwards are likely to be
the required derivative. Alternatively, for competitive reasons, a company may need upside potential from currency movements. In this case, authorizing purchased options and option-combination strategies will provide the desired trade-off of protection against adverse market moves while preserving upside potential from the underlying exposure. It is advisable to provide a broad choice of hedging instruments at the outset since amending the policy later to
include more choices is usually administratively burdensome.

STEP SIX: EXECUTE STRATEGIES

This step governs the actual execution of a derivative instrument for a hedge. The individuals
approved to enter into transactions would be identified. Levels of approval based upon size or nature of transaction would be specified. A counterparty or counterparties, together with credit limits for outstanding positions, would be established. This step also includes implementing
appropriate internal controls, including independent confirmation of trades.

STEP SEVEN: MONITOR EXPOSURES AND HEDGES

Once risk management actions have been taken, the process does not end. Monitoring
must become a standard practice:

• The hedge actions need to be monitored for performance, as FAS 133 requires a company to reflect the mark-to-market results of the derivatives in financial
statements.

• The underlying exposures must be monitored on an on-going basis to insure
that the position does not become over or under hedged.

• Responsibility for the appropriate measurements needs to be defined.

• The chain of responsibility to whom the results are communicated and in what format should be established.

• An escalation procedure should be in place if there is ever any evidence of an erroneous outcome or impropriety.

• Finally, there should be a secure set of controls for measuring the hedging outcome. Any spreadsheet used for measuring purposes should have a secure backupin an audit function. To the extent possible, hard-coded formulas should be used to avoid corruption of internal equations.

STEP EIGHT: REVIEW AND MEASURE PERFORMANCE

Risk management should be a process of continuous improvement. The policy itself
should be viewed as a living document. Within the policy, there should be an explicit commitment to review the policy on an annual basis to confirm that it is meeting its
compliance objectives of risk reduction and enabling the company to reach its financial goals. This process should be documented, reviewed, approved and signed so that the mandated officers can attest to the integrity of the provisions on an on-going basis.

CONCLUSION

The benefits of comprehensive FX risk management should be realized in a more predictable
and stable financial performance. A well-crafted risk management policy is an essential component of this process. Once goals and responsibilities have been made clear, every person in treasury will benefit from the well-defined mandate. The policy will provide a sound foundation for SOX compliance. And ultimately, the shareholders will benefit the most from improved financial controls and performance.

For more information about risk management and hedging, please register with ForexCT today and speak to one of our highly trained Forex Specialists!

Instant credit card deposit

2007-12-19T20:36:00.000-08:00

There are many online brokers or Forex companies out there that offer you "Credit Card Deposit". However, what they don't tell you is that it takes 12hrs or 24hrs to process. This can be a pain, and could potentially cost you thousands of dollars. While you are waiting for your account to be credited with the funds, the market is going crazy and you have missed the train. How do you resolve this problem? The simple answer is ForexCT!

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Weekly Country Focus: Switzerland

2007-12-19T17:07:00.000-08:00

The economy of Switzerland is one of the world's most stable economies. Its policy of long-term monetary security and bank secrecy has made Switzerland a safe haven for investors, creating an economy that is increasingly dependent on a steady tide of foreign investment. Because of the country's small size and high labour specialisation, industry and trade are the keys to Switzerland's economic livelihood.

GDP Ranking (2007)
36th

GDP (2006)
CHF486.2, $371.5 billion

GDP growth rate (2006)
4.9% nominal, 3.2% real

GDP per Capita (Q2 '04 annualised)
$33,800

GDP by sector (2004)
agriculture (1.5%), industry (34.0%), services (64.5%)

Inflation rate (Q1 2006)
1.4%

Pop below poverty line (2005)
3.3%

Labour force (June 2004)
NA million (includes unemployed)

Labour force by occupation (2002)
agriculture (4.6%), industry (26.3%), services (69.1%)

Unemployment rate (2007 est)
2.5%

Main Industries
machinery, chemicals, watches, textiles, precision instruments

Trade
Apart from industry, trade has been the key to prosperity in Switzerland. The country is dependent upon exports to generate income and on imports for raw materials and goods. With the notable exception of a strict policy of agricultural protectionism, Switzerland has liberal trade and investment policies. An expansive commercial and bank law system makes Switzerland one of the most secure investment places in the world. The Swiss franc is one of the world's soundest currencies, and the country is known for its high standard of Swiss banking and financial services.

The machinery, metals, electronics, and chemicals sectors are known for precision and quality. Together, they account for well over half of Switzerland's export revenues. The country is approximately 60% self-sufficient, taking only 7.5% of its imports from the U.S.
Switzerland ranks 18th among the main trading partners of the U.S. worldwide. The Swiss economy earns roughly half of its corporate earnings from the export industry and about 70% of Swiss exports are destined for the EU market.

The United States is the second-largest importer (9.1%) of Swiss goods after Germany (20.0%). Germany, on the other hand, exports more to Switzerland each year than to all the countries of the former Soviet Union and Eastern Europe combined. In addition, the United States is the largest foreign investor in Switzerland, and conversely, the primary destination of Swiss foreign investment. It is estimated that 200,000 American jobs depend on Swiss foreign investments. Total U.S.-Swiss bilateral trade, nevertheless, decreased by 12% to $17.16 billion during 2002 compared to the previous year.

Economic policy

Terrorism
Through the United States-Swiss Joint Economic Commission (JEC), Switzerland has passed strict legislation covering anti-terrorism financing and the prevention of terroristic acts, marked by the implementation of several anti-money laundering procedures and the seizure of al-Qaeda accounts. Continued relationship with the United States through the JEC has brought the Swiss economy into closer proximity with that of the Western world, with mutualistic goals in terrorism prevention providing the impetus.

European Union
With exception of agriculture, economic and trade barriers between the European Union and Switzerland are minimal. In the wake of the Swiss voters' rejection of the European Economic Area Agreement in 1992, the Swiss Government set its sights on negotiating bilateral economic agreements with the EU. Four years of negotiations culminated in Bilaterals, a cross-platform agreement covering seven sectors: research, public procurement, technical barriers to trade, agriculture, civil aviation, land transport, and the free movement of persons. Parliament officially endorsed the Bilaterals in 1999 and it was approved by general referendum in May 2000. The agreements, which were then ratified by the European Parliament and the legislatures of its member states, entered into force on June 1, 2002. The Swiss government has since embarked on a second round of negotiations, called the Bilaterals II, which will further strengthen the two organisations' economic ties.

Switzerland has since brought most of their practices into conformity with European Union policies and norms in order to maximise the country's international competitiveness. While most of the EU policies are not contentious, police and judicial cooperation to international law enforcement and the taxation of savings are controversial, mainly because of possible side effects on bank secrecy.

Swiss and EU finance ministers agreed in June 2003 that Swiss banks would levy a withholding tax on EU citizens' savings income. The tax would increase gradually to 35% by 2011, with 75% of the funds being transferred to the EU. Recent estimates value EU capital inflows to Switzerland to $8.3 billion.

To learn more about Switzerland:

How do I Get Started Trading Currency?

2007-12-19T16:47:00.000-08:00

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Best Business Books for 2007

2007-12-18T15:01:00.000-08:00

Amazon.com has released a list of the best business books for 2007. These books give great insight into the business-world and corporate strategy. They may not necessarily be 'Forex' related but they are still a good read. Being that it is that time of year again, these may be a good Christmas present for someone looking to venture into the corporate world.

Check these books out

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Market Wrap 17/12/07

2007-12-17T20:37:00.000-08:00

Dollar

What happened?
Dollar rallied across the board against all majors as data was much above expectations thus giving a perfect excuse to the market, who have been looking to lock some Dollar short profits ahead of the holidays. Consumer Price Inflation recorded its largest increase in two years while a weak Dollar is providing the much needed impetus to the U.S. manufacturing sector with Industrial Production came in much higher than expected thanks to overseas demand for cheap US goods.

What next?
In this scenario it will be very hard for the Fed to cut rates aggressively thus adding to the woes of the embattled average American home owner struggling to pay its mortgage, Subprime concerns are here to stay and with holidays upon us expect sharp volatile moves in the market. Dow’s gains from the previous day were wiped out in no time and expect further correction in the equity markets.

Euro

What happened?
Like other majors the Euro tracked general Dollar strength and has fallen by over 350 pips in the last few trading days recording its biggest one day decline in over 2 years. While the market has been eagerly awaiting a break out in this pair with many gunning for the 1.50 mark constant failure in achieving that figure increased the profit taking liquidation on longs. Euro – Zone inflation came in higher than expected which is likely to keep the ECB hawkish.

What next?
Data from the Euro-Zone should continue to outperform the U.S data and bottom pickers could come in at this level to send the Euro back into range trading mode. Today’s manufacturing and services PMI data should remain steady around current levels. Its cross against the Yen could see further liquidation which could weigh in on the Euro.

Yen

What happened?
Yen pared back its recent gains against the Dollar but strengthened against its crosses which were largely due to the losses in the equity markets and the corresponding carry trade liquidation. Yen was on the back foot all day due to the lower than expected result in the Q4 Tankan surveys which fell for the first time in more than 6 months. Corporate and Consumer sentiment is uncertain given the likelihood of a recession in the U.S. economy and its high correlation with the Japanese economy.

What next?
This morning’s Tertiary Industry index rose by 1.1% in line with expectations while business confidence should remain on the low side. But the Yen should continue to strengthen against high yielders with a fair chance of large scale liquidation in carry trades

Pound

What happened?
Pound crashed by 300 pips against the Greenback, sinking towards it lowest level in two years. Its decline was based on broad based Dollar strength rather than its own fundamentals. This morning’s data will not help its case either with the under pressure housing sector showing another decline in house prices as it recorded its sharpest monthly decline since the series began in January 2002. It was also stated that house prices will not rise in 2008

What next?
All eyes will be on Bank of England’s meeting minutes to be released this week, if the statement is not as dovish as expected it could lead to a relief rally in the Pound. A paper released by BoE stated that mortgage holders were not struggling to make repayments as the interest rate increases over the last few years have been in a gradual manner .

Aussie & Kiwi

What happened?
The Aussie and the Kiwi got sold off due to the general liquidation on carry trades however they have bounced well in early Asian trading. This morning’s data showed that the number of private housing starts rose which reinforces the view that the housing market down under is on much better footing than its counterparts in U.S. and U.K. Inflationary pressures in the New Zealand are likely to keep interest rates high well into the next year.

What next?
This is a busy data week for the commodity currencies, with the RBA policy meeting minutes likely to be hawkish in line with concerns of inflationary pressures. In New Zealand Business Confidence could inch lower on high interest rates and GDP could show a decline as well.

Weekly Country Focus: Australia

2007-12-16T16:45:00.000-08:00

The Economy of Australia is a prosperous, Western-style market economy dominated by its services sector (68% of GDP), though the agricultural and mining sectors (29.9% of GDP combined) account for 65% of its exports. Rich in natural resources, Australia is a major exporter of agricultural products, particularly grains and wool, and minerals, including various metals, coal, and natural gas.

Australia occupies a continent close to the size of the contiguous United States. Service industries have expanded in recent decades at the expense of the manufacturing sector, which now accounts for just under 12 per cent of GDP.

Australia's emphasis on reforms is often cited as a key factor behind the continuing strength of the economy. In the 1980s, the Australian Labor Party, led by Prime Minister Bob Hawke and Treasurer Paul Keating, commenced the modernisation of the Australian economy by floating the Australian dollar in 1983, leading to full financial deregulation.

Current areas of concern to some economists include Australia's large current account deficit, the absence of a successful export-oriented manufacturing industry, a real estate bubble, and high levels of net foreign debt owed by the private sector.

Trade and economic performance

In the second half of the twentieth century, Australian trade shifted decisively away from Europe and North America to Japan and other East Asian markets.

Despite high global demand for Australian mineral commodities, export growth has remained flat in comparison to strong import growth. Even though Australia enjoys high commodity prices, economists have warned that structural change is needed in order to increase the size of manufacturing sector. The Australian economy has been performing nominally better than other economies of the OECD and has supported economic growth for 16 consecutive years. According to the Reserve Bank of Australia, Australian per capita GDP growth is higher than that of New Zealand, US, Canada and The Netherlands. The performance of the Australian economy is heavily dependent on US and Chinese economic growth.

Currency
Australian Dollar ($A or A$, AU$ or $AU, AUD)

GDP (PPP)
$645.3 billion (2006 est.)

GDP growth
3.8% (Q2 2007)

GDP per capita
$32,900 (2006 est.)

Inflation (CPI)
2.1% (Q2 2007)

Unemployment
4.3% (Q2 2007)

Main industries
Mining, industrial and transportation equipment, food processing, chemicals, steel

Disappointment in Fed Cut: Was it enough?

2007-12-12T17:14:00.000-08:00

The Fed's interest rate cut of 0.25%, disappointed many investors, as concerns of recession, the housing slump and the credit crunch grow. Many investors believe that this cut in rates was not enough and 0.5% would have been more appropriate if the Fed was serious about avoiding recession.

