Forex Trading by SelMcKenzie

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Forex Trading Author: Dieter Selzer-McKenzie

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Forex, what is this?

Foreign Exchange (forex) is the simultaneous buying of one currency, and selling of another currency. Daily volume in the currency market exceeds $1.4 trillion, making it the largest and most liquid market in the world. Unlike other financial markets, the forex market has no physical location or central exchange. It is an over-the-counter market where buyers and sellers including banks, corporations, and private investors conduct business. Foreign exchange trading takes place in financial trading centers all over the world, including New York, London, and Tokyo creating one cohesive, international market. The huge number and diversity of players involved make it difficult for even governments to control the direction of the market. The unmatched liquidity and around-the-clock global activity make forex the ideal market for active traders.

Traditionally the forex market was only available to larger entities trading currencies for commercial and investment purposes through banks. Now trading platforms, such as the FX Trading Station, allow smaller financial institutions and retail investors access to a similar level of liquidity as the major foreign exchange banks, by offering a gateway to the primary (Interbank) market.


In the forex market currencies are always priced in pairs; therefore all trades result in the simultaneous buying of one currency and the selling of another. The objective of currency trading is to exchange one currency for another in the expectation that the market rate or price will change so that the currency you bought has increased its value relative to the one you sold. If you have bought a currency and the price appreciates in value, the trader must sell the currency back in order to lock in the profit. An open trade or position is one in which a trader has either bought/sold one currency pair and has not sold/bought back the equivalent amount to effectively close the position.

Quoting Conventions

The first currency in the pair is referred to as the base currency, and the second currency is the counter or quote currency. The U.S Dollar, as the world’s dominant currency, is usually considered the base currency for quotes, and includes USD/JPY, USD/CHF, and USD/CAD. This means that quotes are expressed as a unit of $1 USD per the other currency quoted in the pair. The exceptions are the Euro, Great Britain pund, and Australian dollar. These currencies are quoted as dollars per foreign currency.

As with all financial products, FX quotes include a "bid" and "ask". The bid is the price at which a market maker ( Forex Day Trading) is willing to buy (and clients can sell) the base currency in exchange for the counter currency. The ask is the price at which a market maker ( Forex Day Trading) will sell (and clients can buy) the base currency in exchange for the counter currency. The difference between the bid and the ask price is referred to as the spread.

In the wholesale market, currencies are quoted using five significant numbers, with the last placeholder called a point or a pip. In forex, like any traded instrument, there is an immediate cost in establishing a position. For example, USD/JPY may bid at 131.40 and ask at 131.45, this five-pip spread defines the trader’s cost, which can be recovered with a favorable currency move in the market.

By quoting both the bid and ask in real time, Laketurion Equities ensures that traders always receive a fair price on all transactions. For other commodities where traders must request a price before dealing, brokers have the opportunity to check a trader's existing position and 'shade' the price (in their favor) a few pips depending on the trader's position.


The margin deposit is not a down payment on a purchase of equity, as many perceive margins to be in the stock markets. Rather, the margin is a performance bond, or good faith deposit, to ensure against trading losses. The margin requirement allows traders to hold a position much larger than the account value. Laketurion Equities’ s online trading platform has margin management capabilities, which allow for this high leverage. The trading platform performs an automatic pre-deal check for margin availability, and will only execute the deal if the client has sufficient margin funds in his or her account. The system also calculates the funds needed for current positions and displays this information to clients in real time.

In the event that funds in the account fall below margin requirements, the Laketurion EquitiesDealing Desk will close all open positions. This prevents clients' accounts from falling below the available equity even in a highly volatile, fast moving market.


In the spot forex market trades must be settled in two business days. For example, if a trader sells 100,000 euros on Tuesday, the trader must deliver 100,000 euros on Thursday, unless the position is rolled over. As a service to our traders, FXCM automatically rolls over all open positions i.e. swaps the trade forward to the next settlement date (two business days) at 5:00 PM New York time. The swap rates are determined at the Interbank level and are tradable instruments. In any spot rollover transaction there is a difference in interest rates between the two currencies that will be reflected in the overnight “loan.” If the trader is long the currency with the higher interest rate in the pair, the trader should gain on the spot rollover through the premium relationship of that currency relative to the short currency.  

What Every Currency Trader Should Know

The forex market is one of the most popular markets for speculation due to its enormous size, liquidity, and tendency for currencies to move in strong trends. An enticing aspect of trading currencies is the high degree of leverage available. Forex Day Trading allows positions to be leveraged up to 100:1. Without proper risk management, this high degree of leverage can lead to enormous swings between profit and loss. Knowing that even seasoned traders suffer losses, speculation in the forex market should only be conducted with risk capital funds that if lost will not significantly affect one's personal financial well being.

The Forex Day Trading Mini account was designed for those new to online currency trading. There is a smaller deposit required to open an Forex Day Trading Mini account and trading sizes are 1/10th the size of a regular account. The smaller trade size enables traders to take smaller risks. The Forex Day Trading Mini is intended to introduce traders to the excitement of currency trading while minimizing risk.

Rollover (swap) charges

Rollover charges are determined by the difference between US interest rates and the interest rates in the corresponding country. The greater the interest rate differential between the currency pair, the greater the rollover charge will be. If, for example, the British Pound has the greatest differential with the US Dollar, then the rollover charge for holding British Pound positions would be the most expensive. Conversely, if the Swiss Franc were to have the smallest interest rate differential to the US Dollar, then overnight charges for USD/CHF would the least expensive of the 8 currency pairs we offer.

The spot forex market is traded on a 2-business day value date. For trades executed on Monday, the value day, or day of delivery, is Wednesday. However, if a position is opened on Monday and held until Tuesday, then the next value day will be that Thursday. For positions that are opened and held overnight on Wednesday, the value date is in fact the following Monday, under the criteria that there is not a holiday in any of the participating markets. On Wednesday, rollover fee is charged for Monday, meaning an extra two days of fees for the weekend when banks are not open and actual delivery of currency cannot be made. Trades executed on Friday would have a value date on Tuesday, which when rolled over, will incur only one day charge. It is important to understand that every deal has a value day. If the deal is not closed on the same day, then the trade is subject to rollover.

Rollover takes place when the settlement of a trade is rolled forward to next value date with the cost of this process based on the interest rate differential of the two currencies. On the DealStation™ platform, rollover occurs at 3:00 PM (EST). Rollover charges and credits are shown in dollar terms under the 'Rollover' column on the DealStation™. A negative number represents a charge and a positive number shows a rollover credit. These figures are usually updated a few hours prior to 3:00 PM (EST).

Effective December 1st, 2003, clients will be able to earn rollover credits on a margin of 2% or higher as long as they are long the currency with the higher interest rate. Rollover charges will apply to all other transations.

Spot/Next Swap Points

Here is an example for the calculations for interest rate swap points on any particular day?

EUR 0.6 points
JPY 0.7 points
GBP 1.5 points
CHF 0.6 points
AUD 1 point
CAD 0.9 points
EUR/JPY 1 point
AUD/JPY 1 point

* These points are taken from our news feeds every day around noon. Swap points are traded instruments and are subject to market volatility.

The formulas are calculated as follows:

EUR = .00006 x 100,000 = $6.
JPY = 15,000,000/120.25 = $124,740.12 x 0.007 = JPY 873.18/120.25 = $7.26
GBP = .00015 x 100,000 = $15.00
CHF = 150,000/1.3750 = 109090.90 x .00006 = CHF 6.55/1.3750 = $4.76
AUD = .0001 x 100,000 = $10
CAD = 150,000/1.5000 = $100,000 x .00009 = CAD 9.00/1.50 = $6
EUR/JPY = 0.01 x 100,000 = 1000 yen/120.25 = $8.32
AUD/JPY = 0.01 x 100,000 = 1000 yen/120.25 = $8.32

Forex Market Terminology

Base Currency
The currency against which other currencies are quoted. Example, the primary base currency is the u.s. dollar.

Bear Market
A market in which prices decline sharply against a background of widespread pessimism (opposite of Bull Market). Bear Markets are generally shorter in duration than Bull Markets.

The rate at which a dealer is willing to buy the base currency.

Bull Market
A market characterized by rising prices.

An agent who handles investors' orders to buy and sell currency.

The customer or bank with which a foreign exchange deal is executed.

Day Trading
Refers to opening and closing the same position or positions before the close of that day's trading (3:00p.m. EST).

Flat / Square
Where a Client has not traded in that currency or where an earlier deal is reversed thereby creating a neutral (flat) position. Example: bought $100,000 then sold $100,000 = FLAT.

An abbreviation of foreign exchange.

Fundamental Analysis
Analysis based on economic factors.

"Good Till Cancelled." An order left with a Dealer to buy or sell at a fixed price. The order remains in place until it is cancelled by the client.

Interbank Rates
The FX rates large international banks quote other large international banks. Normally the public and other businesses do not have access to these rates. Global Forex is one of the few companies able to provide clients with interbank rates on transactions sizes of less than $1,000,000.

Limit Order
An order given which has restrictions upon its execution, where the client may specify a price and the order can be executed only if the market reaches that price.

A market position where the Client has bought a currency he previously did not own. Normally expressed in base currency terms. For example: long Dollars (short Japanese Yen).

Margin is a cash deposit provided by clients as collateral to cover possible future losses that may result from the clients Foreign Exchange trades.

Margin Call
A demand for additional funds. A requirement by a clearing house that a clearing member (or by a brokerage firm that a client) brings margin deposits up to a required minimum level to cover an adverse movement in price in the market.

The rate at which a Dealer is willing to sell the base currency.

Open Position
Any deal which has not been offset or reversed by an equal and opposite deal.

Overnight Trading
Refers to positions held open between 3p.m. EST and 7p.m. EST.

Pip or Points
Depending on context, normally one basis point, i.e. 0.0001.

A market position where the Client has sold a currency he does not already own. Normally expressed in base currency terms, example, short Dollars (long D. Marks).

The difference in prices between bid and offer rates.

Stop Loss Order
An order to buy or sell at the market when a particular price is reached, either above or below the price that prevailed when the order was given.

Technical Analysis
Analysis based on market action through chart study, moving averages, volume, open interest, formations, and other technical indicators.

A measure of price fluctuations.

Foreign Exchange - The Basics

Foreign exchange is essentially about exchanging one currency for another. The complexity arises from three factors. Firstly what is the foreign exchange exposure, secondly what will be the rate of exchange, and thirdly when does the actual exchange occur.

Identification of Foreign Exchange Exposures
Foreign exchange exposures arise from many different activities. A traveller going to visit another country has the risk that if that country's currency appreciates against their own their trip will be more expensive.

An exporter who sells its product in foreign currency has the risk that if the value of that foreign currency falls then the revenues in the exporter's  home currency will be lower.

