fx primer

Document Sample
fx primer Powered By Docstoc
					                 Contents
Forex
  Forex Overview
  Currency Pairs & Rates
      Rates Calculation
      Spread
      Long/Short
  Trading
      Strategies Day/Position
      Decision making
            1. Technical Analysis – mainly statistical function design by
               some clever folks
            2. Fundamental --- Economic/macro-economic news
                1. Political
                2. Any news
      Brokers/Dealing Firms
            1. Trading Platforms - PC based with broadband access
            2. Selecting firms and trading station software
            3. Signup for account/Deposit etc

      
                                    Forex Overview
What is FOREX/FX
FX/Forex is the exchange of one currency for another. The purpose of FX market is to facilitate trade and
investment. The need for a foreign exchange market arises because of the presence of multifarious
international currencies such as US Dollar, Pound Sterling, etc., and the need for trading in such
currencies.

The foreign exchange market is unique because of

              its trading volumes,
              the extreme liquidity of the market,
              its geographical dispersion,
              its long trading hours: 24 hours a day except on weekends (from 22:00 UTC on Sunday
               until 22:00 UTC Friday),
              the variety of factors that affect exchange rates.
              the low margins of profit compared with other markets of fixed income (but profits can be
               high due to very large trading volumes)
              the use of leverage

According to the Bank for International Settlements,[2] average daily turnover in global foreign exchange
markets is estimated at $3.98 trillion. Of the $3.98 trillion daily global turnover, trading in London
accounted for around $1.36 trillion, or 34.1% of the total, making London by far the global centre for
foreign exchange. In second and third places respectively, trading in New York accounted for 16.6%, and
Tokyo accounted for 6.0%.

The foreign exchange market (currency, forex, or FX) market is where currency trading takes place. It
is where banks and other official institutions facilitate the buying and selling of foreign currencies. [1]FX
transactions typically involve one party purchasing a quantity of one currency in exchange for paying a
quantity of another. The foreign exchange market that we see today started evolving during the 1970s
when world over countries gradually switched to floating exchange rate from their erstwhile exchange
rate regime, which remained fixed as per the Bretton Woods system till 1971.

Now, the FX market is one of the largest and most liquid financial markets in the world, and includes
trading between large banks, central banks, currency speculators, corporations, governments, and other
institutions. The average daily volume in the global foreign exchange and related markets is continuously
growing. Traditional daily turnover was reported to be over US$3.2 trillion in April 2007 by the Bank for
International Settlements.[2] Since then, the market has continued to grow. According to Euromoney's
annual FX Poll, volumes grew a further 41% between 2007 and 2008.[3]




Market participants
      2.1 Banks
      2.2 Commercial companies
      2.3 Central banks
      2.4 Hedge funds as speculators
      2.5 Investment management firms
      2.6 Retail foreign exchange brokers
      2.7 Non-bank Foreign Exchange Companies
      2.8 Money Transfer/Remittance Companies
Unlike a stock market, where all participants have access to the same prices, the foreign exchange market
is divided into levels of access. At the top is the inter-bank market, which is made up of the largest
investment banking firms. Within the inter-bank market, spreads, which are the difference between the
bid and ask prices, are razor sharp and usually unavailable, and not known to players outside the inner
circle. The difference between the bid and ask prices widens (from 0-1 pip to 1-2 pips for some currencies
such as the EUR). This is due to volume. If a trader can guarantee large numbers of transactions for large
amounts, they can demand a smaller difference between the bid and ask price, which is referred to as a
better spread. The levels of access that make up the foreign exchange market are determined by the size
of the “line” (the amount of money with which they are trading). The top-tier inter-bank market accounts
for 53% of all transactions. After that there are usually smaller investment banks, followed by large multi-
national corporations (which need to hedge risk and pay employees in different countries), large hedge
funds, and even some of the retail FX-metal market makers. According to Galati and Melvin, “Pension
funds, insurance companies, mutual funds, and other institutional investors have played an increasingly
important role in financial markets in general, and in FX markets in particular, since the early 2000s.”
(2004) In addition, he notes, “Hedge funds have grown markedly over the 2001–2004 period in terms of
both number and overall size” Central banks also participate in the foreign exchange market to align
currencies to their economic needs.