The Fed's warning that the turbulence in global credit markets has led to more uncertainty in the economic outlook. This has led to bond traders pricing in a further 0.25% cut when the bank meets again on January 30th.

There is growing concern that the tight credit markets will increase the risks for an economy that is expected to grow a measly 1.8% in 2008.

Australian Unemployment: November 2007

2007-12-12T17:03:00.000-08:00

Australian unemployment results for November came out today. The market was expecting a figure of around 4.3%, but the actual amount was 4.5%. This had an immediate negative impact on the AUD, as it has fallen to 0.8828 against the USD by 12:14pm Australian EST.

The number of employed increased by 52,600 in November - more than the 20,000 that had been forecast. The seasonally adjusted workforce participation rate increased to 65.3 percent in November - up from 65.0 percent in October.

The number of people employed in November was 10.58 million, marking an rise of 30,000 from October's 10.53 million. The total number of full-time workers in November rose by 8,200 to 7.6 million. The total number of part-time workers was up 44,400 to 2.99 million.

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Weekly Country Focus: South Africa

2007-12-10T21:46:00.000-08:00

South Africa has a two-tiered economy; one rivaling other developed countries and the other with only the most basic infrastructure. It therefore is a productive and industrialised economy that exhibits many characteristics associated with developing countries, including a division of labour between formal and informal sectors--and uneven distribution of wealth and income. The formal sector, based on manufacturing, services, mining, and agriculture, is well developed.
South Africa's transportation infrastructure is among the best in Africa, supporting both domestic and regional needs. The OR Tambo International Airport serves as a hub for flights to other Southern African and International countries. South Africa also has several major ports that make it a central point for most trade in the southern African region.

Currency
1 Rand = 100 cents

GDP ranking
24th (2005)

GDP
$576.4 billion (2006)

GDP growth
4.5% (2006 est.)

GDP per capita
$13,000 (2006 est.)

Forex reserves
$20.16 billion (February 2006)

Inflation
5% (2006)

Unemployment
25.5% (2006 est.)

Main industries
Mining (Platinum, Gold, Chromium, Diamonds), Automobile assembly, Metalworking, Machinery, Textile, Iron, Steel, Chemicals, Fertilizer and Foodstuffs

Inflation Targeting and GDP growth
In the February 2000 Budget Speech, the Minister of Finance, announced a policy of inflation targeting, helping to bring consumer inflation, which had been running in the double digits for over 20 years, under control. Inflation declined from 6.9% in 1998 to less than 6.0% in 2000. The target was set to keep the consumer price index (CPIX) — a key indicator of inflation — between 3% and 6% average per annum. Although initially successful, the rand's rapid depreciation in late 2001 led to greater inflationary pressure and the South African Reserve Bank missed the target during the course of 2002, with inflation coming in at an average of 9.3% for the year.

Since September 2003, however, the CPIX inflation rate has remained consistently within the target range. The average annual rates of CPIX since 2001 were: 2001 - 6.6%, 2002 - 9.3%, 2003 - 6.8%, 2004 - 4.3%, 2005 - 4.3%.

Success in keeping inflation down allowed the Reserve Bank to reduce the prime lending rate — that determines the interest rate. During 2003 alone interest rates were cut by 550 basis points (5.5%), while between 2002 and 2006 interest rates were cut by a total 650 basis points (6.5%).
The cut in interest rates saw consumer spending rise, the construction sector boom and the sale of new vehicles reach record levels. This in turn generated much needed growth in gross domestic product (GDP). Ironically enough, GDP growth started to gather steam just as the end of the GEAR period neared. Since 1999, quarterly GDP growth has been consistently positive and annual GDP growth consistently above 2%. The present business cycle upswing is the longest on record. Between 1996 and 2004, GDP growth averaged 3.1%, rising to 4.5% (based on 2005 market prices) in 2004. Growth for 2005 is expected to comfortably exceed 4%, some predicting growth rates greater than 5%. This contrasts sharply with the erratic growth rates of 4.3% in 1996, 2.6% in 1997, 0.5% in 1998 and 2.4% in 1999 under GEAR (baseline 2005).

Although economic growth has improved, the growth has been largely jobless, and quicker growth is still needed. The South African Government estimates that the economy must achieve growth at an average of 4.5% until 2010 and 6% thereafter to reach its goal of halving South Africa's high levels of unemployment, estimated at 26.5% (March 2005 - Stats SA), by 2014.
In an effort to boost economic growth further and spur job creation, the government has launched special investment corridors to promote development in specific regions and also is working to encourage small, medium, and micro enterprise development. In fact the policy has been condemned and opposed by the ANC (African National Congress) alliance partners, namely the Congress of South African Trade Unions (COSATU) and the South African Communist Party (SACP).

Some Useful links:
Johannesburg Stock Exchange, South Africa
The South African Futures Exchange(SAFEX), South Africa

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Major News: Week December 10th, 2007

2007-12-10T20:04:00.000-08:00

The Federal Open Market Committee is widely tipped to decrease US interest rates by 25 basis points on Tuesday. There was specualtion earlier in the week that they cut would rates by 50 basis points, however the market has since dismissed this, since US Payrolls results were better than expected on Friday.

The value of the AUD has increased to highs of 0.8886 by late Tuesday afternoon on the back of the carry trades.

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Some New Links

2007-12-09T18:35:00.002-08:00

Share Data and Calls for Indian Stock Market - This site is for sharing Historical data and sharing intrday, delivery and futures calls with everyone. You are free to give calls and use others in the forum.

Free Internet Marketing - Provides free internet marketing space such as Free business directory, free link exchange, free advertising forum, free classified ads

How to Exploit Nonrandomness in Currency Returns

2007-12-06T17:05:00.000-08:00

Currency returns are positively correlated; that is they trend. Here we describe a trading rule to exploit the nonrandomness of currency returns. For the approach to be useful, the historical presence of trends must, of course, be more than a period-specific phenomenon. One reason to believe that currencies will in fact continue to trend is the conclusion that the trending arises from central bank inteventions. The reasoning for such a conclusion is as follows. Central banks prefer stable exchange rates. Thus, whenever an economic or political shock occurs, they intervene to prevent exchange rates from moving abruptly. Generally, they do not prevent the currency from eventually reaching its market determined price, but by "leaning against the wind," they stretch out the change in a currency's value over time. They cushion its movement to the new price.

If an investor believes that central banks will continue to promote stable exchange rates and accepts the argument that central bank interventions promote currency trending, then that investor will believe a profit can be made by purchasing a currency after it rises and selling it after it falls. The rationale is that, because of the central bank's intervention, the currency's value will continue to move in the direction it has been going until underlying market forces gradually overcome the central bank's dampening efforts.

If currency returns trend, adding value to a buy-and-hold exposure may be possible by following a dynamic strategy that generates a convex payoff function. This is illustrated in the diagram below.

The horizonral axis is the exchange rate of a currency and the vertical axis represents the returns - the conditional return of a buy-and-hold exposure to the currency and the return of a dynamic strategy that produces a convex payoff function. The buy-and-hold strategy produces a straight-line payoff function with a slot of 0.5 (because it is assumed to begin with a 50% exposure to the currency); thus if the currency were to move from a value of 1.0 to 1.2, the buy-and-hold strategy would generate a return of 10%.

As can be seen, the convex strategy outperforms the buy-and-hold strategy when the exchange rate moves significantly away from its value at inception (1.0), and the direction of that move does not matter. Thus, the dynamic strategy is appealing in an environment in which currencies trend, because trending increases the likelihood that the currency's exchange rate will move to one extreme or the other rather than fluctuate within a narrow interval.

An investor can generate a convex payoff fucntion by following a linear investment rule that increases exposure to a currency as it appreciates and decreases exposure to a currency as it depreciates. For example, suppose an investor starts out with 50% exposure to a currency and the currency appreciates 1.2%. The change in the value of the currency by itself increases the buy-and-hold exposure to 50.6%. The investor can increase this exposure exposure by multiplying the currency's return by a multiple greater than 1 and then adding this value to the initial exposure. If the multiple equals 5, the new exposure to the currency would equal 56%; that is , 50% + (1.2% x 5). If the currency declines by 1.2%, the new exposure under this rule would equal 43%. As long as the currency trends, the rule produces a convex pay-off function and adds value to a buy-and-hold strategy.

The value added as the currency trends in one direction is lost, however, during turning points when the trend changes direction unless the investor imposes a ceiling and a floor to constrain the exposure to the currency. Suppose, for example, that the investor's neutral exposure is 50%. The investor may impose a 75% ceiling and 25% floor. As the currency appreicates, the investor increases exposure to the currency unltil the ceiling is reached. As the currency continues continues to trend up, the exposure remains at 75%, thus adding value relative to the buy-and-hold exposure. At some point, the currency changes direction, however, so with this rule, the investor begins to reduce exposure to the currency. During this transition, some of the profits that accrued to the strategy as the currency appreciated are lost, but because the maximum exposure was constrained to 75%, the strategy returns to a neutral exposure relatively quickly, before all of the profits are lost. It then begins to add additional value as the exposure is reduced bellow the neutral exposure. In the same fashion, as the currency's move once again changes direction, the 25% floor serves to protect some of the added value. In general if the ceiling or floor is reached before the trend changes direction, this strategy will add value beyond a buy-and-hold strategy.

Bollinger Bands

2007-12-06T16:31:00.000-08:00

Bollinger Bands are a technical analysis tool invented by John Bollinger in the 1980s. Having evolved from the concept of trading bands, Bollinger Bands can be used to measure the highness or lowness of the price relative to previous trades.

Bollinger Bands consist of:

a middle band being a N-period simple moving average
an upper band at K times a N-period standard deviation above the middle band
a lower band at K times a N-period standard deviation below the middle band

Typical values for N and K are 20 and 2, respectively.

95% of price action will take place within the Bollinger bands and thus the Bands act as strong areas of support and resistance when the forex market is without trend. It is possible at times like this to successfully trade the price rising or falling from one Bollinger line to the other. When a trend begins and the volatility of the market increases thus the spacing of the Bollinger Bands will widen, as the trend slows down the Bollinger bands will narrow.

The use of Bollinger Bands varies wildly among traders. Some traders buy when price touches the lower Bollinger Band and exit when price touches the moving average in the center of the bands. Other traders buy when price breaks above the upper Bollinger Band or sell when price falls below the lower Bollinger Band. Moreover, the use of Bollinger Bands is not confined to stock traders; options traders, most notably implied volatility traders, often sell options when Bollinger Bands are historically far apart or buy options when the Bollinger Bands are historically close together, in both instances, expecting volatility to revert back towards the average historical volatility level for the stock.

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Hedging Currency Risk

2007-12-05T21:13:00.000-08:00

The investor can react to foreign exchange risk in one of two ways. One alternative is to do nothing. In this case, the investor is left with the foreign exchange risk and remains either the gains or losses from the currency exposure. The alternative is to hedge the risk in some way by shifting some of the risk to others. The decisions about whether to hedge or not and, if so, how much to hedge and when can be complex. The choices depend on how much volatility the investor is exposed to, how much the volatility can be reduced, how much it costs to hedge, what expectations the investor is willing to make between the reduction in volatility and the cost of the hedge.

For the investor who has decided to hedge some part of foreign exchange exposure, there are three typical hedge alternatives. The first is a symmetrical hedge using forward or futures contracts to minimize both currency gains and losses. A matched hedge uses the same currency to hedge as the investor is exposed to. A currency-basket hedge uses a portfolio of currencies to hedge the investor's exposure; the portfolio is configured in such a way as to reduce the expected hedging cost while minimizing the tracking error of the hedge.

The asymmetrical hedge uses options. The asymmetry of options is designed to preserve some gains from currency exposure while protecting against losses. The two most common option strategies are the protective put and the range forward or collar. The protective put generarlly the most expensive protection, but it preserves the majority of the gains from favourable currency exposure. The range forward (collar) is somewhat less expensive than the alternativel; it lowers the cost by capturing the gains from favourable currency exposure only up to a certain level.

The final hedge alternative consists of active management of the hedge. In this strategy, currency exposure is left unhedged when currency returns are expected to be favourable and hedged when currency returns are expected to be unfavourable. The goal of active hedge management is to capture the benefits of hedging while paying as little as possible for protection. One might think of it as trying to create the same results as a protective put while minimizing the cost of the put option. Effective active hedge management requires a systematic, on-going evaluation of potential changes in foreign exchange rates.

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The Black-Scholes Model

2007-12-05T16:08:00.000-08:00

"Once a model has been developed, we are able to improve the realism of its assumptions step by step. But unlike physics, which is a science with constant (if poorly understood) laws, the "laws" of economics and finance change constantly, even as we discover them. Sometimes they change because we have discovered them." - Charles Sanford: The Risk Management Revolution

Origins of the Black-Scholes Formula

The roots of the Black-Scholes formula go back to the nineteenth century. In the 1820s, a Scottish scientist, Robert Brown, observed the motion of pollen suspended in water and noticed that the movements followed no distinct pattern, moving randomly, independent of any current in the water. This phenomenon came to be known as Brownian motion. Similar versions of Brownian motion were subsequently discovered by other scientists studying other natural phenomena. In 1990, a French doctoral student Louis Bachelier, wrote his dissertation on the pricing of options in the Paris market and developed a model strikingly similar to the Black-Scholes model. Unfortunately, his dissertation advisor was disappointed because Bachelier's work was orientated toward such a practical issue as pricing a financial instrument. Although Bachelier received his degree, the less than enthusiastic support of his advisor damaged his career, and nothing further was heard from him.