An importer who buys goods priced in foreign currency has the risk that the the foreign currency will appreciate thereby making the local currency cost greater than expected.

Fund Managers and companies who own foreign assets are exposed to falls in the currencies where they own the assets. This is because if they were to sell (repatriate) those assets their exchange rate would have a negative effect on the home currency value.

Other foreign exchange exposures are less obvious and relate to the exporting and importing in ones local currency but where the negotiated price is being effected by exchange rate movements.

Generally the aim of foreign exchange risk management is to stabilise the cash flows and reduce uncertainty from financial forecasts. Fortunately there are a range of hedging instruments that achieve exactly that.

  • The currencies to be bought and sold - in every contract there are two currencies the one that is bought and the one that is sold
  • The amount of currency to be bought or sold
  • The date at which the contract matures
  • The rate at which the exchange of currencies will occur

It is point three that requires further explanation. Whenever you see exchange rates advertised either in the newspapers or on the various information services, the rates of exchange assume a deal with a maturity of two business days ahead -a deal done on this basis is called a spot deal.

In a spot transaction the currency that is bought will be receivable in two days whilst the currency that is sold will be payable in two days. This applies to all major currencies with the exception of the Canadian Dollar.

However most market participants want to exchange the currencies at a time other than two days in advance but would like to know the rate of exchange now. For example if ABC Ltd had contracted to purchase a machine for the price of USD 1 mil payable in 6 months time but wanted to be sure that the USD would not become too strong in the interim. ABC Ltd could agree now to buy the USD for delivery in 6 months time. In other words ABC Ltd could negotiate a rate at which it could buy USD at some time in the future, setting the amount of USD needed, the date needed etc. and hence be sure of the Australian Dollar purchasing price now.

In determining the rate of exchange in six months time there are two components:

1) the current spot rate
2) the forward rate adjustment

The spot rate is simply the current market rate as determined by supply and demand. The forward rate adjustment is a slightly more complicated calculation that involves the interest rates of the currencies involved.

Let us make a few assumptions about the markets:

AUD/USD spot rate: .6600
AUD 3 month interest rates is 6 %
USD 3 month interest rates 6.5 %

Now what is the forward adjustment that is made and why?

The forward rate can be calculated as follows: Forward rate = (.6600+(.6600*.065*90/360)) / (1+(1*.06*90/365)) = .66095

This equation may look a little complex at first and in practice your financial institution will calculate it for you.

If you defer the value date of a spot transaction each party will have the funds that they would have paid to invest. The person who sold Australian Dollars has those Dollars to invest for 90 days which assuming it was   A$100 would equal A$ 101.4795.   The person who sold US Dollars has those Dollars to invest for 90 days which assuming it was  USD 66 would equal USD 67.0725   at the interest rates above. The forward rate is calculated simply by dividing 67.0725 by 101.4795 equalling  .660947. If the forward rate was not calculated as such one party would be receiving an unfair advantage by deferring the exchange of currrencies.

Purchasing Foreign Currency
The actual purchase of foreign currency is a simple procedure. If ABC Ltd knows that it will need USD 1 million in three months time and believes that the best time to buy the USD is now all that is required is that ABC Ltd telephone or fax their FX service provider and a forward deal can be entered into.

There are two components to the price in forward transaction and they are the spot price and the forward rate adjustment.

eg. the current market rate is 0.6600
the forward point adjustment for 3 months is +.00095
and therefore the forward rate would be .6600+0.00095= 0.66095.

The deals are totally flexible as to the maturity date, the size of the transaction and as to currency involved.

Also it just takes another phone call to change the payment date if there is some delay in receiving the goods.

Once the deal is done then the rate is fixed and ABC Ltd knows the Australian Dollar cost of purchasing those materials. When it comes time for payment the foreign exchange contract is delivered, this means that the foreign currency amount is sent to the raw materials supplier and at the same time ABC Ltd's bank sends a debit note to ABC Ltd for an Australian Dollar amount which represents the cost of the raw materials.

Why Do Exchange Rates Move ?

Floating Exchange Rates
In a floating exchange-rate environment, the exchange-rate responds to many factors including the flow of imports and exports, the flow of capital, relative inflation rates, etc. Often, limits are placed on exchange-rate fluctuations according to government policies.

One factor affecting the exchange-rate between the Australian Dollar and other currencies is the merchandise trade balance. By definition, the merchandise trade balance is the net difference between the value of merchandise being exported and imported into a particular country. For example, consider the exchange-rate for AUD/USD. Australia imports products from the U.S. To pay for them, Australians need US Dollars; therefore, the Australian companies trade Australian dollars for US Dollars. On the other hand, because Americans desire Australian-made goods, they purchase Australian dollars to pay for Australian goods. The net effect is an increase in the supply of US Dollars and Australian dollars. The Australian demand for American goods and services contributes to the demand for US Dollars while American purchases of Australian goods and services contribute to the supply of Australian dollars. In this case, the net difference between Australian purchases of American goods and services, and American purchases of Australian goods and services, is the merchandise trade balance between the two countries.

The flow of funds between countries to pay for stocks and bonds purchases also contributes to the currency exchange-rate between currencies. In the near term, these capital flows are greatly influenced by yield differentials. All else being equal, the higher the yield on German securities compared to American securities, the more attractive German securities are relative to American securities. An increase in German yields would tend to raise the flow of U.S. dollars into German securities as well as decrease the outflow of Deutsche marks to American securities. Combined, this increased flow of funds into Germany would lower the value of the U.S. dollar and increase the value of the Deutschemark, therefore, the Deutsche mark to U.S. dollar ("DM/USD") ratio, as it is represented in the forex market, would decrease.

The rate of inflation is another factor influencing currency exchange-rates. Consumers try to avoid the eroding effect inflation has on their purchasing power. Consequently, goods from countries with a low inflation rate become more attractive than the goods from countries with higher inflation. In turn, the currency from the lower inflation country rises in value, while the currency from the higher inflation country falls in value. Both the inflation factor and the purchasing power of the currencies directly impact currency exchange-rates. For example, if the United States is experiencing lower inflation than its trading partner Germany, the DM/USD ratio rises to reflect the growing price level in Germany relative to the United States. This fact is rooted in the concept of a purchasing power parity, which holds that, over the long run, a currency exchange-rate adjusts to reflect the difference in price levels between countries.

Because of these risks, governments throughout history have intervened to fix currency exchange-rates. In 1944, for example, western world leaders met in Bretton Woods, New Hampshire, to create the International Monetary Fund to cope with world economic and financial problems that occurred following the Great Depression and World War II. As part of the agreement, the value of the U.S. dollar, the worlds leading currency at the time, was set at 1/35 of an ounce of gold. And, world central banks were asked to keep the exchange-rates of their currencies pegged to the dollar's gold content, with variations limited to plus or minus 1%. Since 1944, there have been several instances when world leaders have met to adjust the fixed currency exchange-rate; but these rates have been abandoned over the years, and volatility in the market continues. Firms exposed to currency-exchange risk have turned to the forex market and currency futures markets to manage these risks. In the forex market, transactions are customized where the rate of exchange and other terms are agreed upon by both parties. Participation in the forex market is generally limited to very large customers.

Fundamental Versus Technical Analysis
While technical analysis concentrates on the study of market action, fundamental analysis focuses on the economic forces which cause prices to move higher, or lower, or stay the same. The fundamental approach examines all of the relevant factors affecting the exchange-rate between two currencies to determine the intrinsic value of each currency.The intrinsic value is what the fundamentals indicate one currency is actually worth against another currency. If this intrinsic value is under the current market price, then the currency is overpriced and should be sold. If market price is below the intrinsic value, then the market is undervalued and should be bought. Both of these approaches to market forecasting attempt to solve the same problem, that is, to determine the direction prices are likely to move. They just approach the problem from different directions.

A "fundamentalist" studies the cause of market movement, while a technician studies the effect. Most market traders classify themselves as either technicians or fundamentalists. In reality, there is a lot of overlap. Most fundamentalists have a working knowledge of the basic tenets of chart analysis. At the same time, most technicians have at least a passing awareness of the fundamentals. The problem is that the charts and fundamentals are often in conflict with each other. Usually at the beginning of important market moves, the fundamentals do not explain or support what the market seems to be doing. It is at these critical times in the trend that these two approaches seem to differ the most. Usually they come back into sync at some point, but often too late for the trader to act. One explanation for these seeming discrepancies is that market price tends to lead the known fundamentals. Stated another way, market price acts as a leading indicator of the fundamentals or the conventional wisdom of the moment. While the known fundamentals have already been discounted and are already "in the market," prices are now reacting to the unknown fundamentals. Some of the most dramatic market movements in history have begun with little or no perceived change in the fundamentals. By the time those changes became known, the new trend was well underway.

Advantages of Forex  vs  Stocks

In order to maintain a diversified and growing portfolio, stock holdings need to be balanced by foreign exchange positions. Currency rates, economic issues and the health of the company in question compound the impact of stock positions in your portfolio. Forex provides the diversity that is necessary to maintain consistent portfolio growth.

Forex Brings Profit in Bear and Bull Markets
In the foreign exchange market, there is no short selling restriction. There is potential for profit in currencies regardless of which way the market moves. Forex always involves selling one currency to buy another, so there is no structural bias to the market. Depending on short and long positions, a trader always has an opportunity to profit in a fluctuating market.

Forex Provides up to 50 Times the Leverage of Stocks
Foreign exchange trading with Forex Capital Management can give you up to 50 times the leverage of your stock trading accounts. For every US$1,000 you invest in stocks, you gain control of at the most US$2,000 worth of shares. But with Forex Capital Management, margin of only US$1,000 gives you control of a currency trade of up to US$100,000 in currencies.

Determining which effect will dominate can be difficult, but there is typically a consensus in the marketplace as to what a rate change will do. Rate changes are typically anticipated since they usually take place after regularly scheduled meetings of central banks. Indicators that typically have the biggest impact on interest rates are PPI, CPI, and GDP.

Forex Offers Broad Diversity
The balance of trade between nations is one determinant to the relative value of these currencies. A nation that imports more than it exports has a deficit trade balance, which is considered unfavorable to the value of that currency. Prudent investors know that they should diversify the U.S. Dollar balance in their assets through holding a range of currencies. This is challenging since most U.S. banks do not offer foreign currency accounts. Through foreign exchange trading, you control hundreds of thousands of dollars worth of currencies with up to 50 times more leverage than with your stocks. For every US$1,000 margin deposit, you control up to US$100,000 worth of Euros, or Pounds, or Yen, or the currency you believe will outperform the U.S. Dollar in the future.