[edit] Banks

The interbank market caters for both the majority of commercial turnover and large amounts of
speculative trading every day. A large bank may trade billions of dollars daily. Some of this trading is
undertaken on behalf of customers, but much is conducted by proprietary desks, trading for the bank's
own account.

Until recently, foreign exchange brokers did large amounts of business, facilitating interbank trading and
matching anonymous counterparts for small fees. Today, however, much of this business has moved on to
more efficient electronic systems. The broker squawk box lets traders listen in on ongoing interbank
trading and is heard in most trading rooms, but turnover is noticeably smaller than just a few years ago.

[edit] Commercial companies

An important part of this market comes from the financial activities of companies seeking foreign
exchange to pay for goods or services. Commercial companies often trade fairly small amounts compared
to those of banks or speculators, and their trades often have little short term impact on market rates.
Nevertheless, trade flows are an important factor in the long-term direction of a currency's exchange rate.
Some multinational companies can have an unpredictable impact when very large positions are covered
due to exposures that are not widely known by other market participants.

[edit] Central banks

National central banks play an important role in the foreign exchange markets. They try to control the
money supply, inflation, and/or interest rates and often have official or unofficial target rates for their
currencies. They can use their often substantial foreign exchange reserves to stabilize the market. Milton
Friedman argued that the best stabilization strategy would be for central banks to buy when the exchange
rate is too low, and to sell when the rate is too high—that is, to trade for a profit based on their more
precise information. Nevertheless, the effectiveness of central bank "stabilizing speculation" is doubtful
because central banks do not go bankrupt if they make large losses, like other traders would, and there is
no convincing evidence that they do make a profit trading.

The mere expectation or rumor of central bank intervention might be enough to stabilize a currency, but
aggressive intervention might be used several times each year in countries with a dirty float currency
regime. Central banks do not always achieve their objectives. The combined resources of the market can
easily overwhelm any central bank.[6] Several scenarios of this nature were seen in the 1992–93 ERM
collapse, and in more recent times in Southeast Asia.

[edit] Hedge funds as speculators

About 70% to 90% of the foreign exchange transactions are speculative. In other words, the person or
institution that bought or sold the currency has no plan to actually take delivery of the currency in the end;
rather, they were solely speculating on the movement of that particular currency. Hedge funds have
gained a reputation for aggressive currency speculation since 1996. They control billions of dollars of
equity and may borrow billions more, and thus may overwhelm intervention by central banks to support
almost any currency, if the economic fundamentals are in the hedge funds' favor.

[edit] Investment management firms

Investment management firms (who typically manage large accounts on behalf of customers such as
pension funds and endowments) use the foreign exchange market to facilitate transactions in foreign
securities. For example, an investment manager bearing an international equity portfolio needs to
purchase and sell several pairs of foreign currencies to pay for foreign securities purchases.

Some investment management firms also have more speculative specialist currency overlay operations,
which manage clients' currency exposures with the aim of generating profits as well as limiting risk.
Whilst the number of this type of specialist firms is quite small, many have a large value of assets under
management (AUM), and hence can generate large trades.

[edit] Retail foreign exchange brokers

There are two types of retail brokers offering the opportunity for speculative trading: retail foreign
exchange brokers and market makers. Retail traders (individuals) are a small fraction of this market and
may only participate indirectly through brokers or banks. Retail brokers, while largely controlled and
regulated by the CFTC and NFA might be subject to foreign exchange scams.[7][8] At present, the NFA
and CFTC are imposing stricter requirements, particularly in relation to the amount of Net Capitalization
required of its members. As a result many of the smaller, and perhaps questionable brokers are now gone.
It is not widely understood that retail brokers and market makers typically trade against their clients and
frequently take the other side of their trades. This can often create a potential conflict of interest and give
rise to some of the unpleasant experiences some traders have had. A move toward NDD (No Dealing
Desk) and STP (Straight Through Processing) has helped to resolve some of these concerns and restore
trader confidence, but caution is still advised in ensuring that all is as it is presented.