In the early twentieth century, Albert Einstein, working on the foundations of his theories relativity, used the principles of Brownian motion to explain movements in molecules. This work led to several research papers that earned Einstein the Nobel Prize and world renown. By that time, a fairly well developed branch of mathematics, often attributed to American mathematician Norbert Wiener, proved useful for explaining the movements of random particles. Other contributions to the mathematics were made by Japanese mathematician Kiyoshi Ito. In 1951, Ito developed an extremely important result called Ito's Lemma that 20 years later made it possible to find an option price. Keep in mind, however, that these people were working complex problems in physics and mathematics, not finance.

The mathematics that was used to model random movements had now evolved into its own subdiscipline, which came to be known as stochastic calculus. While ordinary calculus defined the rates of change of known functions, stochastic calculus defined the rates of change of functions in which one or more terms were random but behaved according to well-defined rules of profitability.

In the late 1960s, Fischer Black finished his doctorate in mathematics at Harvard. Passing up a career as a mathematician, he went to work for Arthur Little, a management consulting firm in Boston. Black met a young MIT finance professor named Myron Scholes, and the twon began an interchange of ideas on how financial markets worked. Soon Black and Scholes then began studying options, which at that time were traded only on the OTC market. They first reviewed the attempts of previous researchers to find the elusive option pricing formula.

Black and Scholes took two approaches to finding the price. One approach assumed that all assets were priced according to Capital Asset Pricing Theory, a well-accepted model in finance. The other approach used stochastic calculus. They obtained an equation using the first approach, but the second method left them with a differential equation they were unable to solve. The more mathematical approach was considered more important, so they continued to work on the problem, looking for a solution. Black eventually found that the differential equation could be transformed into the same one that described the movement of heat as it travels across an object. There was already a known solution, and Black and Scholes simply looked it up, applied it to their problem, and obtained using the first method. Their paper reporting their findings was rejected by two academic journals before eventually being published in the Journal of Political Economy, which reconsidered an earlier decision to reject the paper.

At the same time, another young financial economist at MIT, Robert Merton, was also working on option pricing. Merton discovered many of the arbitrage rules. In addition, Merton more or less simultaniously derived the formula. Merton's modesty, however, compelled him to ask a journal editor that his paper not be published before that of Black and Scholes. As it turned out, both papers were published, with Merton's paper appearing in Bell Journal of Economics and Management Science at about the same time. Merton, however, did not initially receive as much credit as Black and Scholes, whose names became permanently associated with the model.

Fischer Black left academia in 1983 and went back to work for the Wall Street firm Goldman Sachs. Unfortunately, he died in 1995 at the age of 57. Scholes and Merton have remained in academia but have been extensively involved in real world derivatives applications.

In 1997, the Nobel Committee awarded the Nobel Prize for Economic Science to Myron Scholes and Robert Merton, while recognising Black's contributions.

The model has been one of the most significant developments in the history of pricing of financial instruments. It has generated considerable research attempting to test the model and improve on it. A new industry of derivative products based on the Black-Scholes model has developed. Even if one does not agree with everything the model says, knowing something about it is important for surviving in the finance markets.

Black-Scholes Model - The Theory Behind it

The Black-Scholes model, often simply called Black-Scholes, is a model of the varying price over time of financial instruments, and in particular stocks. The Black-Scholes formula is a mathematical formula for the theoretical value of European put and call stock options that may be derived from the assumptions of the model.

The key assumptions of the Black-Scholes model are:

The price of the underlying instrument is a geometric Brownian motion, in particular with constant drift and volatility.
It is possible to short sell the underlying stock.
There are no riskless arbitrage opportunities.
Trading in the stock is continuous.
There are no transaction costs.
All securities are perfect divisible (e.g. it is possible to buy 1/100th of a share).
The risk free interest rate is constant, and the same for all maturity dates.

Black-Scholes in practice

The use of the Black-Scholes formula is pervasive in the markets. In fact the model has become such an integral part of market conventions that it is common practice for the implied volatility rather than the price of an instrument to be quoted. (All the parameters in the model other than the volatility - that is the time to expiry, the strike, the risk-free rate and current underlying price—are unequivocally observable. This means there is one-to-one relationship between the option price and the volatility.). Traders prefer to think in terms of volatility as it allows them to evaluate and compare options of different maturities , strikes, etc...

However, the Black-Scholes model can not be modelling the real world exactly. If the Black-Scholes model held, then the implied volatility of an option on a particular stock would be constant, even as the strike and maturity varied. In practice, the volatility surface (the two-dimensional graph of implied volatility against strike and maturity ) is not flat. In fact, in a typical market, the graph of strike against implied volatility for a fixed maturity is typically smile-shaped (see volatility smile). That is, at-the-money (the option for which the underlying price and strike co-incide) the implied volatility is lowest; out-of-the-money or in-the-money the implied volatility tends to be different, usually higher on the put side (low strikes), and call side (high strikes).

Practically, the volatility surface of a given underlying instrument depends among other things on its historical distribution, and is constanty re-shaping as investors, market-makers, and arbitragists re-evaluate the probability of the underlying reaching a given strike and the risk-reward associated to it.

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Information taken from Wikipedia - the free encyclopedia

Some Great Quotes

2007-12-02T19:54:00.000-08:00

"Man does not live by stocks and bonds alone" - Chicago Mercantile Exchange advertisement

"Trading is like no other profession I can think of than dragon slaying. Facing that hot breath, and those toothy jaws fearlessly, armed only with a belief in oneself, on a daily basis" - Mara Koppel: Women of the Pits, 1998

"Order and simplification are the first steps toward mastery of a subject - the actual enemy is the unknown" - Thomas Man: The Magic Mountain, 1924

"Models are like cars: you can have the best car in the world, but it won't stop you crashing if you don't drive it properly" - Mahmouh Barakat: Risk, April 1997, p. 6

"A bird in the hand is an apt way to describe the strategy of today's options investor. Taking the immediate income of writing a covered call, the battle-tested investor is strategically managing market risk" - Lawrence Severn: Futures and Options World, October 1995

"You can get as fancy as you want with your option strategies, but in this business, there's no substitute for being right. There's never been a guarantee for incremental returns" - Gene Brody: Risk, June 1995

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Forex Books

2007-11-29T16:33:00.000-08:00

There are a number of Forex-related books that should get a mention on this blog. They may or may not be of some use to you when trading. Let's have a look at them:

Forex Made Easy : 6 Ways to Trade the Dollar
by James Dicks

This books introduces different trading tools to use when trading in Forex. It discusses a six-step process for Forex trading. There is also an in-depth discussion on techinical analysis and many different examples to illustrate the key points.

Hardcover: 256 pages
Publisher: McGraw-Hill; 1 edition (March 12, 2004)
Language: English
ISBN-10: 0071438947
ISBN-13: 978-0071438940

Forex Revolution: An Insider's Guide to the Real World of Foreign Exchange Trading
by Peter Rosenstreich

This book covers a number of different areas:

Why Forex has become your #1 profit opportunityHow the currency markets became indispensable to the active investor
Meet the players, markets, tools, portals, and platformsEverything you should know before you get started
Choose the right FX investmentsUnderstand currency futures, options, swaps, and more
Master both fundamental and technical trading strategiesand discover why you need to know both
Gut check: What it takes to win in the Forex marketsDevelop the discipline you need to succeed

Hardcover: 304 pages
Publisher: FT Press (June 12, 2005)
Language: English
ISBN-10: 013148690X
ISBN-13: 978-0131486904

ForeX Trading for Maximum Profit: The Best Kept Secret Off Wall Street
by Raghee Horner

This book provides an in-depth look at Forex trading using the methods, analysis, and insights of the well-known author - Raghee Horner.

Horner has been trading Forex for many years and she introduces her winning tools and methods, including charting techniques, which have helped her succeed in the Forex market.

Hardcover: 216 pages
Publisher: Wiley; Har/DVD edition (December 27, 2004)
Language: English
ISBN-10: 0471710326
ISBN-13: 978-0471710325

Electronic Currency Trading for Maximum Profit: Manage Risk and Reward in the Forex and Currency Futures Markets
by Keith Long & Kurt Walter

Hardcover: 368 pages
Publisher: Prima Lifestyles (April 5, 2001)
Language: English
ISBN-10: 0761525203
ISBN-13: 978-0761525202

Day Trading the Currency Market: Technical and Fundamental Strategies To Profit from Market Swings
by Kathy Lien

Kathy Lien is a chief strategist for one of the largest online currency trading companies in the world has a very large following. This book explains how the Forex market works and discusses a variety of technical and fundamental strategies which can be used to help generate profits.

Hardcover: 256 pages
Publisher: Wiley (December 2, 2005)
Language: English
ISBN-10: 0471717533
ISBN-13: 978-0471717539

For all your Forex Trading Needs, visit ForexCT

Currency Options Explained

2007-11-28T15:46:00.000-08:00

A "Currency/Forex option' is the right, without an obligation, to buy or sell one currency against another currency at a specified price, during a specified period.

Calls and Puts

A 'call' is the right without an obligation, to buy a currency. A 'put' is the right, without an obligation, to sell a currency.

In every foreign exchange transaction, one currency is purchased and another is sold. Consequently, every currency option is both a call and a put. An option to buy USD against JPY is both a USD call, and a JPY put.

Parties to an Option

There are two parties to an option - the buyer and seller. The buyer of the option enjoys the right to exercise the option and the right not to do so (ie to let it lapse). The seller of the option has an obligation to deal at the contracted rate if the buyer elects to exercise the option. The seller is also known as the 'writer' or 'grantor' of the option.

Option Premium

The price of the option is known as the 'option premium'. The buyer pays the premium to the seller as compensation for the risk involved in writing the option. The premium is normally paid on the spot value date from the date on which the option is contracted.

Value Terms

The 'strike price' or 'strike rate' is the exchange rate at which the option will be exercised if the buyer elects to exercise the option.

'In-the-money' (ITM) describes an option which would produce a profit if exercised (excluding consideration of the premium). 'Out-of-the-money' (OTM) describes an option which would produce a loss if exercised (excluding consideration of the premium). 'At-the-money' (ATM) describes an option which would produce neither a profit, nor a loss if exercised. The at-the-money strike price is the forward rate.

The premium will be higher if the option is in-the-money, and lower if the option is out-of-the-money.

Maturity of the Option

The 'expiration date' or 'expiry date' refers to the date on which the buyer's right to exercise ends. In practice, a specific expiry time (eg 10:00am New York time or 3:00pm Tokyo time on the expiry date) is agreed. If an option is exercised on the expiry date, the cash flows will occur on the then spot value date.

An 'American Option' refers to an option which can be exercised for spot value on an date between the contract date and the expiry date. A 'European option' refers to an option which theoretically, can only be exercised for spot value on the expiry date. In practice, writers of European options allow buyers to give notice prior to the expiry date that they will exercise the option. If a European option is 'exercised' prior to expiry date, the cash flows will occur on the spot value date following the original expiry date.

Sources of Options

Exchange-traded options are contracts traded through certain stock, futures or commodity exchanges. These contracts have strictly defined characteristics such as standard amounts, standard expiry dates and standard strike prices. Over-the-counter (OTC) options are options written by banks and other institutions but not traded through public exchanges. OTC options can be tailored to suit the exact needs of the option buyer. The currency options traded in the market are predominantly OTC options.

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Currency-Linked Note

A 'currency-linked note' is an instrument for which the yield is a function of the exchange rate. Many structures are possible. A popular one gives the investor a better-than-market yield provided the exchange rate remains within the specified range, but a lower-than-market yield if it moves outside that range.

If the 6-month USD interest rate is 5% per annum when spot USD/JPY is 110,000, an investor might be able to purchase a currency-linked note for which the yield will be 10% per annum, provided the USD remains within a range of 100.00 to 120.00 for the enture six months, but only 2% per annum if at any time the spot rate touches or moves above 120.00 or below 100.00.

The currency-linked note would normally be packaged by the bank as a single product. To construct it, the bank would merely sell two one-touch digitals. The future value of the premium received would be sufficient to lift the yield to 10% per annum provided another level is touched. The payout would be such that the yield is reduced to 2% per annum if either digital is exercised.

This sort of product appeals to many investors because their capital is guaranteed, and they are assured a minimum acceptable return, with the possibility of a yield which is much higher than otherwise available. The investor is effectively betting that the exchange rate will be less volatile than is being priced into the options.

Barrier Options

'Path-dependent options' are those whose payout depends on the path which the market price follows through the life of the option.