Forex – Perfect for Technical Traders
Currencies rarely spend time in tight trading ranges, and there is a tendency for strong trends to develop. Over 80% of trading volume is speculative in nature, so the market frequently overshoots before correcting itself. A technically trained trader can identify these breakouts, providing a range of opportunities for entering and exiting positions.

Analyze a Nation like a Corporation
Currencies are always traded in pairs –one currency is purchased with holdings in another. As with stocks, better FX returns are provided by the currency of a country that demonstrates faster growth and is in a better economic condition that others.

Currency pricing reflects the amount of available supply and demand. Interest rates and the relative strength of the economy are the two primary factors that determine the availability of a currency. Leading economic indicators reflect the economic health of a nation, and are in large part responsible for shifts. An overwhelming amount of data is available at regular intervals – the challenge is to determine what factors are more influential than others. Interest rates and international trade ratios are typically the most important.

Trade Forex 24-Hours a Day
Forex trading is a window to the world economy. Trading starts on Sunday at 5:00 PM Eastern Time with the opening of the markets in Singapore and Sidney. A couple of hours later, the Tokyo market is open. Next is London, which opens at 2:00 AM Eastern Time on Monday. And by the time the day catches up to New York, the world currency markets have been at work for fifteen hours. You determine the timing of your trades, instantly reacting to any news or market pressure. Trading stocks when the U.S. markets are closed is not easy and does not provide much liquidity. With forex, you can trade 24-hours a day in the largest and most liquid market in the world.

Advantages of Forex  vs  Futures

The forex market is approximately 46 times larger than the combined world futures markets. Greater day-to-day price stability enables trades with higher leverage than what is typical with futures.

Forex Provides More Leverage
You control the degree of leverage you wish to employ in trading. Forex Capital Management automatically sets your leverage level at the most lenient requirement, based on the size of your account. As an example, a US$30,000 account has a margin requirement of US$1,000 for every position held that is approximately equal to US$100,000 worth of currencies. At this account level, 1% of the total value of the currency traded is required to be maintained on margin – a leverage ratio of 100 to 1.

Forex Provides Less Liability
Forex Capital Management gives investors important peace of mind in the volatile currency marketplace. If the funds in an account ever drop below margin requirements, any open positions will be closed, protecting the account from catastrophic losses. In the event that your strategy proves to be wrong and there is a significant move against you, your liability will never exceed the value in your account.

Forex trading is your window to the world economy. Trading starts on Sunday at 5:00 PM Eastern Time with the opening of the markets in Singapore and Sidney. A couple of hours later, the Tokyo market is open. Next is London, which opens at 2:00 AM Eastern Time on Monday. By the time the day catches up to New York, the world currency markets have been at work for fifteen hours. You determine the timing of your trades, reacting instantly to any news or market pressures.

Forex is Firm Prices and Instantaneous Execution
Forex Capital Management enables price certainty and instant execution on orders up to US$1 million. Your trading is based on real time streaming currency prices so there is no discrepancy between the offered price and the execution price. This remains true even during volatile, fast moving trading sessions. Streaming prices ensure that your orders, stops, and limits are executed without partial fills or slippage.

Forex Enables Automatic Rollovers
With Forex Capital Management, open positions are automatically rolled over every two days. At 5:00 PM Eastern Time, your account automatically rolls over any open positions, swapping the trade forward to a settlement date two business days in the future. Rolling over a position does include some carrying costs, which is true with futures as well.

Rolling over a Forex position can sometimes make you money, since carrying cost is determined by the difference between interest rates for the two currencies. If you are long in the currency with the higher interest rate, you can gain on the spot rollover from the premium relationship of the long currency relative to the short currency. Gain is determined by the differential between the interest rates of the two currencies, and fluctuates with the movement of rates.

Currency Pairs – Points for Comparison

Foreign exchange is always traded in currency pairs, such as EUR/USD (Euro/U.S. Dollar.) All trades are the purchase of one kind of currency with another. The first currency in the pair is referred to as the base currency. The base currency is the one that provides a baseline for the purchase or sale. Think of the currency pair as an instrument to be bought or sold. You are buying either the Euro or the U.S. Dollar in either case.

The following are some scenarios that help to explain these pairs and how to think in terms of the basis currency:

BUY if the U.S. securities markets are to continue in a bear market and the Euro is going to go up against the U.S. Dollar. SELL if you expect Wall Street to recover and the U.S. Dollar to climb against the Euro.

BUY if you expect the Yen is about to be weakened in support of Japanese trade. SELL if Japanese equity is leaving the U.S. financial markets to make stronger investments at home.

BUY if you expect that the Swiss government to devalue the currency to accelerate exports to Europe. SELL if inflation takes hold in Germany and France, increasing the value of the Swiss Franc against the Euro.

BUY if world commodity prices are going to boost the commodity-based export market in Australia. SELL if the Australian economy shows signs of recession or unfavorable trade imbalances are emerging.

BUY if the US economy is going to rebound faster than Canada. SELL if the Canadian Dollar is fundamentally undervalued against the U.S. Dollar.

BUY if you think the notoriety of the “Lord of the Rings” films will increase income from tourism. SELL if you expect international uncertainties to continue to depress the tourist industry.

BUY if you believe the U.K. is about to adopt the Euro, expecting the Pound to weaken as it is devalued prior to the merger. SELL if you believe that the U.K. economy will grow at a faster rate than the European Union as a whole.

BUY if the Japanese banking crisis is expected to worsen. SELL if you believe that Europe is going into recession, anticipating the Euro to fall against the Yen.

BUY if the Bank of England is going to raise interest rates. SELL if the Nikkei index is about to outperform the FTSE.

BUY if you believe that international instability will cause an oil price spike, impacting the import-dependent Japanese economy. SELL if you expect regional conflicts will result in lower oil prices, making Japanese markets more attractive than the conservative Swiss Franc.

BUY if you expect the Bank of England to raise rates. SELL if you believe the British are about adopt the Euro, anticipating a weaker Pound against the Swiss Franc as it is devalued in anticipation of the merger.

BUY if Australia is heading towards recession. SELL if you expect international commodity prices are going to increase dramatically.

Seven Steps In Forex Trading

Here are seven steps that every forex trader should consider when managing a foreign exchange account:

1. Maximize Your Tools
Forex Capital Management provides effective on line tools to help make you a more effective currency trader. This includes free market news and real time charts. Perhaps the single most helpful tool is the FX Demo Account, which enables you to test strategies and learn from the process without risking your cash.

2. Risk Management
Every successful trader needs answers to key questions in order to be able to set an acceptable level of risk. How much will the market move? Where should I take my profits? How much am I willing to lose? Where should my stop and limit orders be placed? Forex Capital Management can help you to make the right decisions to manage your risk.

3. Two Ways to Trade
What kind of trader are you – fundamental or technical? The fundamental analyst studies the underlying causes of relative movements in price. The technical analyst studies the historic movement of actual prices. Forex Capital Management supports all kinds of traders.

4. Basics for Technical Analysis
Sound trading decisions start with trend analysis tools. What is a market trend? How do you classify the different kinds of trends, and how do you plot trends over time? How do you identify price support levels, and how do you find price resistance points? What role do retracements play in your strategy? Forex Capital management helps you to gain a basic understanding of technical analysis.

5. Applying Technical Analysis
Charts are available at intervals that are appropriate for the length of the position you intend to hold. Five-, fifteen- and sixty-minute intervals help if you are planning on trading in a few hours. One, four and twenty-four hour intervals are appropriate if you plan on holding the position for a couple of days. Longer-term intervals provide data to support trading decisions based on long term trends.

6. Fundamentals that Every Trader Should Know
Supply and demand drives the price of currencies. Interest rates and the overall strength of an economy are two primary factors that influence exchange rates. Indicators such as Gross Domestic Product, foreign investment rates, and the balance of trade reflect the overall health of an economy, and can be responsible for shifts in the demand for that particular currency. A tremendous amount of data is available at regular intervals - statistics related to interest rates and international trade always receive the closest scrutiny.

7. Psychology of Trading
The biggest enemy to most traders is not the market, but themselves. Cut your losses early and let your profits run. Always trade based on objective analysis. And always remember that leverage is a double-edged sword - be sure to never bet the mortgage.

Types of Orders

Following are typical FX orders that are executed every day by clients of

Entry Order:
An Entry Order is executed when a designated price threshold is reached or broken. These orders are executed under the direct supervision of the dealing desk and remain in effect until canceled by the client.

Limit Entry Order:
A Limit Entry Order is executed when the exchange rate reaches but does not break a preset value. A Limit Entry Order is placed when the trader believes that, once a currency has touched a certain level, it will move in the direction opposite of its previous momentum.

Limit Order:
A Limit Order is a Limit Entry Order pegged to a specific price for the purpose of locking in gains on a current position. Limit Orders placed on Buy positions are Limit Entry Orders to Sell that position. A Stop Limit order will remain in effect until the position is liquidated, or the client cancels the Stop Limit order.

Stop Entry Order:
A Stop Entry Order is executed when the rate of exchange breaks a preset level. This kind of order is placed when the trader believes that, when the market reaches the preset level, rates will continue to trend in the same direction.

Stop-Loss Orders:
Stop-Loss Orders are Entry Orders linked to a certain position for the purpose of preventing the position from accumulating additional losses. Stop-Loss Orders that are placed on a Buy position are Stop Entry Orders to Sell that position. A Stop-Loss Order will remain in effect until the position is liquidated, or the client cancels the Stop-Loss Order.

Foreign Exchange Risk Management Guidelines


Your business is open to risks from movements in competitors' prices, raw material prices, competitors' cost of capital, foreign exchange rates and interest rates, all of which need to be (ideally) managed.

This section addresses the task of managing exposure to Foreign Exchange movements.

These Risk Management Guidelines are primarily an enunciation of some good and prudent practices in exposure management. They have to be understood, and slowly internalised and customised so that they yield positive benefits to the company over time.

It is imperative and advisable for the Apex Management to both be aware of these practices and approve them as a policy. Once that is done, it becomes easier for the Exposure Managers to get along efficiently with their task.

Exposure Analysis

An Exposure can be defined as a Contracted, Projected or Contingent Cash Flow whose magnitude is not certain at the moment. The magnitude depends on the value of variables such as Foreign Exchange rates and Interest rates.

The company will determine and analyse its Foreign Exchange exposures.

The following cash flows/ transactions will be considered for the purpose of exposure management. 

Variable / Cash Flows Transaction Type
  • Contracted Foreign Currency Cash Flows
  • Foreign Interest Rates, whether Floating or Fixed
  • Cash Flows from Hedge Transactions
  • Projected/ Contingent Cash Flows
  • Both Capital and Revenue in nature
  • All Interest Payments/ Receipts
  • All Open hedge transactions
  • Both Capital and Revenue in nature
  • Cash Flows above $100,000/- in value will be brought to the notice of the Exposure Manager, as soon as they are projected.
  • It is the responsibility of the Exposure Manager to ensure that he receives the requisite information on exposures from various sections of the company in time.