[edit] Non-bank Foreign Exchange Companies

Non-bank foreign exchange companies offer currency exchange and international payments to private
individuals and companies. These are also known as foreign exchange brokers but are distinct in that they
do not offer speculative trading but currency exchange with payments. I.e., there is usually a physical
delivery of currency to a bank account.

It is estimated that in the UK, 14% of currency transfers/payments[9] are made via Foreign Exchange
Companies.[10] These companies' selling point is usually that they will offer better exchange rates or
cheaper payments than the customer's bank. These companies differ from Money Transfer/Remittance
Companies in that they generally offer higher-value services.

[edit] Money Transfer/Remittance Companies

Money transfer/remittance companies perform high-volume low-value transfers generally by economic
migrants back to their home country. In 2007, the Aite Group estimated that there were $369 billion of
remittances (an increase of 8% on the previous year). The four largest markets (India, China, Mexico and
the Philippines) receive $95 billion. The largest and best known provider is Western Union with 345,000
agents globally.



Exchange rates and units used
Foreign Exchange is the simultaneous buying of one currency and selling of another. Currencies are
traded in pairs, for example Euro/US Dollar (EUR/USD) or US Dollar/Japanese Yen (USD/JPY).

Understanding forex quotes: 1 unit of the base currency = the exchange rate in the quote currency. Eg if
EUR/USD is trading at 1.2762, 1 Euro will buy you 1.2762 Dollars.

Understanding contract size in forex trading: The contract size is normally a lot of 100,000. This means
per standard contract you are controlling 100,000 units of the base currency. For this contract size, each
pip (the smallest price increment) is worth $10. Many firms offer mini accounts now where you can trade
units of 10,000, where the pip value is $1.

A pip is a very small measure of change in a currency pair in the forex market. It can be measured in
terms of the quote or in terms of the underlying currency. A pip is a standardized unit and is the smallest
amount by which a currency quote can change, which is usually $0.0001 for U.S.-dollar related currency
pairs, which is more commonly referred to as 1/100th of 1%, or one basis point. This standardized
size helps to protect investors from huge losses. For example, if a pip was 10 basis points, a one-pip
change would cause more extreme volatility in currency values.

What is a pip?
Pip stands for "percentage in point" and is the smallest increment of trade in FX. In the FX market, prices
are quoted to the fourth decimal point. For example, if a bar of soap in the drugstore was priced at $1.20,
in the FX market the same bar of soap would be quoted at 1.2000. The change in that fourth decimal point
is called 1 pip and is typically equal to 1/100th of 1% or one basis point Among the major currencies, the
only exception to that rule is the Japanese yen. Because the Japanese yen has never been revalued since
the Second World War, 1 yen is now worth approximately US$0.08; so, in the USD/JPY pair, the
quotation is only taken out to two decimal points (i.e. to 1/100th of yen, as opposed to 1/1000th with other
major currencies).

What are you really selling or buying in the currency market?
The short answer is "nothing". The retail FX market is purely a speculative market. No physical exchange
of currencies ever takes place. All trades exist simply as computer entries and are netted out depending on
market price. For dollar-denominated accounts, all profits or losses are calculated in dollars and recorded
as such on the trader's account.


Currency Pairs & Rates
      what are they ? Example EUR/USD EUR/GBP
      Rates are quoted as a range of two figures with the difference being the spread. The lower the
       spread the better the deal
Because currencies always trade in pairs, when a trader makes a trade he or she is always long one
currency and short the other. For example, if a trader sells one standard lot (equivalent to 100,000 units)
of EUR/USD, she would, in essence, have exchanged euros for dollars and would now be "short" euro
and "long" dollars. To better understand this dynamic, let's use a concrete example. If you went into an
electronics store and purchased a computer for $1,000, what would you be doing? You would be
exchanging your dollars for a computer. You would basically be "short" $1,000 and "long" 1 computer.
The store would be "long" $1,000 but now "short" 1 computer in its inventory. The exact same principle
applies to the FX market, except that no physical exchange takes place. While all transactions are simply
computer entries, the consequences are no less real.