Standard calls and puts, as well as at-expiry digitals, are not path-dependent because their payout depends only on where the market price is at expiry compared with the strike price.

One-touch digital options are one example of path-dependent options. The most common group of path-depenedent options are known as barrier options. Other examples of path-dependent options include average rate or average strike options and look-back options.

'Barrier options' are options which can be knocked-out or which only kick-in if the market price reaches a specified level. There are vairations where the barrier applies for only a specified part of the life of the option. These are known as 'window' options. There are also options with multiple barriers.

'Knock-out options' have a zero payout if the barrier level is reached, even if the market price at expiry is better than the strike price. 'Knock-in options' have zero payout unless the option expires in-the-money (ie the market price at expiry is better than the strike price and at sometime during the life of the option the market price has reached the barrier level).

Hedging Options - Delta Hedging

What can a bank do to hedge the risk when it sells an option?

The risk the bank has is that if the exchange rate moves so that the option becomes more valuble, then if left unhedged, the seller has the potential to incur limitless losses. Suppose a trader sells a call option on the AUD at 0.8800 and the exchange rate goes to 0.9000. Under these circumstances, it is highly likely that the buyer will exercise his right to buy AUD at o.8800. In other words, it is highly likely that the trader will incur a 200-point loss.

Since a bank selling an option knows what the option will be valued at if the exchange rate moves ina certain direction, it is able to either buy or sell the currency in the spot market to hedge the risk. The process is known as 'delta hedging'.

Delta hedging sold options will inevitably incur losses. These losses are the debit side of selling an option. The credit side is that the seller receives an option premium from the buyer. The objective of the bank that sells an option is to lose less money in heding that it receives as a premium from the buyer. This will happen if the currency exhibits less volatility during the life of the option than was priced into the option. If the currency exhibits more volatility, then this will lead to losses from hedging that are larger than the amount received in the form of option premium.

It follows that a bank will sell and hedge an option when it believes that the future volatility of the currency will be less than the volatility entered into the Black-Scholes formula at the time of the sale. A bank will buy and hedge an option when it believes that the future volatility of the currency will be greater than the volatility input into the Black-Scholes formula at the time of the purchase.

What are Currency Futures?

2007-11-28T15:13:00.000-08:00

A 'Currency Future' is an agreement to buy or sell a standard quantity of a specified currency, at a specified price, on a specified future date.

Futures contracts are a type of forward contract, meaning they represent a pledge to make a certain transaction at a future date. Futures are distinguished from over-the-counter (OTC) forward contracts in that they contrain standardised terms; trade on a formal exchange; are regulated by overseeing agencees; are guaranteed by clearing houses; have a range of delivery dates; are settled daily.

Here is some more information about the different types of accounts you are able to open at ForexCT

Terminology

Currency futures are traded in a standardised, transferable parcels called contracts. They are governed by their contract specification which details the size of each contract, when delivery is to take place and what exactly is to be delivered.

The contract unit or size specifies the amount of underlying currency to be delivered per contract. This is also known as the 'face value' of the contract.

The 'futures price' is one at which the two counterparties in a futures contract agree to transact at/on the settlement date. In terms of a currency future, this is usually a calculated arithmatic mean of a range of price quotations on the last trading day prior to settlement date. Prices are quoted in terms of USD per currency.

The 'last trading day' is the last business day prior to settlement date in the delivery month.

The 'settlement date' is the date of completion and execution of the terms of the contract - in this case the delivery of the underlying currency.

The 'delivery month' is the month during which a futures contract expires, and during which delivery may take place according to the terms of the contract. For currency futures this is usually march, June, September, and December.

A 'tick' is the smallest permitted price movement in a future contract. As each futures contract is a standardised size, the smallest price movement is known as the 'tick value'.

A currency futures contract can be 'closed' out by making an offsetting trade, or taking delivery of the underlying currency.

There are 2 parties to a currency futures contract - a buyer and a seller. The buyer of a future enters into an obligation to buy the foreign currency on a specified date. The seller of a future is under an obligation to sell the foreign currency on a future date.

The risk to the holder of the currency future is unlimited, and because of the payoff pattern is symmetrical, the risk to the seller is unlimited as well. Loss and gains by each party on a futures contract are equal and opposite. In other words, futures trading is a 'zero-sum game'.

The clearing house acts as an intermediary in futures transactions as it guarantees the performance of each party to the transaction. In order to ensure that payment occurs, futures have a 'margin requirement' or 'clearing margin'. This margin is calculated as the difference between the current value of futures position (mark-to-market) and the position value at the time purchase/sale. This margin is calculated and settled daily with the clearning house - the form of payment/receipt into each parties account.

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Currency Swaps - How do they work?

2007-11-27T15:07:00.000-08:00

A 'Currency Swap' is a contract which commits two counterparties to exchange, over an agreed period, two streams of interest payments in different currencies, and at the end of the period to exchange the corresponding principal amounts at an exchange rate agreed to at the start of the contract. The principal amounts are also exchanged at the prevailing spot rate on inception.

The two streams of interest payments can be fixed/fixed, fixed/floating, floating/fixed or floating/floating.

Unlike an interest rate swap, the principal and interest are usually both exchanged in full in a currency swap.

A swap is referred to as 'cross-currency' when it involves an exchange of two streams of interest payments in different currencies, where at least one stream is at a floating rate of interest.

Let's look at the Terminology:

A Currency Swap is one one where two fixed rate interest streams in different currencies are exchanged.

A 'Cross-Currency Coupon Swap' is on where a fixed rate interest stream is exchanged for a floating rate one.

A 'Cross-Currency Basis Swap' is one where two floating rate interest streams in different currencies are exchanged.

In all cases the principal is usually exchanged at inception at the prevailing spot rate and at maturity at an agreed contract rate.

There are other less commonly transacted swaps. They include 'Asset Swaps' which is a currency swap with interest streams backed by cash flows from assets, 'Differential Swaps' which is a cross-currency basis swap that does not involve any exchange of principal, and 'Circus Swaps' which is a combination of a cross currency coupon swap and a single currency coupon swap.

The counterparties to a swap transaction are commonly known as Payers and Receivers. Alternatively the terms Buyers and Sellers are used.

Floating rate interest streams are based on agreed reference rates - commonly 6 Month USD LIBOR (London Interbank Offer Rate). NB AUD floating rates are based on BBSW (Bank Bill Swap Rate).

Fixed Rate interest streams are agreed to at the start of the contract. There are two methods of quoting the fixed rates - the all-in price, or as a swap spread on a benchmark rate.

All-In Prices

A quote for one year swap may be given as 8.00% - 7.85%. This is a two-way price in which the dealer would pay a fixed rate of 7.85%, and would look to receive 8.00% fixed. The dealing spread of 15 basis points represents the dealers profit.

Swap Spreads

This is the convention of quoting the fixed rate in two parts - swap spread and a benchmark interest rate. For example, a GBP/USD cross-currency basis swap might be quoted at +10 - meaning that the swap is between US dollar LIBOR on one hand and sterling LIBOR plus +10 basis points on the other.

The Advantages and Disadvantages of Currency/Cross Currency Swaps

The advantages of currency swap transactions are:
1. They allow active currency exposure management - ie hedging translation risk.
2. They allow aceess to markets with the cheapest source of funds - comparative advantage.

The disadvantages of currency swap transactions are:
1. A default by one counter party leaves a currency exposure.
2. There are higher credit risk issues.
3. They can be expensive to terminate.

Application of Currency Swaps

Currency swaps are regularly used for hedging and arbitrage purposes.

Hedging

Currency swaps can be used as an instrument for eliminated translation risk.
Consider an Australian company that raised AUD 100,000,000 by issuing USD 62,000,000 of USD denominated 3-year bonds paying 6.0% per annum coupons semi-annually when the exchange rate was 0.6200. Each coupon payment is USD 1,860,000, and the principal nrepayment is USD 62,000,000. If the AUD/USD rate falls it will cost more AUD to purchase the USD to make the interest payments, and the principal repayment.

The company could swap from paying fixed USD into paying fixed AUD. If the USD 3-year swap rate was 6.0% per annum and the AUD 3-year swap rate was 6.5% per annum, the company could eliminate its currency risk by receiving the USD rate, and paying the AUD rate.

NB The foreign exchange conversion is done at the spot rate prevailing at the time of the swap. If the swap was done at the time of the issue of the bond when the spot rate was 0.6200, the AUD amount payable at each interest payment date would be a fixed amount of AUD 100,000,000 x 0.065/2 = AUD 3,250,000. The repayment of the USD 62,000,000 principal would be AUD 100,000,000 based on the spot rate of 0.6200.

Arbitrage

Currency swaps can also be used to arbitrage comparative advantage in different markets. Arbitrage opportunities arise because lenders require a larger 'credit premium' for borrowers with poor credit ratings raising funds in weak currencies - than for the same borrowers raising funds in strong currencies.

Consider an Australian company that can raise funds by borrowing in AUD at fixed rate of 15% or issuing Euro denominated bonds at a fixed rate of 9%. By contrast a German Company with a better credit rating can issue AUD Euro bonds at 12% or Euro bonds at 8%. See below:

For AUD Investor

Australian Borrower: 15%
German Borrower: 12%
Interest Differntial: 3%
AUD Equiv: 3%

For Euro Investor

Australian Borrower: 9%
German Borrower: 8%
Interest Differential: 1%
AUD Equiv: 1.15%

Arbitrage Opportunity = 3% - 1.15% = 1.85%

The interest differential reflects the credit premiums required for the less credit worthy borrower.

NB For a more meaningful comparison, the Euro credit premium is translated into Aud percentage points using an AUD/EUR interest conversion factor 1:1.15. The factor is dependent on the interest between the 2 currencies. It is not an exchange rate.

From the example above, it appears the Australian borrower has a comparative advantage in the Euro market, where it faces a premium of only 1.15% against a 3% mark-up in AUD. Similarly the German borrower has a relatively best market in AUD where it can obtain funds 3% below the Australian borrower's rate (15%) - whereas it can only obtain Euro at 1.15% below the Australian borrower's rate (9%).

There to take advantage of the comparative differences, the individual borrowers should raise funds in their relatively best markets, and complete the operation by transacting a currency swap with each other. The arbitrage opportunity of 1.85% is divided between the counterparties within the terms of the swap, accoring to their individual negotiating powers!

What is 'Arbitrage'?

2007-11-27T14:54:00.000-08:00

'Arbitrage' refers to the practice of taking advantage of inconsistent pricing to lock in risk-free profits. If two banks are quoting rates where one bank's rate is higher than the other bank's offer rate, then an arbitrage opportunity exists.

Let's look at the following example:

Bank A quotes USD 1 = JPY 120.10 (bid) and 120.15 (offer)
Bank B quotes USD 1 = JPY 120.17 (bid) and 120.20 (offer)

As Bank B's bif rate 120.17 is higher than Bank A's offer rate 120.15, it is possible to buy USD from Bank A at 120.15, and to sell them to Bank B at 120.17 for a profit of two points, without creating a net exchange position.

Once they realise that this has arisen, one or both banks will quickly trend their rates so that the arbitrage opportunity disappears.

For more information about the Forex market, contact one of our highly trained Forex specialists today!

Market-Making

2007-11-26T22:00:00.000-08:00

'Market-making' refers to the practice of quoting bid and offer rates to 'make a market'.

A benefit of market-making is that the price-making bank obtains more market information. Being aware of the transactions which are taking place in the market is important if the bank follows a strategy of taking positions.

It is not always desirable for banks to deal at their own prices. If rates are moving quickly in one direction because of a bias in the market, banks will be better off if they square their positions by dealing at market rates.

For example, if a bank is long USD 2,000,000 at JPY 108.10 and a very large trade deficit is announced, all market participants may expect rates to fall. Banks will tend to lower their quotes and possibly widen them as uncertainty grows. As there will be many keen sellers and possibly no keen buyers, it would be folly for a bank to wait in the vain hope of being able to sell at its offer rate. The prudent course would be to square off its position by dealing at another banks bid rate, and to trend its rates down accordingly. This will probably result in the bank taking a loss, but it is better to take a small loss now than to be caught and incur a much larger loss later.

Attention Traders!

2007-11-26T20:48:00.000-08:00

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Key Indicators to Focus on

2007-11-26T20:11:00.000-08:00

Tues, 27 Nov 2007

United States

9am: National Home Price Index - Expecting a decline to the tune of 5%
10am: Consumer Confidence - Forcasting 91.5 which is done on the previous level of 95.6

Euro

Tentative: German CPI m/m (p) - Expecting an increase of around 0.1%, which is slightly down from previous period (0.2%)

Japan

6:50pm: Retail Sales y/y - The market is anticipating an increase of 0.6% in yearly retail sales, which is slightly up from previous period (0.5%)

Wed, 28 Nov 2007

United States

8:30am: Core Durable Goods Orders m/m - Forecasted at 0.4%, which is up from the previous month (0.3%)
10am: Existing Home Sales - Sales are expected to show a decline from 5.04m to 5m. This indicates a potential drop in demand for existing homes. It will be interesting to see how the subprime issues have effected the US housing market.