These exposures will be analysed and the following aspects will be studied:

  • Foreign Currency Cash Flows/ Schedules
  • Variability of Cashflows - how certain are the amounts and/ or value dates?
  • Inflow-Outflow Mismatches / Gaps
  • Time Mismatches / Gaps
  • Currency Portfolio Mix
  • Floating / Fixed Interest Rate ratio

Market Forecasts

After determining its Exposures, the company has to form an idea of where the market is headed.

The company will focus on forecasts for the next 6 months, as forecasts for periods beyond 6 months can be unreliable.

The focus of the Apex Management is to be aware of

  • The Direction or the Big Trend in rates.
  • The underlying assumptions behind the forecasts
  • The Probability that can be assigned to the forecast coming true
  • The possible extent of the move
  • The Risk Appraisal exercise and Benchmarking decisions will be based on such forecasts.

Risk Appraisal

This exercise is aimed at determining where the company's exposures stand vis-a-vis market forecasts.

Reporting Gap where there are delays/ errors in reporting exposures to the Exposure Management cell
Implementation Gap where there is a gap between the decision to hedge and the implementation of such hedge decision.

This exercise aims to state where the company would like its exposures to reach.

  1. The company will set a Benchmark for its Exposure Management practices.
  2. The Benchmarks will be set for 6 months periods.
  3. The Benchmark will reflect and incorporate the following:
  • The Objective of Exposure Management, or in other words, "Should Exposure Management be conducted on a Profit Centre or Cost Centre basis ?"
  • The Forecasts discussed and agreed upon earlier. Mathematically, the Benchmark should be the Probabilistic Expectation of the rate in question.
  • The Forecast risk, Market and Transaction risk, and Systems risk as determined earlier.
  • Room for error in keeping with the Stop Loss Policy to be decided

Companies whose exposures are of long-term Capital nature can look to manage them on a Profit Centre basis, since the exposures are not open to day-to-day business risks.
Companies whose exposures are of short-term Revenue nature should manage them on a Cost Centre basis, since the exposures impact the P&L Account directly. 

A small note on the Profit/ Cost centre concept:

Profit Centre
under this concept, the Exposure Manager is required to generate a NET profit on the exposure over time. This is an aggressive stance implying a high degree of risk appetite on the part of Apex Management. A company with a strong position in its daily bread and butter business can afford to take some financial risks and can opt for this concept.
The Benchmarks under a Profit-Centre concept would take the form of “The total cost of a foreign currency loan should be reduced by at least 25 bp over a one year period, from the forecasted rate of x.x % p.a.”.
Cost Centre
under this concept, the Exposure Manager would be required to ensure that the cashflows of the company are not adversely affected beyond a certain point. This is a defensive strategy, implying a lower risk appetite. A company whose cash-flows are volatile, or whose underlying business is not on a very sound footing would be advised to adopt this concept.
The Benchmarks under a Cost-Centre concept would take the form of “Foreign Exchange fluctuations should add no more than x% to the cost of Imported Raw Material over and above the budgeted cost.”


This is the most visible and glamourised part of the Exposure Management function. However, the Trader is like the Driver in a car rally, who needs to follow the general directions of the Navigator.

  1. Hedging strategies will be designed to meet the Exposure Management objectives, as represented by the Benchmarks
  2. The Exposure Management Cell will be accorded full operational freedom to carry out the hedging function on a day to day basis
  3. Hedges will be undertaken only after appropriate Stop-Loss and Take-Profit levels have been predetermined
  4. The company will use all hedging techniques available to it, as per need and requirement. In this regard, it will pass a Board Resolution authorising the use of the following:
  • Rupee-Foreign Currency Forward Contracts
  • Cross Currency Forward Contracts
  • Forward-to-Forward Contracts
  • FRAs
  • Currency Swaps
  • Interest Rate Swaps
  • Currency Options
  • Interest Rate Options
  • Others, as may be required

Indian companies with sizeable US Dollar denominated exposures are extremely vulnerable to sudden drastic moves in the USD-INR rate. They can, to an extent, insulate themselvs from such shocks by undertaking hedges in currencies other than Rupee-Dollar.
For instance, a Dollar payable can be hedged by selling a currency (say Sterling Pound) in order to buy Dollars, instead of selling the Rupee. The choice of currency would, of course, depend on the trend and forecast for the currency(s) at that point of time.

It is easier and safer to generate profits from a Cross-Currency Forward Contract and a Rs 1 Lac profit thereon is equivalent to saving a 10 paise depreciation in the Rupee (on USD 1 million)

Stop Loss
Exposure Management should not be undertaken without having a Stop-Loss policy in place. A Stop-Loss policy is based on the following two fundamental principles:
1. To err is human
2. A stitch in time saves nine

It is appropriate to recount here some words from a speech Dr Alan Greenspan, Chairman of the US Federal Reserve, delivered in December 1997, on the Asian financial crisis. He says, “There is a significant bias in political systems of all varieties to substitute hope (read, wishful thinking) for possibly difficult pre-emptive policy moves. There is often denial and delay in instituting proper adjustments Reality eventually replaces hope and the cost of the delay is a more abrupt and disruptive adjustment than would have been required if action had been more preemptive. 

Whether an Exposure is hedged or not, it is assumed that the decision to hedge/ not to hedge is backed by a View or Forecast, whether implicit or explicit. As such, Stop Loss is nothing but a commitment to reverse a decision when the view is proven to be wrong.

Stop Losses should be activated when

Critical levels in the rate being monitored are reached, which clearly tell that the view held has been proven wrong.
The factors/ assumptions behind a view either change or are proven wrong.

The Exposure Manager should be accorded flexibility to set appropriate Stop-Losses for each trade.
The Exposure Manager should, however, make sure he has set a stop-loss for positions he enters into, on an a priori basis.

While Benchmarks will be based upon the Big Trend and will incorporate a certain amount of room for error, the Exposure Manager should be careful to not violate the Benchmark on the wrong side.

Reporting and Review

There needs to be continuous monitoring whether the Exposures are headed where they are intended to reach. As such, the Exposure Management activities need to be reported and reviewed.

The Exposure Manager will prepare the following Reports on a regular basis:  

Report Name What it shows Periodicity
MTM Report The Mark-to-Market Profit/ Loss status on Open Forward Contracts Daily, closing
Exposure NAV Report The All-in-all exchange/ interest rate achieved on each Exposure, and profitability vis-a-vis the Benchmark Fortnightly
VAR Report Expected changes in overall Exposure due to forecasted exchange/ interest rate movements Monthly

A monthly Review meeting will consider the following:  


On the basis of

Points to be reviewed

Exposure Performance Exposure NAV Report
  • Is the Benchmark being met/ bettered?
  • What are the chances of the Benchmark being violated on the wrong side?
  • Reasons for the Benchmark being violated on the wrong side
Market Situation
  • Reviews of market developments
  • Forecasts of market movements
Is the Big Trend still in place? Or has it changed?
Benchmarking The above two Does the Benchmark need to be changed?
Hedging Strategy MTM and Exposure NAV Reports Is the strategy working well? Or does it need to be finetuned/ overhauled?
Operational issues Exposure Manager's experiences Operational problems to be solved


Exposure Management is an essential part of business and should be viewed with Objectivity. It is neither a license to print money nor is it a cause for getting trapped in a Fear Psychosis, and should be viewed with the same clarity of vision as, say, Production or Marketing is viewed.

Having said that, it should be remembered that

  • All that has been stated above cannot start happening straightaway
  • Installing Hedging, Reporting and Review systems that work takes time and effort
  • There will be a Learning Curve to be overcome when setting Benchmarks
  • There will be initial losses, which should be viewed as what they are - initial losses.

There has to be a long-term commitment to Exposure Management, because it is today an activity, which no company can afford to ignore.

Forex Risk Management

Forex Risk Management:  Stop-Loss and Limit Orders

The most common and important risk management tool in forex trading is the stop-loss order. A stop-loss order ensures a particular position is automatically liquidated at a predetermined price in order to limit potential losses should the market move against a trader's position. You should decide on a stop-loss level before entering the market and we recommend you always place a stop-loss order immediately after a new position is taken.  You must set up strict stop-loss limits for your losing trades, so that you don't lose more than you can handle. If the market starts going in the wrong direction, don't try to think of excuses why you shouldn't close that position and cancel the order. This is the reason you have to place the order and not just have a stop-loss level set in your mind. Even if the market starts going in the right direction 5 minutes later, you have eliminated the risk of it not turning around. Your trading rules are there so that you can trade by them, not to try to go around them - you would only be hurting yourself if you did. One of the most deadly mistakes a trader may commit, one which can destroy any trading strategy, is when he (after already being down on a position) begins to think of excuses not to close the position - perhaps the market will suddenly turn around and move in a favorable direction? The trader keeps thinking of this, and doesn't have the discipline to close the falling position, waiting until this happens. The market does not do any favors for anyone. Eventually the trader may be forced to close the position with much greater losses.
Losing the amount the trader was willing to lose using the original stop-loss level probably wouldn't hurt his opportunity to make up his losses. Losing  2,3 or 4 times that in 1 trade can completely destroy any strategy. Not only will the trader lose more money than intended, but he will lose morale as it's now much harder to make up the losses.  He will also lose confidence in himself and his ability.

In order to avoid this trouble you must follow a simple rule - Always place stop-losses, not just in your mind, but in the trading system or with your broker. A good habit to get into is to place stop-losses as soon as you enter into a new position.

Aswell as placing stop-loss orders, we recommend in most cases to enter limit (profit take) orders at the same time using the OCO order function that most trading systems now have. The reason for this is similar to the reason for placing stop orders.
Whereas with losing positions it can be very tempting to overrun losses, with winning positions it can be just as tempting to lock in a profit too early. By placing limits you will eliminate the risk of not being patient enough and taking profit too early. The target level should also be decided along with the choice of point of entry, not after position has been entered. However, you may feel confident in your ability not to profit take too early, and prefer to monitor the market to take advantage of possible breakthroughs in support or resistance levels. In this case placing only a stop-loss order is an option.

Forex Risk Management:  Always use a positive Risk/Reward ratio 

A very common mistake made by novice forex traders is that they do not use a positive Risk/Reward ratio. By positive Risk/Reward ratio we mean the difference between the take-profit trade and the level of trade entry is greater than the difference between the stop-loss trade and the level of trade entry. In other words it means that you should not be willing to lose more than you want to make on a single trade.