Long – it is going up
Short – it is going down


Which currencies are traded?
Although some retail dealers trade exotic currencies such as the Thai baht or the Czech koruna, the
majority trade the seven most liquid currency pairs in the world, which are the four majors:

      EUR/USD (euro/dollar)
      USD/JPY (dollar/Japanese yen)
      GBP/USD (British pound/dollar)
      USD/CHF (dollar/Swiss franc)

and the three commodity pairs:

      AUD/USD (Australian
       dollar/dollar)
      USD/CAD (dollar/Canadian
       dollar)
      NZD/USD (New Zealand
       dollar/dollar)

These currency pairs, along with their various combinations (such as EUR/JPY, GBP/JPY and
EUR/GBP) account for more than 95% of all speculative trading in FX. Given the small number of
trading instruments - only 18 pairs and crosses are actively traded - the FX market is far more
concentrated than the stock market.

What is carry?
Carry is the most popular trade in the currency market, practiced by both the largest hedge funds and the
smallest retail speculators. The carry trade rests on the fact that every currency in the world has an interest
rate attached to it. These short-term interest rates are set by the central banks of these countries: the
Federal Reserve in the U.S., the Bank of Japan in Japan and the Bank of England in the U.K. (To learn
more, see What Are Central Banks?)
The idea behind the carry is quite straightforward. The trader goes long the currency with a high interest
rate and finances that purchase with a currency with a low interest rate. In 2005, one of the best pairings
was the NZD/JPY cross. The New Zealand economy, spurred by huge commodity demand from China
and a hot housing market, has seen its rates rise to 7.25% and stay there (at the time of writing), while
Japanese rates have remained at 0%. A trader going long the NZD/JPY could have harvested 725 basis
points in yield alone. On a 10:1 leverage basis, the carry trade in NZD/JPY could have produced a 72.5%
annual return from interest rate differentials alone without any contribution from capital appreciation.
Now you can understand why the carry trade is so popular! But before you rush out and buy the next
high-yield pair, be aware that when the carry trade is unwound, the declines can be rapid and severe. This
process is known as carry trade liquidation and occurs when the majority of speculators decide that the
carry trade may not have future potential. With every trader seeking to exit his or her position at once,
bids disappear and the profits from interest rate differentials are not nearly enough to offset the capital
losses. Anticipation is the key to success: the best time to position in the carry is at the beginning of the
rate-tightening cycle, allowing the trader to ride the move as interest rate differentials increase.

What is leverage?




FX Jargon
Every discipline has its own jargon, and the currency market is no different. Here are some terms to know
that will make you sound like a seasoned currency trader:

       Cable, sterling, pound - alternative names for the
        GBP
       Greenback, buck - nicknames for the U.S. dollar
       Swissie - nickname for the Swiss franc
       Aussie - nickname for the Australian dollar
       Kiwi - nickname for the New Zealand dollar
       Loonie, the little dollar - nicknames for the Canadian
        dollar
       Figure - FX term connoting a round number like
        1.2000
       Yard - a billion units, as in "I sold a couple of yards
        of sterling."

T




Trading

            Brokers/Dealing Firms
                1. Trading Platforms - PC based with fast broadband access
                2. Selecting firms and trading station software

                           Goggle for forex trading and look through the listing.
                            Example below:
                           1. http://www.dbfx.com/?engine=adwords&keyword=fore
                              xtrading&CMP=SFS-70130000000HwJuAAK
                           2. http://www.fxcm.com
3. http://www.ac-markets.com

				
DOCUMENT INFO
Shared By:
Categories:
Tags:
Stats:
views:1
posted:4/14/2012
language:
pages:8