Euro

2am: German Consumer Confidence - This is expected to fall to around 4.5% from 4.9%

Market Wrap - 20 November 2007

2007-11-20T15:53:00.000-08:00

USD: The dollar declined against the yen on Monday, but held steady versus the Euro as a global rout in stock markets and higher oil prices raised concern about the health of the U.S. economy and left investors wary of risky trades. Investors grew particularly cautious after Goldman Sachs added U.S. banking giant Citigroup to its "sell" list, saying the bank would likely face more mortgage-related losses next year. With few major economic events and data releases this week, investor’s awaited data on U.S. home construction starts due out later today. Housing starts are forecast to show an annual pace of 1.170 million units for October, down from September and reflecting continued weakness in the U.S. housing market as tighter lending standards and lower home prices keep activity at bay. In addition, the Federal Reserve will release the minutes of its October policy meeting when it cut rates by 25 basis points to 4.5 percent, having slashed them by 50 basis points in September. Many in the market are expecting more Fed rate cuts, although recent comments from several policymakers have hinted that the central bank sees no need for further easing yet.

JPY: The yen held gains against the dollar and Euro on Tuesday and climbed against high yielder’s after more trouble in the U.S. subprime mortgage and credit markets kept investors cautious about risky carry trades. A 1.9 percent fall in the Nikkei stocks average to a 16-month low, after U.S. equities hit their weakest levels in three months on Monday, also supported the yen as investors used stock movements as a barometer of risk appetite.

AUD: The Australian dollar stayed on the back foot, holding just barely above 88 U.S. cents, after a slide in stocks prompted investors to shun higher-yielding currencies in favour of less risky assets.

Market Wrap - 16 November 2007

2007-11-15T20:49:00.000-08:00

USD: The U.S. dollar rose against the Euro but slid against the yen on Thursday, as ongoing credit market concerns and weak stock markets led investors to pare back on short positions in the greenback. Uncertainty about losses from the U.S. subprime mortgage crisis continued to pervade markets. Data showing benign U.S. core inflation in October and higher-than-expected regional U.S. business activity in November did not have lasting impact on currencies.

EUR: The Euro traded down slightly overnight on the back of a stronger dollar with the exception of Yen. On the data front, the final October Eurozone HICP inflation estimate came in at 2.6% y/y, in line with expectations but up from the previously reported 2.1%

JPY: The yen was little changed on Friday as weaker Asian stocks quelled risk demand, helping the Japanese currency hold gains made against higher-yielding ones in the previous session. The low-yielding yen rallied on Thursday when sluggish stocks and ongoing concerns about the health of major financial institutions prompted investors to trim risky carry trades that involve selling the yen for assets in high yielder’s. The Nikkei stocks average slipped 1.6 percent in early trade, taking a cue from U.S. stocks, which sank on Thursday on worries that credit losses from mortgage defaults and slumping home prices could worsen, hurting the economy.

AUD: The Australian dollar traded weak, holding just above this week's lows, as investors stayed clear of high-yielding currencies on persistent concerns about the fallout from the U.S. subprime mess on the economy and financial markets.

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2007-11-14T17:27:00.000-08:00

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US Economic Data

2007-11-14T15:39:00.000-08:00

In recent times, there has been much volatility in the US financial markets. Let's take some time to focus on the key economic and financial data relevant to the US.

Week of November 12 - November 16

Nov 14
08:30
Retail Sales
Oct Figures
0.2% Actual
0.2% Consensus
0.7% Prior
0.6% Revised From

Nov 14
08:30
Retail Sales ex-auto
Oct Figures
0.2% Actual
0.3% Consensus
0.3% Prior
0.4% Revised From

Nov 14
08:30
PPI
Oct Figures
0.1% Actual
0.3% Consensus
1.1% Prior

Nov 14
08:30
Core PPI
Oct Figures
0.0% Actual
0.2% Consensus
0.1% Prior

Nov 14
10:00
Business Inventories
Sep Figures
0.4% Actual
0.4% Consensus
0.3% Prior
0.1% Revised From

Nov 15
08:30
CPI
Oct Figures
0.3% Consensus
0.3% Prior

Nov 15
08:30
Core CPI
Oct Figures
0.2% Consensus
0.2% Prior

Nov 15
08:30
Initial Claims
10 November Figures
325K Consensus
317K Prior

Nov 15
08:30
NY Empire State Index
Nov Figures
18.0 Consensus
28.8 Prior

Nov 15
10:30
Crude Inventories
9 September Figures
-821K Prior

Nov 15
12:00
Philadelphia Fed
Nov Figures
5.0 Consensus
6.8 Prior

Nov 16
09:00
Net Foreign Purchases
Sep Figures
$66.0B Consensus
$-69.3B Prior

Nov 16
09:15
Industrial Production
Oct Figures
0.1% Consensus
0.1% Prior

Nov 16
09:15
Capacity Utilization
Oct Figures
82.0% Consensus
82.1% Prior

In the coming week we will have more US economic and financial data released:

Housing Starts
Building Permits
Initial Claims
Crude Inventories and more!

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Market Wrap - 14 November 2007

2007-11-14T14:36:00.000-08:00

USD: The dollar fell against most major currencies on Tuesday, resuming a long-term decline after a respite from previous sessions. On Wednesday, the U.S. government will release its October retail sales report which will be scrutinized for any signs weakness in the housing sector has hurt consumer spending.

EUR: The Euro dollar traded higher towards 1.4650 despite Germany’s ZEW survey disappointing. The survey of economic sentiment worsened from -19 in October to -30.0 in November, well below the expected -20. Data releases out of the Eurozone were on the whole disappointing on Tuesday. French CPI edged up more than expected while Eurozone industrial production fell 0.7% m/m in September, worse than the expected 0.2% decline.

JPY: The dollar was higher against the Yen; however, as the Japanese currency fell from an 18-month high against the dollar after comments from Japan's prime minister abruptly ended the unwinding of carry trades that had pushed the unit higher in recent days. Japanese Prime Minister Yasuo Fukuda told the Financial Times that the yen was appreciating "too fast" and speculators needed to be careful to avoid the possibility of intervention. Dealers had previously been rapidly unwinding risky trades, increasing volatility in the currency and equity markets. The low-yielding yen had surged in recent days as renewed fears that credit-related problems could spread to the wider U.S. economy sapped risk appetite among investors, prompting them to buy back yen they had sold to fund purchases of higher-return currencies in carry trades.

AUD: The Australian dollar advanced past 90 U.S. cents on Wednesday as firmer regional stock markets encouraged investors to return to riskier positions in high-yielding currencies. Asian stocks tracked big gains on Wall Street, where the market benefited from favorable comments by Goldman Sachs on asset write downs and from a surprisingly strong retail sales report from Wal-Mart Stores Inc.

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2007-11-13T17:18:00.000-08:00

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Market Wrap - 13 November 2007

2007-11-13T16:52:00.000-08:00

USD: The dollar gained on Monday, reversing some of its recent losses as nervousness about credit-related losses at U.S. banks triggered a wave of risk reduction in light volume trading. With bets against the dollar at record levels, major investment banks have announced more than $50 billion in write-downs and losses resulting in part from subprime mortgage loans gone bad. This has raised fears that there may be more losses to come, driving dealers to reduce the level of risk they take overseas. Prior to Monday, the dollar had been falling steadily on expectations the Federal Reserve would cut its benchmark interest rate to stave off an economic recession potentially brought on by weakness in the housing sector.

EUR: The Euro dollar traded to a low of 1.4527 before closing around the 1.4550 level in the New York session. On the data front, Eurozone industrial output and the German ZEW survey are both due out later today in Europe.

JPY: Independent of dollar strength, the yen has been charging higher in the last week. It climbed to a 1-1/2-year high against the dollar on Monday, benefiting as investors unraveled risky trades in which they borrow low-yielding currencies to buy higher-yielding ones. Top government spokesman Nobutaka Machimura said on Monday it was wrong to conclude that a high yen was a bad thing for Japan and that the government has no plan to intervene in the foreign exchange market. Data released today showed that Japan's economy grew a bigger than expected 0.6 percent in the July-September quarter. But the market shrugged off the growth as it did little to alter views that the Bank of Japan will not raise interest rates until well into next year. The BOJ kept interest rates unchanged at 0.50 percent on Tuesday, as widely expected, reflecting caution among central bankers over market uncertainty and fallout from problems in the U.S. housing sector.

AUD: The Australian dollar recovered off three-week lows against the U.S. dollar after most regional stock markets edged up, leading to an easing in the savage unwinding of risky carry trades that hit the Aussie in recent sessions. The Aussie inched up against the yen from a two-month low of 95.58 yen, but investors remained wary of returning to carry trades as risk aversion remained dominant, given expectations big U.S. banks could face more subprime losses. A series of announcements by major U.S. investment banks about losses from the subprime mortgage crisis in the past week have raised fears that credit-related woes would spread to the broader U.S. economy.

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Market Wrap - 11 November 2007

2007-11-12T14:46:00.000-08:00

USD: The US dollar remained weak in the New York trading Wednesday after a Chinese official called for greater reserve diversification. US equity markets all closed down sharply with embattled financial stocks driving the declines. On the data front, strong Q3 GDP growth was reflected in a surge in productivity and a decline in unit labour costs. Productivity exceeded expectations, increasing at an annualized 4.9%, its fastest pace in four years, while unit labour cost declined 0.2% in Q3. Looking ahead, weekly jobless claims are due out later in the States today with Bernanke also due to testify before the Joint Economic Committee.

EUR: The Euro rallied after the comment from the Chinese official and traded to a high of 1.4731 before closing around 1.4650. On the data front, Germany’s industrial production increased 0.3% m/m in September, well above the expected 0.3% decline. Later today in Europe, the ECB is expected to make no change to rates of 4.00%. ECB President Trichet will hold a press conference.

JPY: USD/JPY hit a three-month low against the yen and stayed pressured against other currencies on Thursday as a plunge in U.S. stocks overnight kept intact expectations for another Federal Reserve interest rate cut next month. Dollar selling had not been that severe against the yen, but it has now spread to this pair, indicating that downside risks to the U.S. currency are growing. The dollar was trading around 112.70 yen in late U.S. trade on Wednesday after falling to a three-month low of 112.00 yen earlier this session. Traders said the dollar's recovery was due to buying from Japanese importers. Traders said the yen could gain against the dollar and high-yielding currencies on slides in Asian equities, which would prompt risk-averse investors to unwind carry trades in which they use low-yielding yen to buy higher-yielding currencies and assets.

AUD: Australia employment rose 12,900 in October mainly due to 70,600 full-time jobs being added. The unemployment rate rose to 4.3 percent and the participation rate was steady at 65.0. Forecasts centered on a rise of 20,000 in employment, the unemployment rate holding steady at 4.2 percent and the participation rate steady at 65.0 percent. The Australian dollar edged lower after a softer than expected headline jobs figure added to the dour sentiment caused by growing risk aversion which has prompted investors to dump high-yielding currencies and stocks.

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2007-10-03T23:28:00.001-07:00

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2007-10-03T21:31:00.000-07:00

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2007-10-03T21:20:00.000-07:00

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2007-10-03T21:08:00.000-07:00

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Why Trade Forex?

2007-10-03T20:04:00.000-07:00

Key Benefits of Forex Trading
The Forex market is becoming more attractive to traders because of some of the following:

Liquidity
The market turns over $1.8 trillion USD a day. This results in there always being a buyer and a seller. The trading volumes and trade sizes in Forex dwarf the capacity of any other market. The liquidity of Forex allows any speculator to open or close a position at will, 24 hours a day.

Access
The Forex market is open 24 hours daily, 5 days a week. Usually brokers do close over the weekend and public holidays. Check with your broker on their respective closing times. The market follows the sun around the world, with New Zealand being one of the first countries to open, typically at 8am Sydney time. The other important times to consider during the day are:

• Tokyo open – 10am Sydney time
• European Bond Market – 4pm Sydney time
• European Equity Markets – 5pm Sydney time
• London Open – 6pm Sydney time
• USA open – 10.30pm Sydney time
• London Close – 2.00am Sydney time
• USA Close – 5am Sydney time

During the day trading is on a continuous basis without any stop and resumption in trading to reflect the above opening times. Knowing these times simply allows you to know when the most liquidity is in the market. Clearly this is during Tokyo trading hours increasing to the European and USA open times. It is possible to trade at any time during the weekdays up until Friday USA close when the market does not trade over the weekend and re opens Monday morning. Usually you will only need to look for entries in the 3 hours after these market open times.

Leverage
Trading in Forex is done using contracts or “lots”. Each contract is approx. worth
$100,000 of the base currency you are trading. To trade a contract a trader does not need to physically have this amount of money in there trading account. Instead margin is applied in Forex trading and is expressed as a percentage of the $100,000.