Here is an example of a positive Risk/Reward ratio:

Buy EUR/USD 100,000 at 1.1500

T/P Sell EUR/USD 100,000 at 1.1600

S/L Sell EUR/USD 100,000 at 1.1440

In the above example the take-profit is 100 pips higher than the level at which the position was entered, and the stop-loss is 60 pips lower than the level at which the position was entered. The Risk/Reward ratio is 1:1.66.

Below is an example of a negative Risk/Reward ratio:

Buy USD/JPY 100,000 at 110.00

T/P Sell USD/JPY 100,000 at 110.30

S/L Sell USD/JPY 100,000 at 108.00

In the above example the take-profit is 30 pips higher than the level at which the position was entered, and the stop-loss is 200 pips lower than the level at which the position was entered. The Risk/Reward ratio is 1:0.15.

Most successful currency traders nearly always use a positive or equal Risk/Reward ratio. The reason for this is simple: Successful traders want to avoid the unpleasant scenario of losing 2,3 or 4 times more than they can make on one trade. As mentioned previously, it is much harder to make up losses trading like this.

Another reason successful traders are able to apply a positive Risk/Reward ratio is that they often place their entry BUY orders just above key support levels and SELL orders just below key resistance levels. In this situation, stop-losses can be placed on the other side of the levels so that if the market breaks out of its range and through these key levels, the position is liquidated.

With this sensible trading strategy losses are limited and highly controlled.

Unfortunately, many novice and unsuccessful traders choose to use a negative Risk/Reward ratio and often enter orders/trades similar to the USD/JPY example above.
It is very common for unsuccessful traders to increase trade size in order to recoup the losses quickly. This is a recipe for disaster, you must trade with consistancy and control.

We recommend a Risk/Reward ratio of anything between 1:1 and 1:3.
This means we recommend your take-profit trade being the same as or up to 3 times the distance of your stop-loss trade (from the level of market entry of a new position.)
Forex Position Management: Overtrading and it's negatives

Another mistake many novice currency traders make is that they trade way too much.

The most common and expensive mistake made here is the immediate re-entry of a forex position. This usually happens after a stop-loss order has been triggered and the trader still feels "attached" to the position.
If you are in this situation and tempted to re-enter a losing trade, you have to take a deep breath and let it go. Re-entering a losing trade is almost as strategically bad as not having a stop-loss at all!
The Forex market is always available, 24 hours a day, 5 days a week. There will be many other opportunites in which to open a new position, and you will almost certainly be thinking more clearly then.
We recommend not entering any new trades immediately after a losing position, even if the new trade is in a different currency pair. This is again due to the fact that you may just want to get your revenge on the market and recoup the previous losses immediately. If this is the case, chances are that there will be better trading opportunies available at a later time when you have had time to cool off!

The most obvious example of someone overtrading is when they always have a position.
This is a sign that the trader is constantly chasing profits in the Forex markets as though they were in a casino, and it won't be profitable in the long term. This "have to be in it to win it" trading style usually depends on luck (as there is no strategy if you always have a position!) and you should never depend on luck on the market if you want to be successful.

You must never open a position simply because you get bored and want to do something, because you haven't opened a position in a while. There is no norm as to how many positions you should open in a given period of time. Even if you only open one position every 3-4 days, but are making steady profits - you are on the right track.

Another negative feature of overtrading which is explained in detail in guideline 4, is that excessive daytrading for small profits (5-10 pips) has very poor risk/reward.

We recommend managing the frequency of trading by setting yourself a "cooling off period" after every closed trade and incorporate it into your trading plan. For example, you don't allow yourself to open a new position until 2,4,8 or 24 hours after the previous position was closed.

Many successful traders will limit their trading frequency to say one position daily, regardless of the performance of the previous trade. These "position takers" can then spot the better trading opportunities with a more detached view than someone who is frantically trading 20 times a day!

Forex Position Management: Make use of good spreads

Some online forex brokers offer 3 to 5 pip spreads in the liquid currencies such as Euro/Dollar and Dollar/Yen. These are very competitive prices which a few years ago were unthinkable. As recently as the mid 1990's brokers were quoting 10 pip spreads in the major currencies plus a commission! Thankfully due to the internet, the current boom in Forex trading and the competition between Forex brokers, those days are well and truly over! 

We recommend limiting trading to currency pairs with the best spreads for 3 reasons:

  1. Tight spreads improve your profit potential and risk/reward.
  2. Tight spreads are available in the most heavily traded and liquid currencies which are usually the easiest to trade. 
  3. You should focus your Forex trading to 2-3 currency pairs to gain knowledge and experience in how these markets work. It's therefore sensible to choose the currency pairs with the best spreads.

The excellent value available from trading on tight spreads works very much to your advantage. However, you should avoid overtrading and entering trades for just a 5-10 pip profit or loss. Even when trading like this on 3 pip spreads can adversely affect your profitability.

Below are examples of both a winning trade and losing trade when trading for a 10 pip
profit or loss:

Winning Trade:  

Buy EUR/USD at 1.2020  (price = 17/20)
Sell EUR/USD at 1.2030  (price = 30/33)

Market moves 13 pips before taking profit

Losing Trade:    

Buy EUR/USD at 1.2020  (price = 17/20)
Sell  EUR/USD at 1.2010  (price = 10/13)

Market moves 7 pips before taking loss

The above example highlights that the risk/reward of trading for a 10 pip profit or loss is
very poor. For the same 10 pips P&L, the market must move 13 pips for your winning position, but only 7 pips for your losing position.
For currency pairs quoted in 5-10 pip prices, obviously the risk/reward is even worse.

For this reason we recommend that your proft-take, stop-loss orders or market trades are at least 5 times the spread (away from your point of entry). This strategy will help avoid overtrading and improve risk/reward.

Forex Money Management: Forex Trading within your means

If you have read, understood, remembered and are ready to use guidelines 1 to 4, you are well on your way to creating a solid trading plan. You now understand the basic concepts of risk management and position management. This final chapter deals with money management: How to control the amount of trading equity you are willing to lose should a position go against you.

We recommend that you only risk a maximum of 10% of your total trading equity on a single trade.

10% may sound like too little risk considering many online Forex brokers offer 1% margin or 100 times leverage, which means that you could potentially take a $100,000 position with just $1000 in capital. However, trading like this can be dangerous as you could lose everything in a single trade.  By risking upto 10% of your capital on a single trade, you will still be able to make good profits from successful trades whilst avoiding the risk of being wiped out during a bad streak; Even the most profitable traders can have losing streaks in which they could for example have 3 or 4 consecutive losing positions.
Successful Forex trading is a long term investment which can produce excellent returns if traded with control, discipline, patience and consistency.
Your target should be to make substancial profits over the course of anything over 3 months.  Wanting to double your money in a week is not the right mindset with which to start trading. The risks involved are way too high and belong in the casino!

Here is an example of a reasonably profitable month for a successful trader. Let's imagine that his total capital is $20,000 and risk appetite per trade is 5%. This would mean he is willing to lose upto $1000 per trade. He always trades using a 100% Risk/Reward ratio (meaning that his stop-loss orders are the same distance as his profit-take orders, from the position entry level):

No. of Trades = 20
Winning Trades = 12
Losing Trades = 8

Total Profit = $4000

REO/month (Return on Equity) = 20%

The example shows that he got 60% of his trades right and made an REO of 20% for the month and he only risked 5% of his capital on every trade. This is a good example of solid returns gained from the managed, low risk trading we recommend in our guidelines.

With this type of money management, you can confidently utilize and fine tune your trading strategy in a controlled trading environment which focuses on long term success.

Well that's it for the guidelines. I hope you find them useful, informative and most importantly, profitable! 

Understanding Forex Quotes

Reading a foreign exchange quote may seem a bit confusing at first. However, it's really quite simple if you remember two things:

  1. The first currency listed first is the base currency and
  2. The value of the base currency is always 1.

The US dollar is the centerpiece of the Forex market and is normally considered the 'base' currency for quotes. In the "Majors", this includes USD/JPY, USD/CHF and USD/CAD. For these currencies and many others, quotes are expressed as a unit of $1 USD per the second currency quoted in the pair. For example, a quote of USD/JPY 120.01 means that one U.S. dollar is equal to 120.01 Japanese yen.

When the U.S. dollar is the base unit and a currency quote goes up, it means the dollar has appreciated in value and the other currency has weakened. If the USD/JPY quote we previously mentioned increases to 123.01, the dollar is stronger because it will now buy more yen than before.

The three exceptions to this rule are the British pound (GBP), the Australian dollar (AUD) and the Euro (EUR). In these cases, you might see a quote such as GBP/USD 1.4366, meaning that one British pound equals 1.4366 U.S. dollars.

In these three currency pairs, where the U.S. dollar is not the base rate, a rising quote means a weakening dollar, as it now takes more U.S. dollars to equal one pound, euro or Australian dollar.

In other words, if a currency quote goes higher, that increases the value of the base currency. A lower quote means the base currency is weakening.

Currency pairs that do not involve the U.S. dollar are called cross currencies, but the premise is the same. For example, a quote of EUR/JPY 127.95 signifies that one Euro is equal to 127.95 Japanese yen.

When trading forex you will often see a two-sided quote, consisting of a 'bid' and 'offer'. The 'bid' is the price at which you can sell the base currency (at the same time buying the counter currency). The 'ask' is the price at which you can buy the base currency (at the same time selling the counter currency).

Forex vs  Equities

If you are interested in trading currencies online, you will find the Forex market offers several advantages over equities trading.

24-Hour Trading

Forex is a true 24-hour market, which offers a major advantage over equities trading. Whether it's 6pm or 6am, somewhere in the world there are always buyers and sellers actively trading foreign currencies. Traders can always respond to breaking news immediately, and P&L is not affected by after hours earning reports or analyst conference calls.

After hours trading for U.S. equities brings with it several limitations. ECN's (Electronic Communication Networks), also called matching systems, exist to bring together buyers and sellers - when possible. However, there is no guarantee that every trade will be executed, nor at a fair market price. Quite frequently, traders must wait until the market opens the following day in order to receive a tighter spread.

Superior Liquidity

With a daily trading volume that is 50x larger than the New York Stock Exchange, there are always broker/dealers willing to buy or sell currencies in the FX markets. The liquidity of this market, especially that of the major currencies, helps ensure price stability. Traders can almost always open or close a position at a fair market price.

Because of the lower trade volume, investors in the stock market are more vulnerable to liquidity risk, which results in a wider dealing spread or larger price movements in response to any relatively large transaction.

100:1 Leverage

100:1 leverage is commonly available from online FX dealers, which substantially exceeds the common 2:1 margin offered by equity brokers. At 100:1, traders post $1000 margin for a $100,000 position, or 1%.