Margin between different Forex brokers will vary but are typically 1-4%. A 1% margin means that a trader needs to allocate $1000 of the base currency per contract for each open position.
Therefore if you were to open a position with 5 contracts then physically in the market you are exposed to $500,000 of the base currency. For this exposure assuming a 1% margin requirement you would need $5000. This leverage gives gearing of 100:1 for 1% margin or 50:1 for 2% margin accounts. It is this gearing that allows traders to make large percentage returns on there capital.

Automated Stops
The Forex market is so liquid brokers can offer automated stops allowing traders to control risk. Even though in normal market trading most brokers will guarantee stop losses, there are times when physically it is not possible for them to do so. Over the weekend the market may gap when Monday morning opens and if you are in a position over the weekend with a stop loss it might happen that the market gaps through your stop loss.

If this is the case the broker may not execute your stop at the price you have, but rather where the market has gapped. Most traders will exit there position on Friday night to avoid holding positions over the weekend just in case due to geopolitical issues the market gaps. Another time where the market can gap is during the release of announcements.

When a major important announcement is released, and the result differs greatly from the expected value, you might have a large move of around 50-100 pips in the 1min announcement candle. This move will occur with gaps in it, and again if your stop loss order gets gapped you might encounter slippage.

Two Way Market
Currencies are traded in pairs, for example Dollar/Yen or Dollar/Swiss Franc. Every position involves the selling of one currency and the buying of another. If a trader believes the Swiss Franc will appreciate against the dollar, then the trader can sell dollars and buy francs. I.e. the trader is selling short the dollar against the franc. Forex trading allows profits to be taken from both rising and falling markets with the same ease. Shorting a currency is as easy as going long on the same currency.

Continuity of Price Action
Because the market is a 24-hour a day market and is open 5 days a week there are very few gaps. Thus the market does not gap through your stops. This means that risk can be controlled.

Minimal Slippage
Because the Forex market is so liquid, most trades can be executed at the current market price. In all fast moving markets, slippage is inevitable, however many brokers software reduces this problem by allowing you to get a quote just prior to execution.

You then have the option of accepting that quote and any slippage or rejecting the price.
A Forex internet trader does not have to phone a broker. All transactions are completed online. This eliminates the middleman (the broker) and therefore reduces transaction costs and makes the process of order entry much faster. It also avoids the possibility of a misunderstanding. Confirmation of trades is immediate and all trades can be printed for record keeping purposes. In the event of a temporary technical problem, brokers have a 24-hour a day dealing desk number that can be called to get in or out of a position.

Execution Costs
With most providers you will not pay commissions for the trades you enter. Again most providers will act as a market maker, not as a broker, and makes its earnings from the spreads that are embedded in the currency rates. When trading Spot and Forward transactions you may roll over your positions and then you will pay what is termed a “roll over”.

Narrow Focus
Rather than looking at the entire stock market of many thousands of securities, the
Forex trader is typically analysing just a handful of charts. These are referred to as the major currencies and some of these are listed below:

USDYEN US dollar/Japanese Yen
GBP/USD British Pound/US dollar
EUR/USD Euro/US dollar
USD/CHF US dollar/Swiss Franc
EUR/JPY Euro/US dollar

In addition to the above majors you would also look to trade the following minor
currencies:

USD/CAD US dollar/Canadian dollar
AUD/USD Australian dollar/US dollar

There are also cross rates like GBP/YEN and these can be traded, but based on liquidity it is best to stick to just the major currencies listed above. Since you are only looking at small number of charts you can better follow and understand the patterns in each chart.

Flexible Time Exposure
The trader can choose the time frame of exposure to suit his/her circumstances. Ie: trading daily charts or 5 minutes charts.

Simplicity
Forex trading is not as complicated as many other markets. These are no time decays,
implied volatilities, expiry dates, dividends, exercise prices, conversion factors, deltas, Vegas, elasticity, intrinsic values etc to deal with. Thus trading decisions are much clearer and the market is much fairer.

Identifiable Trends
The currency markets have demonstrated in the past substantial and identifiable trends. Each currency has its own personality and each offers unique historical patterns of trends, providing diversified trading opportunities within the Forex market.
Here are some examples of the EUR in various timeframes demonstrating clear movements in price action and therefore offering the opportunity of trading.
Daily Chart of EUR/USD
30-minute chart of EUR/USD
5-minute chart of EUR/USD

Diversification of an Investment Portfolio
The Forex Market is classified as a separate asset class to equities, properties and bonds. The Forex market is also highly uncorrelated with the mentioned asset classes. Therefore, investing a portion of one’s investments into the Forex market will increase the diversification of the investment portfolio.

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2007-10-03T19:33:00.000-07:00

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What are the Main Economic Indicators coming out of the United States?

2007-10-03T19:06:00.000-07:00

An economic indicator (or business indicator) is a statistic about the economy. Economic indicators allow analysis of economic performance and predictions of future performance.
Economic indicators can be leading, lagging, or coincident which indicates the timing of their changes relative to how the economy as a whole changes.

Leading: Leading economic indicators are indicators which change before the economy changes. Stock market returns are a leading indicator, as the stock market usually begins to decline before the economy declines and they improve before the economy begins to pull out of a recession. Leading economic indicators are the most important type for investors as they help predict what the economy will be like in the future.

Lagged: A lagged economic indicator is one that does not change direction until a few quarters after the economy does. The unemployment rate is a lagged economic indicator as unemployment tends to increase for 2 or 3 quarters after the economy starts to improve.

Coincident: A coincident economic indicator is one that simply moves at the same time the economy does. The Gross Domestic Product is a coincident indicator.
Now we will list the most important US economic indicators followed by traders, investors and analysts.

Now we will list the most important US economic indicators followed by traders, investors and analysts.

Non - Farm Payrolls
Description: As the names suggests this report lists the number of payroll jobs at all non-farm business establishments and governments agencies. This is the most closely watched economic release in the States. Coincident indicator of economic growth.

The greater the increase in employment, the faster the total economic growth. An increasing unemployment rates is associated with an expanding economy. The economy is considered to be at full employment when the unemployment rate is between 5.5% and 6.0 %. Average earnings are also measured in this report and if this rises sharply, it acts as a guide of potential inflationary pressures.

Release Date: 8:30 (EST); monthly, usually first Friday of every month.

ISM Manufacturing Index
Description: Based on surveys of 300 purchasing managers nationwide and represents 20 industries regarding manufacturing activity. The ISM Manufacturing index is considered to be the premier manufacturing indices. Readings of 50% or above are typically associated with an expanding manufacturing sector and healthy economy, while readings below 50 are associated with contraction.

The sub-components of the index are very important and it contains useful information about manufacturing activity. The production component is related to industrial production. The new orders to durable goods orders and employment to factory payrolls. Prices are linked to producer prices, export orders to merchandise trade exports and import orders to merchandise imports. The index is seasonally adjusted for greater accuracy.

Release Date: 10:00 (EST); monthly, first business day after reporting month.

Consumer Price Index (CPI)
Description: a consumer price index (CPI) is a statistical time-series measure of a weighted average of prices of a specified set of goods and services purchased by consumers. It is a price index that tracks the prices of a specified basket of consumer goods and services, providing a measure of inflation. It is also known as a cost of living index. It's important to monitor the CPI excluding food and energy prices for its monthly stability. This is referred to as "core CPI" and gives a clearer picture of the underlying inflation trend. The rate of change of the core CPI is one of the key measures of inflation for the US economy. Inflationary pressure is generated when the core CPI posts larger than expected gains.

Release Date: 8:30 AM (EST); monthly.

Retail Sales
Description: this index measures the total sales of goods by all retail establishments in the U.S. (sales of services are not included). These figures are in current dollars, that is, they are not adjusted for inflation. It is the timeliest indicator of the broad consumer spending patterns and is adjusted for normal seasonal variation, holidays, and trading-day differences.
Retail sales are the first picture of consumer spending for a given month. Retail sales are often viewed ex-autos, as auto sales can move sharply from month-to-month. Retail sales can be quite volatile and the advance reports are subject to large revisions. Data is revised three months back every month and can be substantial.

Release Date:8:30 AM (EST); monthly, midmonth and approximately two weeks following the reporting month's end.

Trade Balance or US Trade Deficit
Description: this report measures the difference between exports and imports of US goods and services. The trade report is most widely watched for trends in the overall trade balance. This report is significant as imports and exports are important components of aggregate economic activity, representing approximately 14 and 12 percent of GDP respectively.
Changes in the trade balance with particular countries can have implications for foreign exchange and policy with that trading partner. Therefore, this report is of importance to investors who are interested in diversifying globally.

Release Date: 8:30 AM (EST); monthly.

Personal Income and Consumption
Description: Personal Spending, also known as PCE, represents the change in the market value of all goods and services purchased by individuals. This is the largest component of GDP. Personal Income represents the income that households receive from all sources, including employment, self-employments, investments, and transfer payments. Income is the major factor in regards to spending and US consumers spend approximately 95 cents of each new dollar. Consumer spending accounts for two-thirds of the economy and greater spending stimulates corporate profits as well as benefiting the stock market.

This indicator has gained further credibility in February 2000 when the FOMC began forecasting inflation in terms of the personal consumption expenditures deflator (PCE Deflator, a component of the report). So basically the FOMC prefers the PCE Deflator rather than the CPI.

Release Date: Released first business day of the month at 8.30 am New York time.

Gross Domestic Product - GDP
Description: Gross Domestic Product (GDP) is the broadest measure of economic activity. GDP measures the dollar value of all goods and services within the borders of the United States, regardless of who owns the assets or the nationality of the labor used in producing the output. Strong GDP growth is between 2.0% and 2.5%. A higher GDP growth will lead to quicker inflation, while lower growth indicates a soft economy.

Quarterly GDP reports are broken down into three announcements: advance, preliminary and final. After the final revision, GDP is not revised again until the annual benchmark revisions each July.

Release Date: 8:30 AM (EST); Figures released monthly, around the 4th week following the reported month.

Durable Goods Orders
Description: This is a government index that measures the dollar volumes of orders, shipments, and unfilled orders of durable goods. Durable goods are new or used items generally with a normal life expectancy of three years or more. The report provides information on the strength of demand for US manufactured durable goods, from both domestic and foreign sources. A rising index suggests demand is strengthening and will result is rising production and employment. A falling index suggests the opposite.

Durable Goods Orders are considered a leading indicator of manufacturing activity, and the market moves on this report despite the volatility and large revisions that make it a less than perfect indicator. Analysts usually exclude defense and transportation orders because of their volatility. The report is also one of the earliest indictors of both consumer and business demand for equipment. Increased expenditures on investment goods reduce the prospect of inflation.

Release Date: 8:30 AM (EST); monthly, 3 to 4 weeks after the reporting month.

Producer Price Index (PPI)
Description: The Producer Price Index measures prices of goods at the wholesale level. There are three broad subcategories within the PPI: industry; commodity; and stage-of-processing. At all stages of production, the market places more emphasis on the index excluding food and energy and this is referred to as core PPI. Core PPI gives a clearer picture of the underlying inflation trend. Changes in the core PPI are considered a precursor of consumer price inflation. Inflationary pressure is generated when the core PPI posts larger-than-expected gains.
The index is not revised on a monthly basis, but annual revisions to seasonal adjustment factors can produce small adjustments to past releases.

Release Date: 12:30 (GMT); monthly, 2 weeks after the reporting month.

Industrial Production and Capacity Utilisation
Description: The index of Industrial Production is a fixed-weight measure of the physical output of the nation's factories, mines and utilities. This report is combined with capacity utilization which is seen as a critical gauge of the slack available in the economy. The industrial sector of the economy represents approximately 25 percent of GDP. Changes in GDP are heavily concentrated in the industrial sector. Therefore, changes in the index of industrial production provide useful information on the current growth of GDP. Investors use the capacity utilization rate as an inflation indicator. If it gets above 85%, inflationary pressures are generated.

The data are revised monthly for the prior three months to reflect more complete information. New seasonal adjustment factors are introduced in December. The revision affects at least three years worth of data and its significance is moderate.

Release Date: 9:15 AM (EST); Monthly, approximately 15 days following the reporting

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Forex Market Analysis

2007-10-03T18:33:00.000-07:00

Introduction

There are two necessary methods in forecasting the currency market, fundamental analysis and technical analysis.

Fundamental analysis focuses on the economic, social and political forces that drive supply and demand. Fundamental analysts look at various macroeconomic indicators such as economic growth rates, interest rates, inflation, and unemployment. However, there is no single set of beliefs that guide fundamental analysis. There are several theories as to how currencies should be valued.

Technical analysis focuses on the study of price movements.

Forex Technical Indicators

A technical indicator is a tool in the technical analyst's box. Those based on price data include any combination of the open, high, low or close over a period of time. Some indicators may use only the closing prices, while others incorporate volume and open interest into their formulas. The price data is entered into the formula and a data point is produced.

A technical indicator offers a different perspective from which to analyse the price action. Some are derived from simple formulas and the mechanics are relatively easy to understand. Others have complex formulas and require more study to fully understand and appreciate. Regardless of the complexity of the formula, technical indicators can provide unique perspective on the strength and direction of the underlying price action. Here we will list the most commonly used technical indicators and offer a brief description

Bollinger Bands

An indicator that allows users to compare volatility and relative price levels over a period of time. The Bollinger Bands are envelopes based on a moving average and a standard deviation which makes the bands widen or narrow relative to the current market volatility.