While certainly not for everyone, the substantial leverage available from online currency trading firms is a powerful, moneymaking tool. Rather than merely loading up on risk as many people incorrectly assume, leverage is essential in the Forex market. This is because the average daily percentage move of a major currency is less than 1%, whereas a stock can easily have a 10% price move on any given day.

The most effective way to manage the risk associated with margined trading is to diligently follow a disciplined trading style that consistently utilizes stop and limit orders. Devise and adhere to a system where your controls kick in when emotion might otherwise take over.

Lower Transaction Costs

It is much more cost-efficient to trade Forex in terms of both commissions and transaction fees. Forex brokers usually charge NO commissions or fees whatsoever, while still offering traders access to all relevant market information and trading tools. In contrast, commissions for stock trades range from $7.95-$29.95 per trade with online discount brokers up to $100 or more per trade with full service brokers.

Another important point to consider is the width of the bid/ask spread. Regardless of deal size, forex dealing spreads are normally 5 pips or less (a pip is .0005 US cents). In general, the width of the spread in a forex transaction is less than 1/10 that of a stock transaction, which could include a .125 (1/8) wide spread.

Profit Potential In Both Rising And Falling Markets

In every open FX position, an investor is long in one currency and short the other. A short position is one in which the trader sells a currency in anticipation that it will depreciate. This means that potential exists in a rising as well as a falling market.

The ability to sell currencies without any limitations is another distinct advantage over equity trading. In the US equity markets, it is much more difficult to establish a short position due to the Zero Uptick rule, which prevents investors from shorting a stock unless the immediately preceding trade was equal to or lower than the price of the short sale.

Understanding Margin

What Is Margin Trading?

Trading currencies on margin lets you increase your buying power. Here's a simplified example: If you have $2,000 cash in a margin account that allows 100:1 leverage, you could purchase up to $200,000 worth of currency-because you only have to post 1% of the purchase price as collateral. Another way of saying this is that you have $200,000 in buying power.

What are the benefits of margin?

With more buying power, you can increase your total return on investment with less cash outlay. To be sure, trading on margin magnifies your profits AND your losses.

Here's a hypothetical example that demonstrates the upside of trading on margin:

With a US$5,000 balance in your margin account, you decide that the US Dollar (USD) is undervalued against the Swiss Franc (CHF).

To execute this strategy, you must buy Dollars (simultaneously selling Francs), and then wait for the exchange rate to rise.

The current bid/ask price for USD/CHF is 1.6322/1.6327 (meaning you can buy $1 US for 1.6327 Swiss Francs or sell $1 US for 1.6322)

Your available leverage is 100:1 or 1%. You execute the trade, buying a one lot: buying 100,000 US dollars and selling 163,270 Swiss Francs.

At 100:1 leverage, your initial margin deposit for this trade is $1,000. Your account balance is now $4000.

As you expected, USD/CHF rises to 1.6435/40. You can now sell $1 US for 1.6435 Francs or buy $1 US for 1.6440 Francs. Since you're long dollars (and are short francs), you must now sell dollars and buy back the francs to realize any profit.

You close out the position, selling one lot (selling 100,000 US dollar and receiving 164,350 CHF) Since you originally sold (paid) 163,270 CHF, your profit is 1080 CHF.

To calculate your P&L in terms of US dollars, simply divide 1080 by the current USD/CHF rate of 1.6435. Your profit on this trade is $657.13


Initial Investment: $1000
Profit: $657.13
Return on investment: 65.7%

If you had executed this trade without using leverage, your return on investment would be less than 1%.

Managing a Margin Account

Trading on margin can be a profitable investment strategy, but it's important that you take the time to understand the risks.

You should make sure you fully understand how your margin account works. Be sure to read the margin agreement between you and your clearing firm. Talk to your account representative if you have any questions.

The positions in your account could be partially or totally liquidated should the available margin in your account fall below a predetermined threshold.

You may not receive a margin call before your positions are liquidated.

You should monitor your margin balance on a regular basis and utilize stop-loss orders on every open position to limit downside risk.

Calculating Profit & Loss

For ease of use, most online trading platforms automatically calculate the P&L of a traders' open positions. However, it is useful to understand how this calculation is derived.

To illustrate a typical FX trade, consider the following example.

The current bid/ask price for USD/CHF is 1.6322/1.6327, meaning you can buy $1 US for 1.6327 Swiss Francs or sell $1 US for 1.6322.

Suppose you decide that the US Dollar (USD) is undervalued against the Swiss Franc (CHF). To execute this strategy, you would buy Dollars (simultaneously selling Francs), and then wait for the exchange rate to rise.

So you make the trade: purchasing US$100,000 and selling 163,270 Francs. (Remember, at 1% margin, your initial margin deposit would be $1,000.)

As you expected, USD/CHF rises to 1.6435/40. You can now sell $1 US for 1.6435 Francs or buy $1 US for 1.6440 Francs.

Since you're long dollars (and are short francs), you must now sell dollars and buy back the francs to realize any profit.

You sell US$100,000 at the current USD/CHF rate of 1.6435, and receive 164,350 CHF. Since you originally sold (paid) 163,270 CHF, your profit is 1080 CHF.

To calculate your P&L in terms of US dollars, simply divide 1080 by the current USD/CHF rate of 1.6435.

Total profit = US $657.13

Factors Affecting USD

Key Fundamentals Impacting the U.S. Dollar

Federal Reserve Bank (Fed): The U.S. Central Bank has full independence in setting monetary policy to achieve maximum non-inflationary growth. The Fed’s chief policy signals are: open market operations, the Discount Rate and the Fed Funds rate.

Interest Rates: Fed Funds Rate: Clearly the most important interest rate. It is the rate that depositary institutions charge each other for overnight loans. The Fed announces changes in the Fed Funds rate when it wishes to send clear monetary policy signals. These announcements normally have large impact on all stock, bond and currency markets.

Discount Rate: The interest rate at which the Fed charges commercial banks for emergency liquidity purposes. Although this is more of a symbolic rate, changes in it imply clear policy signals. The Discount Rate is almost always less than the Fed Funds Rate.

30-year Treasury Bond: The 30-year US Treasury Bond, also known as the long bond, or bellwether treasury. It is the most important indicator of markets’ expectations on inflation. Markets most commonly use the yield (rather than price) when referring to the level of the bond. As in all bonds, the yield on the 30-year treasury is inversely related to the price. There is no clear-cut relation between the long bond and the US dollar.

Nonetheless, as the supply of 30-year bonds began to shrink following the US Treasury's refunding operations (buy back its debt), the 30-year bond's role as a benchmark had gradually given way to its 10-year counterpart.

Depending on the stage of the economic cycle, strong economic data could have varying impacts on the dollar. In an environment where inflation is not a threat, strong economic data may boost the dollar. But at times when the threat of inflation (higher interest rates) is most urgent, strong data normally hurt the dollar, by means of the resulting sell-off in bonds.

Being a benchmark asset-class, the long bond is normally impacted by shifting capital flows triggered by global considerations. Financial/political turmoil in emerging markets could be a possible booster for US treasuries due to their safe nature, thereby, helping the dollar.

3-month Eurodollar Deposits: The interest rate on 3-month dollar-denominated deposits held in banks outside the US. It serves as a valuable benchmark for determining interest rate differentials to help estimate exchange rates. To illustrate USD/JPY as a theoretical example, the greater the interest rate differential in favor of the eurodollar against the euroyen deposit, the more likely USD/JPY will receive a boost. Sometimes, this relation does not hold due to the confluence of other factors.

10-year Treasury Note: FX markets usually refer to the 10-year note when comparing its yield with that on similar bonds overseas, namely the Euro (German 10-year bund), Japan (10-year JGB) and the UK (10-year gilt). The spread differential (difference in yields) between the yield on 10-year US Treasury note and that on non US bonds, impacts the exchange rate. A higher US yield usually benefits the US dollar against foreign currencies.

Treasury: The US Treasury is responsible for issuing government debt and for making decisions on the fiscal budget.

Economic Data: The most important economic data items released in the US are: labor report (payrolls, unemployment rate and average hourly earnings), CPI, PPI, GDP, international trade, ECI, NAPM, productivity, industrial production, housing starts, housing permits and consumer confidence.

Stock Market: The three major stock indices are the Dow Jones Industrials Index (Dow), S&P 500, and NASDAQ. The Dow is the most influential index on the dollar. Since the mid-1990s, the index has shown a strong positive correlation with the greenback as foreign investors purchased US equities. Three major forces affect the Dow: 1) Corporate earnings, forecast and actual; 2) Interest rate expectations and; 3) Global considerations. Consequently, these factors channel their way through the dollar

Cross Rate Effect: The dollar’s value against one currency is sometimes impacted by another currency pair (exchange rate) that may not involve the dollar. To illustrate, a sharp rise in the yen against the euro (falling EUR/JPY) could cause a general decline in the euro, including a fall in EUR/USD.

Fed Funds Rate Futures Contract: Interest rate expectations can be made through the Fed Funds rate in the futures market. The contract’s value shows what the Fed Funds interest rate (overnight rate) is expected to be in the future, depending on the maturity of the contract. Hence, the contract is a valuable barometer of market expectation vis-?-vis Federal Reserve policy. The rate is obtained by substracting the contract’s value from 100, and comparing the result to the prevailing Fed Funds rate in the cash/spot market.

3-month Eurodollar Futures Contract: While the Fed Funds futures contract reflects Fed Funds rate expectations into the future, the 3-month Eurodollar contract does the same for the interest rate on 3-month eurodollar deposits. To illustrate, the difference between futures contracts on the 3-month eurodollar and euroyen deposits is an essential variable in determining USD/JPY expectations.

Factors Affecting USD/JPY

Ministry of Finance: The MoF is the single most important political and monetary institution in Japan. Its influence in guiding the currency is more significant than the ministries of finance of the US, UK or Germany, despite the gradual measures to decentralize decision-making. MoF officials often make statements regarding the economy that have notable impacts on the yen. These statements include verbal intervention aimed at avoiding undesirable appreciation/depreciation of the yen.

Bank of Japan (BoJ). In 1998, Japan passed new laws giving the central Bank (BoJ) operational independence from the government (MoF). While complete control over monetary policy has shifted to the BoJ, the MoF remains in charge of foreign exchange policy.

Interest Rates: The Overnight Call Rate is the key short-term interbank rate. The call rate is controlled by the BoJ’s open market operations designed to manage liquidity. The BoJ uses the call rate to signal monetary policy changes, which impact the currency.

Japanese Government Bonds (JGBs): The BoJ buys 10 and 20-year JGBs every month to inject liquidity into the monetary system. The yield on the benchmark 10-year JGB serves as key indicator of long-term interest rates. The spread, or the difference between 10-year JGB yields and those on US 10-year treasury notes, is an important driver of the $/JPY exchange rates. Falling JGBs (rising JGB yields) usually boost the yen and impact USD/JPY.