95% of price action will take place within the Bollinger bands and thus the Bands act as strong areas of support and resistance when the forex market is without trend. It is possible at times like this to successfully trade the price rising or falling from one Bollinger line to the other. When a trend begins and the volatility of the market increases thus the spacing of the Bollinger Bands will widen, as the trend slows down the Bollinger bands will narrow.

Moving Average Convergence Divergence

An indicator that follows the difference between a pair of moving averages. Developed by Gerald Appel, MACD (moving average convergence divergence) is a trend following momentum indicator that shows the relationship between two moving averages of prices.

Calculation
To calculate the MACD subtract the 26-day exponential moving average (EMA) from a 12-day EMA. A 9-day dotted EMA of the MACD called the signal line is then plotted on top of the MACD. Other lengths of average can be used, but 9-12-26 is the most common "standard" setting.

Function
MACD measures the difference between two moving averages. A positive MACD indicates that the 12-day EMA is trading above the 26-day EMA. A negative MACD indicates that the 12-day EMA is trading below the 26-day EMA. If MACD is positive and rising, then the gap between the 12-day EMA and the 26-day EMA is widening. This indicates that the rate-of-change of the faster moving average is higher than the rate-of-change for the slower moving average. Positive momentum is increasing and this would be considered bullish. If MACD is negative and declining further, then the negative gap between the faster moving average and the slower moving average is expanding. Downward momentum is accelerating and this would be considered bearish.

Application

There are 3 common methods to interpret the MACD:

Crossovers - When the MACD falls below the signal line it is a signal to sell. Vice versa when the MACD rises above the signal line.
Divergence - When the security diverges from the MACD it may signal the end of the current trend. For instance, price may continue to make higher highs while MACD makes lower highs. This is an example of bearish or negative divergence and a warning that the up trend may soon be finished.
Overbought/Oversold - When the MACD rises dramatically (shorter moving average pulling away from longer term moving average) it is a signal the security is overbought and will soon return to normal levels.

Momentum

The impetus of a directional movement, or a technical indicator used to measure directional impetus. Also described as a style of forex trading where one looks for increased impetus as an entry signal. Momentum can refer to a number of things in regard to trading.

Firstly it can refer to 'momentum' as the impetus, or increased activity of an item - such as a stock or index. This can be referred to as gaining momentum or losing momentum
Secondly it is a type of indicator that can be added to a chart as part of technical analysis - this is a Momentum Indicator, which measures the amount of impetus or activity in a stock or index and shows it growing or waning. There are also other types of momentum indicators such as the Relative Strength Index or the Stochastic Momentum Indicator.

Third it can refer to a type of trading or investing, where traders look for an increase in the momentum of a stock or index as an entry point for their trade.

Moving Averages

An average of price, or some other data value, plotted over time. A moving average is referred as such because it is recalculated at each consecutive point in time. Moving averages are used in technical analysis The effect is to produce a line that smoothes out fluctuations in the original data.

Types of Moving Averages
Simple moving average (SMA): The unweighted mean of the previous n data points in the time series. For example, a 10-day simple moving average closing price is the mean of the previous 10 days' closing prices. The larger the value of n, the greater the smoothing effect and the more the MA line is displaced from the original data.

Weighted moving average (WMA): The weighted mean of the previous n data points in the time series. The weighting is generally (but not necessarily always) linear. That means a relative weight of 1 is assigned to time period t, with each previous period's value assigned a lower weight on down to a relative weight of 1/n assigned to time period t-n. The WMA is more responsive to recent movements than the SMA.

Exponential moving average (EMA): An exponentially weighted mean of previous data points. The parameter of a EWMA can be expressed as a proportional percentage. For example, a 10% EMA has each time period assigned a weight that is 90% of the weight assigned to the next more recent time period.

Relative Strength Index (RSI)

RSI is an extremely useful, reliable indicator which is a favourite of many forex traders.
CalculationThe RSI is generally calculated using a 14 day time period (and this is generally the default setting of many trading software packages) however other time periods can be used such a 9 day for a faster setting and 25 day for a slower setting.

The Formula is:

RSI = 100 - 100 / (1 + RS)

RS = AG / AL

AG = Average Gain over RSI Period

Gain = Price - Price.x (when Price > Price.x)

AL = Average Loss over RSI Period

Loss = Price - Price.x (when Price <>

x = Momentum Period

Application

In general terms the RSI is an overbought/oversold indicator. In practice below 30 is considered being an oversold indication and when the RSI crosses 30 to go up, this is a buy signal. At the other end of the scale a value above 70 is considered overbought and when the RSI crosses to go below this, it gives a sell signal.

It should be noted that the RSI will form chart patterns similar to those found on the main chart, such as a double top, head and shoulders etc which may not show up in the stock/indices price, but which will give and an indication as to pending change ahead.

The RSI will also form support and resistance levels, just like the main chart and it may also diverge from the main chart direction indicating change. For example, the stock/index may make a new high, but the RSI doesn't - that's a bearish indicator. Conversely the stock/index may make a drop to a new low but the RSI moves sideways or upwards - that's a bullish indication. In these cases the price will usually follow the direction the RSI has just shown.

Stochastic Oscillator

The Stochastic is a momentum indicator devised by George Lane in the 1950's. It gives overbought or oversold signals depending on its position relative to the 0 level. The Stochastic can also be used to give convergence and divergence indications, such as when a stock/index price makes a new low however the Stochastic does not - this is a bullish divergence. Conversely when the stock/index price makes a new high but the Stochastic does not or moves horizontally this is a bearish divergence and the price of the stock/index will soon follow the Stochastic.

In general terms a Stochastic level below 20 would be considered oversold, where as a level above 80 would be considered overbought. However, Lane did not believe that a reading above 80 was necessarily bearish or a reading below 20 bullish. A buy or sell signal can be generated by the Stochastic when the indicator passes back above the 20 level for a buy signal or below the 80 level for a sell signal.

There are different types of Stochastic Oscillator and reference may be made to a Fast Stochastic or a Slow Stochastic. These are generated by using different settings - as detailed in the calculation below. The Fast Stochastic can be useful for quick trades - made in short time frames. The Slow Stochastic is more smoothed and loses a lot of 'noise' that can lead to confusion with the Fast Stochastic.

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Fundamental Analysis

The role of interest rates

Using the interest rates independently from the real economic environment translated into a very expensive strategy. Because foreign exchange, by definition, consists of simultaneous transactions in two currencies, then it follows that the market must focus on two respective interest rates as well.

This is the interest rate differential, a basic factor in the markets. Forex Traders react when the interest rate differential changes, not simply when the interest rates themselves change. For example, if all the G-5 countries decided to simultaneously lower their interest rates by 0.5 percent, the move would be neutral for foreign exchange, because the interest rate differentials would also be neutral. Of course, most of the time the discount rates are cut unilaterally, a move that generates changes in both the interest differential and the exchange rate. Forex Traders approach the interest rates like any other factor, trading on expectations and facts. For example, if rumor says that a discount rate will be cut, the respective currency will be sold before the fact. Once the cut occurs, it is quite possible that the currency will be bought back, or the other way around. An unexpected change in interest rates is likely to trigger a sharp currency move. Other factors affecting the trading decision are the time lag between the rumor and the fact, the reasons behind the interest rate change, and the perceived importance of the change. The market generally prices in a discount rate change that was delayed. Since it is a fait accompli, it is neutral to the market. If the discount rate was changed for political rather than economic reasons, a common practice in the European Monetary System, the markets are likely to go against the central banks, sticking to the real fundamentals rather than the political ones. This happened in both September 1992 and the summer of 1993, when the European central banks lost unprecedented amounts of money trying to prop up their currencies, despite having high interest rates. The market perceived those interest rates as artificially high and, 29 therefore, aggressively sold the respective currencies. Finally, Forex Traders deal on the perceived importance of a change in the interest rate differential.

Financial factors

Financial factors are Vital to fundamental analysis. Changes in a government's monetary or fiscal policies are bound to generate changes in the economy, and these will be reflected in the exchange rates. Financial factors should be triggered only by economic factors. When governments focus on different aspects of the economy or have additional international responsibilities, financial factors may have priority over economic factors. This was painfully true in the case of the European Monetary System (EMS) in the early 1990s. The realities of the marketplace revealed the underlying artificiality of this approach.

Political crises influence

A political crisis is commonly dangerous for the Forex because it may trigger a sharp decrease in trade volumes. Prices under critical conditions dry out quickly, and sometimes the spreads between bid and offer jump from 5 pips to 100 pips. Unlike predictable political events (parliament elections, interstate agreements conclusion etc), which generally take place in an exact time and give market the opportunity to adopt, political crises come and strike suddenly. Currency traders have a knack for responding to crises. The traders should react as fast as possible with risk management to avoid big losses. They have not much time to take decisions, often they have only seconds. Return on the market after a crisis is often problematic.

Monetary Operations by Central Banks

All central banks and the U.S. Federal Reserve System (FRS) as well, affect the foreign exchange markets changing discount rates and performing the monetary operations (as interventions and currency purchases).

For the foreign exchange operations most significant are repurchase agreements to sell the same security back at the same price at a predetermined date in the future (usually within 15 days), and at a specific rate of interest. This arrangement amounts to a temporary injection of reserves into the banking system. The impact on the foreign exchange market is that the national currency should weaken. The repurchase agreements may be either customer repos or system repos. Matched sale-purchase agreements are just the opposite of repurchase agreements. When executing a matched sale-purchase agreement, a bank or the FRS sells a security for immediate delivery to a dealer or a foreign central bank, with the agreement to buy back the same security at the same price at a predetermined time in the future (generally within 7 days). This arrangement amounts to a temporary drain of reserves. The impact on the foreign exchange market is that the national currency should strengthen.

Monetary operations include payments among central banks or to international agencies. In addition, the FRS has entered a series of currency swap arrangements with other central banks since 1962. Also, payments to the World Bank or the United Nations are executed through central banks.

Intervention in the United States foreign exchange markets by the U.S. Treasury and the FRS is geared toward restoring orderly conditions in the market or influencing the exchange rates. It is not geared toward affecting the reserves.

There are two types of foreign exchange interventions: naked intervention and sterilized Intervention. Naked intervention, or unsterilized intervention, refers to the sole foreign exchange activity. All that takes place is the intervention itself, in which the Federal Reserve either buys or sells U.S. dollars against a foreign currency. In addition to the impact on the foreign exchange market, there is also a monetary effect on the money supply. If the money supply is impacted, then consequent adjustments must be made in interest rates, in prices, and at all levels of the economy. Therefore, a naked foreign exchange intervention has a long-term effect.

Sterilized intervention neutralizes its impact on the money supply. As there are rather few central banks that want the impact of their intervention in the foreign exchange markets to affect all corners of their economy, sterilized interventions have been the tool of choice. This holds true for the FRS as well. The sterilized intervention involves an additional step to the original currency transaction. This step consists of a sale of government securities that offsets the reserve addition that occurs due to the intervention. It may be easier to visualize it if you think that the central bank will finance the sale of a currency through the sale of a number of government securities. Because a sterilized intervention only generates an impact on the supply and demand of a certain currency, its impact will tend to have a short-to medium-term effect.

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What are the Major Currencies?

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US Dollar - $US
Also referred to as the dollar, greenback and buck.

The US Dollar was adopted by the Congress of the Confederation of the United States on July 6, 1785 and is the most used in international transactions. Several countries use the U.S. dollar as their official currency, and many others allow it to be used in a de facto capacity.

In 1995, over US$380 billion were in circulation, of which two-thirds was outside the United States. By 2005, those figures had doubled to nearly $760 billion with an estimated half to two-thirds being held overseas, which is an annual growth of about 7.6%. However, as of December 2006, the dollar was surpassed by the euro in terms of combined value of cash in circulation.

The value of euro notes in circulation has risen to more than € 610 billion, equivalent to US$800 billion at the exchange rates at this time.

The U.S. dollar uses the decimal system, consisting of 100 (equal) cents (symbol ¢).

The Euro - €
The euro (currency sign: €; banking code: EUR) is the official currency of the European states of Austria, Belgium, Finland, France, Germany, Greece, Ireland, Italy, Luxembourg, the Netherlands, Portugal, Slovenia and Spain - also known as the Eurozone - and is the single currency for more than 317 million people in Europe.

Including areas using currencies pegged to the euro, the euro affects more than 480 million people worldwide, with more than €610 billion in circulation as of December 2006. While all EU member states are eligible to join if they comply with certain monetary requirements, the euro is not used in all of the European Union as not all EU members have adopted the currency. All nations which have recently joined the EU are pledged to adopt the euro in due course, but the United Kingdom and Denmark are under no such obligation. Several small European states (The Vatican, Monaco and San Marino), although not EU members, have adopted the euro due to currency unions with member states. Andorra, Montenegro and Kosovo have adopted the euro unilaterally.

The Yen - ¥
The yen or (Japanese yen) is the currency of Japan. It is also widely used as a reserve currency after the United States dollar and euro.

The yen was introduced by the Meiji government in 1870 as a system resembling those in Europe. The yen replaced the complex monetary system of the Edo period, based on the mon.

The mon was a currency of Japan until 1870, as there were hundreds of different styles of currency throughout Japanese history, of many shapes, styles, designs, sizes, and materials, including gold, silver, bronze, etc. Even rice was once a currency, the koku.

The yen lost most of its value during and after World War II; after a period of instability, the yen was pegged at 1 US dollar = ¥360 from April 25, 1949, to until 1971 when the Bretton Woods system collapsed and the value of the yen began to float. After the Plaza Accord of 1985, the yen appreciated against the US dollar, until it reached a peak of about ¥85 per dollar in the mid 1990s. After that, the Bank of Japan adopted a weak yen policy which has held it in the range of ¥100-120 per dollar. In the last couple of years, the yen has grown weaker and weaker against not only the dollar but against nearly all other important world currencies due to a de facto zero interest rate policy which has encouraged massive yen carry trades, where speculators borrow in yen and buy bonds and other assets in currencies that charge significant interest. This can be very profitable, but is a short position on the yen, which in the absence of other factors drives the yen's value down.

The relative value of the yen is determined in foreign exchange markets by the economic forces of supply and demand. The supply of the yen in the market is governed by the desire of yen holders to exchange their yen for other currencies to purchase goods, services, or assets. The demand for the yen is governed by the desire of foreigners to buy goods and services in Japan and by their interest in investing in Japan (buying yen-denominated real and financial assets).

The Great British Pound - £
Other Names - Sterling, Cable and the Pound

The pound (symbol: £; ISO code: GBP), divided into 100 pence, is the official currency of the United Kingdom and the Crown Dependencies. The slang term "quid" is very common in the UK.

The official full name pound sterling (plural: pounds sterling) is used mainly in formal contexts and also when it is necessary to distinguish the currency used within the United Kingdom from others that have the same name. The Sterling is the third most traded currency in the world, after the US dollar and the euro.

The Swiss Franc - CHF
The franc (ISO 4217: CHF or 756) is the currency and legal tender of Switzerland and Liechtenstein. The Italian exclave Campione d'Italia and the German exclave Büsingen also use the Swiss franc. Franc banknotes are issued by the central bank of Switzerland, the Swiss National Bank, while coins are issued by the federal mint, Swissmint.

The Swiss franc is the only version of the franc still issued in Europe. Its name in the four official languages of Switzerland is Franken (German), franc (French and Rhaeto-Romanic), and franco (Italian). The smaller denomination, which is worth a hundredth of a franc, is called Rappen (Rp.) in German, centime (c.) in French, centesimo (ct.) in Italian and rap (rp.) in Rhaeto-Romanic. Users of the currency commonly write CHF (the ISO code), though SFr. is still common. SwF has been used in some publications but is not an official abbreviation.

The current franc was introduced in 1850 at par with the French franc. It replaced the different currencies of the Swiss cantons, some of which had been using a franc (divided into 10 batzen and 100 rappen) which was worth 1½ French francs.

In 1865, France, Belgium, Italy, and Switzerland formed the Latin Monetary Union where they agreed to change their national currencies to a standard of 4.5 grams of silver or 0.290322 grams of gold. Even after the monetary union faded away in the 1920s and officially ended in 1927, the Swiss franc remained on that standard until 1967.

As of November 30, 2006, the Swiss franc was worth US$ 0.826729 or € 0.628625. Since mid-2003, its exchange rate with the Euro has been stable at a value of about 1.55 CHF per Euro, so that the Swiss Franc has risen and fallen in tandem with the Euro against the U.S. dollar and other currencies.

The Swiss franc has historically been considered a safe haven currency with virtually zero inflation and a legal requirement that a minimum 40% is backed by gold reserves. However this link to gold, which dates from the 1920s, was terminated on 1 May 2000 following an amendment to the Swiss Constitution. The Swiss franc has suffered devaluation only once, on 27 September 1936 during the Great Depression, when the currency was devalued by 30% following the devaluations of the British pound, U.S. dollar and French franc.

The Australian Dollar
The Australian dollar (currency code AUD) has been, since 14 February 1966, the currency of the Commonwealth of Australia, including Christmas Island, Cocos (Keeling) Islands, and Norfolk Island, as well as the independent Pacific Island states of Kiribati, Nauru and Tuvalu. It is normally abbreviated with the dollar sign $. Alternatively A$ or $A, $AU or AU$ is used to distinguish it from other dollar-denominated currencies. It is sometimes affectionately called the "Aussie battler"; during a low period (relative to the U.S. dollar) around 2001 and 2002 the currency was sometimes locally called the "Pacific Peso". It is divided into 100 cents.

The Australian dollar is currently the sixth-most-traded currency in world foreign exchange markets (behind the U.S. dollar, the euro, the yen, the Pound sterling, and the Swiss franc), accounting for approximately 4-5% of worldwide foreign exchange transactions. The Australian dollar is popular with currency traders due to the relative lack of government intervention in the foreign exchange market, the general stability of the economy and government as well as the prevailing view that it offers diversification benefits in a portfolio containing the major world currencies (especially because of its greater exposure to Asian economies and the commodities cycle).

Who Trades Forex?

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Central Banks
A Central Bank will intervene to buy or sell currencies if they believe it is substantially under or overvalued and that it is having a negative effect on the economy. The national central banks play a key role in the foreign exchange markets as many central banks have very substantial foreign exchange reserves, thus their intervention power is significant

Commercial Banks
Banks are licensed deposit taking institutions, they also support a variety of other services including foreign exchange. These banks will trade currencies among themselves as part of the system of balancing accounts. While exchange rates for their largest customers are extremely competitive, small and medium sized enterprises and individuals will typically pay a large premium when transacting foreign exchange with their local branch. The interbank market caters for both the majority of commercial turnover as well as enormous amounts of speculative trading every day. It is not uncommon for a large bank to trade billions of dollars on a daily basis.

Non Banking Corporations
This group comprises of companies who are involved in the 'goods' market, conducting international transactions for the purchase or sale of merchandise. Exporters are made up of a diverse range of companies exporting goods and services. Generally, exporters have a positive impact on the value of a country's currency. Importers use the foreign exchange markets to purchase foreign currency to make payments for the goods and services they have bought in other countries. They generally have a negative impact on the value of a country's currency. Their trade sizes are most often inconsequential to affect immediate moves in the market, given the large volume traded daily on the Forex market. However since a major key factor for long term trend of currency movements is the balance of trade, if taken as a whole the capital flows arising from these corporations end up having a significant impact.

Hedge Funds
Their influence has increased significantly in the last few years thanks to the overall growth in their industry and abundance of funds at their disposal; however the net effect of this group depends on the investment decisions they make. With the growth of the FX industry they have been, where possible, investing heavily in foreign securities and other foreign financial instruments.

Brokers
They can be classified into Interbank and Client brokers with the influence of the former declining in the last few years due o the shift of businesses to electronic trading systems. The advent of online pricing systems has revolutionized the operational capabilities of this market and changed the traditional role of brokers. But even in the past, most banks were unable to service the needs of small to medium sized organizations as well as commercial & private clients with large corporations their main targeted market. Thus keeping in mind the client's needs ability to invest a certain amount of minimum margin and still be able to trade on competitive spreads led to the advent of Online Broking Companies and ForexCT.com belongs to this group.

Investors/Speculators
Given that the Forex market has high liquidity, a large amount of leverage and the 24/7 operational nature of the market, it has been an attractive playing field for speculators. The service provided by speculators to a market is primarily that by risking their own capital in the hope of profit, they add liquidity to the market and make it easier for others to offset risk, including those who may be classified as hedgers and arbitrageurs.

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History of Retail Forex

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Retail trading, is more structured than the Forex market as a whole. While Forex has been traded since the beginning of financial markets, modern retail trading has only been around since about 1996. Prior to this time, retail investors were limited in their options for entering the Forex market. They could create multiple bank accounts, each one denominated in a different currency, and transfer funds from one account to another in order to profit from fluctuating exchange rate. This was troublesome, however, because the transaction costs incurred were large due to the small quantity of funds being converted relative to the size of the market. This transaction type was at the very bottom of the Forex pyramid.

By 1996, new market makers took advantage of developments in web-based technology that made retail Forex trading practical. The new companies felt that there was enough liquidity in the Forex market, and eventually within their own customer base, to guarantee markets under all but the most unusual market conditions. These companies also created online trading platforms that provided a quick and easy way for individuals to buy and sell on the Forex Spot market. In addition, the companies realized that by pooling many retail traders together, they had the size to enter the upper echelons of the Forex market, which reduced the size of the spread. As the business grew, the market makers were given better prices, which they then passed on to the customer.

Forex Market History

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Prior to 1971 an agreement called the Bretton Woods Agreement prevented speculation in the currency markets. The Bretton Woods Agreement was set up in 1945 with the aim of stabilizing international currencies and preventing money fleeing across nations. This agreement fixed all national currencies against the dollar and set the dollar at a rate of $35 per ounce of gold. Prior to this agreement the gold exchange standard had been used since 1876. The gold standard used gold to back each currency and thus prevented kings and rulers from arbitrarily debasing money and triggering inflation. Institutions like the Federal Reserve System of the United States have this kind of power.

The gold exchange standard had its own problems however. As an economy grew it would import goods from overseas until it ran its gold reserves down. As a result the country's money supply would shrink resulting in interest rates rising and a slowing of economic activity to the extent that a recession would occur.

Eventually the recession would cause prices of goods to fall so low that they appeared attractive to other nations. This in turn led to an inflow of gold back into the economy and the resulting increase in money supply saw interest rates fall and the economy strengthen. These boom-bust patterns prevailed throughout the world during the gold exchange standard years until the outbreak of World War 1 which interrupted the free flow of trade and thus the movement of gold.
After the war the Bretton Woods Agreement was established, where participating countries agreed to try and maintain the value of their currency with a narrow margin against the dollar. A rate was also used to value the dollar in relation to gold. Countries were prohibited from devaluing their currency to improve their trade position by more than 10%. Following World War II international trade expanded rapidly due to post-war construction and this resulted in massive movements of capital. This destabilized the foreign exchange rates that had been set-up by the Bretton Woods Agreement.

The agreement was finally abandoned in 1971, and the US dollar was no longer convertible to gold. By 1973, currencies of the major industrialized nations became more freely floating, controlled mainly by the forces of supply and demand. Prices were set, with volumes, speed and price volatility all increasing during the 1970's. This led to new financial instruments, market deregulation and open trade. It also led to a rise in the power of speculators.

In the 1980's the movement of money across borders accelerated with the advent of computers and the market became a continuum, trading through the Asian, European and American time zones. Large banks created dealing rooms where hundreds of millions of dollars, pounds, euros and yen were exchanged in a matter on minutes. Today electronic brokers trade daily in the forex market, in London for example, single trades for tens of millions of dollars are priced in seconds. The market has changed dramatically with most international financial transactions being carried out not to buy and sell goods but to speculate on the market with the aim of most dealers to make money out of money.

London has grown to become the world's leading international financial center and is the world's largest forex market. This arose not only due to its location, operating during the Asian and American markets, but also due to the creation of the Eurodollar market. The Eurodollar market was created during the 1950's when Russia's oil revenue, all in US dollars, was deposited outside the US in fear of being frozen by US authorities. This created a large pool of US dollars that were outside the control of the US. These vast cash reserves were very attractive to foreign investors as they had far less regulations and offered higher yields.

Today London continues to grow as more and more American and European banks come to the city to establish their regional headquaters. The sizes dealt with in these markets are huge and the smaller banks, commercial hedgers and private investors hardly ever have direct access to this liquid and competitive market, either because they fail to meet credit criteria or because their transaction sizes are too small. But today market makers are allowed to break down the large inter-bank units and offer small traders the opportunity to buy or sell any number of these smaller units (lots).

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What is the Forex Market?

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The Forex market (Foreign exchange Market) is the market in which currencies are bought and sold. For example, a market participant is able to receive Australian dollars by paying a specified amount of US dollars. In effect the trader has bought Australian dollars and sold US dollars. The prices of currencies that are set in the market are determined by the amounts that buyers and sellers are willing to pay. For example if there are more participants in the market that want to buy Australian dollars than want to sell Australian dollars at a specific price than the price of the Australian dollar will rise until it reaches a price where there is an equal amount of participants willing to buy and sell at the same price. Profits can be made in the Forex market due to moves in the prices of currencies. The idea is; if you were to buy a currency at a lower price than you sell it for, you have made a profit equal to the difference in the two prices. This is made possible by the simple fact that the price of the currency has changed. If the prices of currencies are changing by large amounts and are doing so often, ie. the market is volatile, than there exists greater potential for higher profits to be made. The Forex market is recognized as one of the most volatile markets in the world.

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