Economic and Fiscal Policy Agency: Officially replaces powerful Economic Planning Agency (EPA) on January 6, 2001. Government agency responsible for formulating economic planning programs and coordinating economic policies including employment, international trade and foreign exchange.

Taro Aso: Head of Economic and Fiscal Policy Agency. Aso was appointed on Jan. 2001, after Fukushiro Nukaga resigned over bribery scandal.

Ministry of International Trade and Industry (MITI): Government institution aimed at supporting the interests of Japanese industry and defending international trade competitiveness of Japanese corporations. MITI’s power and visibility is not as significant as it used to be in the 1980s and early 1990s, when US-Japan trade issues were the “hottest” topics in FX markets.

Economic Data: The most important economic data items from Japan are: GDP; Tankan survey (quarterly business sentiment and expectations survey); international trade; unemployment; industrial production and money supply (M2+CDs).

Nikkei-225: Japan’s leading stock index. A reasonable decline in the yen usually lifts stocks of export-oriented companies, which tends to boost the overall stock index. The Nikkei-yen relationship is sometimes reversed, wherein a strong open market in the Nikkei tends to boost the yen (weighs on USD/JPY) as investors’ funds flow into yen-denominated stocks.

Cross Rate Effect: The USD/JPY exchange rate is sometimes impacted by movements in cross exchange rates (non-dollar exchange rates) such as EUR/JPY or EUR/USD. To illustrate: A rising USD/JPY (rising dollar & a falling yen) could be a result of an appreciating EUR/JPY, rather than direct strength in the dollar. This rise in the cross rate could be highlighted due to contrasting sentiment between Japan and the Eurozone.

Another example: Both EUR/JPY and EUR/USD rally because of a general strengthening in the euro. For some particular factors (such as better prospects in Japan), this could have a larger impact on the dollar than it does on the yen. As a result, USD/JPY weakens since the yen is relatively less hurt by the appreciating euro.

Factors Affecting GBP/USD

Bank of England (BoE): Under the Bank of England Act of June 1997, the BoE obtained operational independence in setting monetary policy to deliver price stability and to support the government’s growth and employment objectives. The price stability objective is set by the government's inflation target, defined as 2.5% annual growth in Retail Prices Index excluding mortgages (RPI-X). Hence, despite its independence in setting monetary policy, the BoE remains dependent upon having to meet the inflation target set by the Treasury.

Interest Rates: The Central Bank's main interest rate is the minimum lending rate (base rate), which it uses to send clear signals on monetary policy changes at thefirst week of every month. Changes in the base rate usually have a large impact on sterling. The BoE also sets monetary policy through its daily market operations used to change the dealing rates at which it buys government bills from discount houses (specialized institutions in trading money market instruments).

Gilts: Government bonds known as gilt-edged securities. The spread differential (difference in yields) between the yield on the 10-year gilt and that on the 10-year US Treasury note usually impacts the exchange rate. The spread differential between gilts and German bunds is also important, as it impacts the EUR/GBP exchange rate, which could affect GBP/USD (see cross-rate effect).

3-month Eurosterling Deposits: The interest rate on 3-month sterling-denominated deposits held in banks outside the UK. It serves as a valuable benchmark for determining interest rate differentials to help estimate exchange rates. Using a theoretical example on GBP/USD, the greater the interest rate differential in favor of the eurodollar against the eurosterling deposit, the more likely GBP/USD is to fall. Sometimes, this relation does not hold due to the confluence of other factors.

Treasury: The Treasury's role in setting monetary policy diminished markedly since the Bank of England Act of June 1997. Yet, the Treasury still sets the inflation target for the BoE and makes key appointments at the Central Bank.

Sterling and EMU Membership: British Prime Minister Tony Blair often impacts the sterling when he makes vital references regarding Britain’s possible membership into the single European currency, the euro. In order for Britain to join the single currency, UK interest rates will have to converge down to the levels of the Eurozone. If the British people vote in favor of adopting the euro (vote expected after 2001), the sterling will have to decline against the euro so as to achieve sufficient trade advantage for British industry. Thus, any signs (speeches, remarks or polls) indicating a closer UK to the euro, is expected to have a downward impact on the sterling.

Economic Data: The most important economic data items released in the UK are: Claimant unemployment (number of unemployed); claimant unemployment rate; average earnings; RPI-X; retail sales; PPI; industrial production; GDP growth; purchasing managers; surveys (manufacturing and services); money supply (M4); balance of payments and housing prices.

3-month Eurosterling Futures Contract (short sterling): The contract reflects markets expectations on 3-month euro sterling into the future. The difference between futures contracts on the 3-month eurodollar and eurosterling deposits is an essential variable in determining GBP/USD expectations.

FTSE-100: Britain's leading stock index. Unlike in the US or Japan, Britain's main stock index has relatively less influence on the currency. Nevertheless, the positive correlation between the FTSE-100 and the Dow Jones Industrial Index is one of the strongest in the global markets.

Cross Rate Effect: GBP/USD is sometimes impacted by movements in cross exchange rates (non-dollar exchange rates) such as EUR/GBP. To illustrate: A rise in EUR/GBP (fall in sterling) -- triggered by strengthening expectations of UK membership into the euro -- could lead to a decline in GBP/USD (cable). Conversely, reports indicating that the UK may not join the single currency project will hurt the EUR/GBP, thereby boosting cable.

Factors Affecting EUR/USD

The Eurozone: The 12 countries that have adopted the euro in order of GDP: Germany, France, Italy, Spain, Netherlands, Belgium, Austria, Finland, Portugal, Ireland, Luxembourg and Greece.

ECB Policy Targets: The ECB has a primary objective of price stability. It has two main "pillars" of monetary policy. The first one is the outlook for price developments and risks to price stability. Price stability is defined as an increase of the Harmonized Index of Consumer Prices (HICP) of below 2%. While the HICP is very important, a broad number of indicators and forecasts are used to determine the medium term threat to price stability. The second pillar is monetary growth as measured by M3. The ECB has a "reference value" of 4.5% annual growth for M3.

The ECB holds a Council meeting every other Thursday to make announcements on interest rates. At each first meeting of the month, the ECB holds a press conference in which it gives its outlook on monetary policy and the economy as a whole.

Interest Rates: The ECB’s refinancing rate is the Bank’s key short-term interest rate used for managing liquidity. The difference between the refinancing rate and the US Fed Funds rate is a good indicator for the EUR/USD.

3-month Eurodeposit (Euribor): The interest rate on 3-month Euribor, deposits held in banks outside the Eurozone. It serves as a valuable benchmark for determining interest rate differentials to help estimate exchange rates. Using a theoretical example on EUR/USD, the greater the interest rate differential in favor of the euribor against the eurodollar deposit, the more likely EUR/USD is to rise. Sometimes, this relation does not hold due to the confluence of other factors.

10-Year Government Bonds: Another important driver of the EUR/$ exchange rate is the difference in interest rates between the US and Eurozone. The German 10-year Bund is normally used as the benchmark. Since the rate on the 10-year Bund is below that of the US 10-year note, a narrowing of the spread (i.e. rise in Germany yields or fall in US yields or both) is theoretically expected to favor the EUR/$ rate. A widening in the spread, will act against the exchange rate. So the 10-year US-German spread is a good number to be aware of. The trend in this number is usually more important than the absolute value. The interest rate differential, of course, is usually related to the growth outlook of the US and eurozone, which is another fundamental driver of the exchange rate.

Economic Data: The most important economic data is from Germany, the largest economy, and from the euro-wide statistics, still in their infancy. The key data are usually GDP, inflation (CPI and HICP), Industrial Production, and Unemployment. From Germany in particular, a key piece of data is the IFO survey, which is a widely watched indicator of business confidence. Also important are the budget deficits of the individual countries, which according to the Stability and Growth Pact, must be kept below 3% of GDP. Countries also have targets for reducing their deficits further, and failure to meet these targets will likely be detrimental to the euro (as we saw with Italy’s loosening of its budget deficit guidelines).

Cross Rate Effect: The EUR/$ exchange rate is sometimes impacted by movements in cross exchange rates (non-dollar exchange rates) such as EUR/JPY or EUR/JPY. To illustrate: EUR/USD could fall as a result of significantly positive news in Japan, that filters through a falling EUR/JPY rate. Even though, $/JPY may be declining, euro weakness spills onto a falling EURUSD.

3-month Euro Futures Contract (Euribor): The contract reflects markets expectations on 3-month euro-Euro deposits (euribor) into the future. The difference between futures contracts on the 3-month cash eurodollar and on the euro-Euro deposit is an essential variable in determining EUR/USD expectations.

Other Indicators: There is a strong negative correlation between EUR/USD and USD/CHF, reflecting a steadily similar relation between the euro and the Swiss franc. This is because the Swiss economy is largely dependent upon the Eurozone economies. In most cases, a spike (dip) in EUR/USD is accompanied by a dip (spike) in EUR/CHF. The inverse also usually holds. This relationship sometimes fails to hold in the event of data or factors pertaining solely to either of the currencies.

Political Factors: As with all exchange rates, EUR/USD is susceptible to political instability such as a threat to coalition governments in France, Germany or Italy. Political or financial instability in Russia is also a red flag for EUR/USD, because of the substantial amount of Germany investment directed to Russia.

Factors Affecting USD/CHF

Swiss National Bank (SNB): The Swiss Central Bank has maximum independence in setting monetary and exchange rate policy. Unlike most Central banks, the SNB does not use a specific money market rate to guide monetary conditions. Until fall 1999, the Bank used foreign exchange swaps and repurchase agreements as the main instruments to impact money supply and interest rates.

Liquidity management has characteristically affected the Swiss franc due to the use of Foreign Exchange Swaps. If the Bank wishes to inject liquidity, it buys foreign currency (primarily dollars) against Swiss francs, thereby pressuring the currency.

As of December 1999, the Bank shifted from a monetarist approach (targeting money supply) to an inflation-based approach namely; a 2.00% annual inflation rate. The Bank will use a range in the 3-month London Interbank Offer Rate (LIBOR) to stir monetary policy in order to achieve the 2.00% inflation target.

SNB officials can affect the Swiss Franc by making occasional remarks on liquidity, money supply or the currency itself.

Interest Rates: The SNB uses the discount rate to announce changes in monetary policy. These changes have a significant impact on the currency. The discount rate, however, is rarely used at the Bank’s discount facility.

3-month Euroswissfranc Deposits: The interest rate on 3-month swiss-denominated deposits held in banks outside Switzerland. It serves as a valuable benchmark for determining interest rate differentials to help estimate exchange rates. Using a theoretical example on USD/CHF, the greater the interest rate differential in favor of the eurodollar against the euroswiss deposit, the more likely USD/CHF is to rise. Sometimes, this relation does not hold due to the confluence of other factors.

Swiss franc’s Changing Role as a Safe-Haven Status: The Swiss franc has historically enjoyed an advantageous role as a “safe” asset due to: SNB independence in preserving monetary stability; secrecy of the nation’s banking system; and the neutrality of Switzerland’s political position. Moreover, the SNB’s relatively hefty gold reserves had largely contributed to the franc’s solidity. Even as the currency’s international role starts to wane in the mid-1990s (partly due to the emergence of the dollar and fall in gold), the Swiss franc remains a valuable alternative in Forex markets.

Economic Data: The most important economic data items released in Switzerland are: M3 (broadest measure of money supply), CPI, unemployment, balance of payments, GDP and industrial production.

Cross Rate Effect: USD/CHF is sometimes impacted by movements in cross exchange rates (non-dollar exchange rates), such as EUR/CHF or GBP/CHF. To illustrate: A rise in GBP/CHF that is triggered by an interest rate hike in the UK, could extend franc’s weakness against other currencies, including the dollar.

3-month Euroswiss Futures Contract: The contract reflects markets expectations on 3-month euro swiss deposits into the future. The difference between futures contracts on the 3-month eurodollar and euroswiss eposits is an essential variable in determining USD/CHF expectations.

Other factors: Due to the proximity of the Swiss economy to the Eurozone (specifically Germany), the Swiss franc has exhibited a considerably positive correlation with the euro. The relationship is most prominent in the highly negative correlation between USD/CHF and EUR/USD. To illustrate, a sudden move in EUR/USD (triggered by a major fundamental factor) is most likely to cause an equally sharp move in USD/CHF in the opposite direction. The relationship between these two currency pairs is one the strongest in currency markets.

A Primer on the FOREX Market

With the increasingly widespread availability of electronic trading networks, trading on the currency exchanges is now more accessible than ever. The foreign exchange market, or FOREX, is notoriously the domain of government central banks and commercial and investment banks, not to mention hedge funds and massive international corporations. At first glance, the presence of such heavyweight entities may appear rather daunting to the individual investor. But the presence of such powerful groups and such a massive international market can also work to the benefit of the individual trader. FOREX offers trading 24-hours a day, five days a week, and the daily dollar volume of currencies traded in the currency market exceeds $1.4 trillion, making it the largest and most liquid market in the world.

Trading Opportunities
The sheer number of currencies traded serves to ensure a rather extreme level of volatility on a day-to-day basis. There will always be currencies that are moving rapidly up or down, offering opportunities for profit (and commensurate risk) to astute traders. Yet, like the equity markets, FOREX offers plenty of instruments to mitigate risk and allows the individual to profit in both rising and falling markets. FOREX also allows highly-leveraged trading with low margin requirements relative to its equity counterparts. Perhaps best of all, FOREX charges zero dealing commissions!

Many of the instruments utilized in FOREX--such as forwards and futures, options, spread betting, contracts for difference, and the spot market--will appear similar to those used in the equity markets. Since the instruments on the FOREX often maintain minimum trade sizes in terms of the base currencies (the spot market, for example, requires a minimum trade size of 100,000 units of the base currency), the use of margin is absolutely essential for the person trading these instruments.

Base and Counter Currencies and Quotes
Currency traders must become familiar also with the means by which currencies are quoted. The first currency in the pair is considered the base currency; and the second is the counter or quote currency. Most of the time, the US currency is considered the base currency, and quotes are expressed in units of $1 USD per counter currency (for example, USD/JPY or USD/CAD). The only exceptions to this convention are in relation to the Euro, the Pound Sterling, and the Australian dollar--these three are quoted as dollars per foreign currency.

FOREX quotes always include a bid and an ask price. The bid is the price at which the market maker is willing to buy the base currency in exchange for the counter currency. The ask price is the price at which the market maker is willing to sell the base currency in exchange for the counter currency. The difference between the bid and the ask prices is referred to as the spread.

The cost of establishing a position is determined by the spread, and prices are always quoted using five numbers (for example, 134.85), the final digit of which is referred to as a point or a pip. For example, if USD/CAD was quoted with a bid of 134.85 and an ask of 134.90, the five-pip spread is the cost of trading this position. From the very start, therefore, the trader must recover the five-pip cost from his profits, necessitating a favorable move in his position in order simply to break even.

More about Margin
Trading in the currency markets requires a trader to think in a slightly different way also about margin. Margin on the FOREX is not a down payment on a future purchase of equity but a deposit to the trader's account that will cover against any currency-trading losses in the future. A typical currency trading system will allow for a very high degree of leverage in its margin requirements, up to 100:1. The system will automatically calculate the funds necessary for current positions and will check for margin availability before executing any trade.

In the spot FOREX market, trades must be settled within two business days. For example, if a trader sells a certain number of currency units on Wednesday, he or she must deliver an equivalent number of units on Friday. Yet currency trading systems may allow for a "rollover," with which open positions can be swapped forward to the next settlement date (giving an extension of two additional business day). The interest rate for such a swap is predetermined, and, in fact, these swaps are actually financial instruments that can also be traded on the currency market.

In any spot rollover transaction the difference between the interest rates of the base and counter currencies is reflected as an overnight loan. If the trader holds a long position in the currency with the higher interest rate, he or she would gain on the spot rollover. The amount of such a gain would fluctuate day-to-day according to the precise interest-rate differential between the base and the counter currency. Such rollover rates are quoted in dollars and are shown in the interest column of the FOREX trading system. Rollovers, however, will not affect traders who never hold a position overnight, since the rollover is exclusively a day-to-day phenomenon.

As one can immediately see, trading in FOREX requires a slightly different way of thinking than the equity markets. Yet, for its extreme liquidity, its multitude of opportunities for large profits due to strong trends, and its high levels of available leverage, the currency markets are hard to resist for the advanced trader. With such potential, however, comes significant risk, and traders should quickly establish an intimate familiarity with methods of risk management.

Until next time, all the very best in your trading endeavors!

The Fundamentals of FOREX Fundamentals

Those trading in the foreign exchange market (FOREX) rely on the same two basic forms of analysis that are used in the stock market: fundamental analysis and technical analysis. The uses of technical analysis in FOREX are much the same: price is assumed to reflect all news, and the charts are the objects of analysis. But unlike companies, countries have no balance sheets, so how can fundamental analysis be conducted on a currency?

Since fundamental analysis is about looking at the intrinsic value of an investment, its application in FOREX entails looking at the economic conditions that affect the valuation of a nation's currency. Here we look at some of the major fundamental factors that play a role in the movement of a currency.

Economic Indicators
Economic indicators are reports released by the government or a private organization that detail a country's economic performance. Economic reports are the means by which a country's economic health is directly measured, but do remember that a great deal of factors and policies will affect a nation's economic performance.

These reports are released at scheduled times, providing the market with an indication of whether a nation's economy has improved or declined. The effects of these reports are comparable to how earnings reports, SEC filings and other releases may affect securities. In FOREX, as in the stock market, any deviation from the norm can cause large price and volume movements.

You may recognize some of these economic reports, such as the unemployment numbers, which are well publicized. Others, like housing stats, receive little coverage. However, each indicator serves a particular purpose, and can be useful. Here we outline four major reports, some of which are comparable to particular fundamental indicators used by equity investors:

  1. The Gross Domestic Product (GDP) - The GDP is considered the broadest measure of a country's economy, and it represents the total market value of all goods and services produced in a country during a given year. Since the GDP figure itself is often considered a lagging indicator, most traders focus on the two reports that are issued in the months before the final GDP figures: the advance report and the preliminary report. Significant revisions between these reports can cause considerable volatility. The GDP is somewhat analogous to the gross profit margin of a publicly traded company in that they are both measures of internal growth.

  2. Retail Sales - The retail sales report measures the total receipts of all retail stores in a given country. This measurement is derived from a diverse sample of retail stores throughout a nation. The report is particularly useful because it is a timely indicator of broad consumer spending patterns that is adjusted for seasonal variables. It can be used to predict the performance of more important lagging indicators, and to assess the immediate direction of an economy. Revisions to advanced reports of retail sales can cause significant volatility. The retail sales report can be compared to the sales activity of a publicly traded company.

  3. Industrial Production - This report shows the change in the production of factories, mines, and utilities within a nation. It also reports their 'capacity utilizations', the degree to which the capacity of each of these factories is being used. .

  4. Consumer Price Index (CPI) - The CPI is a measure of the change in the prices of consumer goods across over 200 different categories. This report, when compared to a nation's exports, can be used to see if a country is making or losing money on its products and services. Be careful, however, to monitor the exports--it is a focus that is popular with many traders because the prices of exports often change relative to a currency's strength or weakness.

Some of the other major indicators include the purchasing managers index (PMI), producer price index (PPI), durable goods report, employment cost index (ECI), and housing starts. And don't forget the many privately-issued reports, the most famous of which is the Michigan Consumer Confidence Survey. All of these provide a valuable resource to traders, if used properly.

So, How Are these Used?
Since economic indicators gauge a country's economic state, changes in the conditions reported will therefore directly affect the price and volume of a country's currency. It is important to keep in mind, however, that the indicators discussed above are not the only things that affect a currency's price. There are third party reports, technical factors, and many other things that can also drastically affect a currency's valuation. Here are a few useful tips that may help you when conducting fundamental analysis in the foreign exchange market:

  • Keep an economic calendar on hand that lists the indicators and when they are due to be released. Also, keep an eye on the future; often markets will move in anticipation of a certain indicator or report due to be released at a later time.

  • Be informed about the economic indicators that are capturing most of the market's attention at any given time. Such indicators are catalysts for the largest price and volume movements. For example, when the U.S. dollar is weak, inflation is often one of the most watched indicators.

  • Know the market expectations for the data, and then pay attention to whether or not the expectations are met. That is far more important than the data itself. Occasionally, there is a drastic difference between the expectations and actual results and, if there is, be aware of the possible justifications for this difference.

  • Don't react too quickly to the news. Oftentimes, numbers are released and then revised, and things can change quickly. Pay attention to these revisions, as they may be a useful tool for seeing the trends and reacting more accurately to future reports.

There are many economic indicators, and even more private reports that can be used to evaluate the fundamentals of FOREX. It's important to take the time to not only look at the numbers, but also understand what they mean and how they affect a nation's economy. When properly used, these indicators can be an invaluable resource for any currency trader.

The Concept of a Forward Transaction

Spot Transactions, Forwards and Futures

In order to understand options, it is necessary to understand the basics of some related financial instruments: forward and futures contracts.

Forward contracts, futures and options contracts all have one thing in common:They are related to a future date.

For transactions entered into on the spot market, one takes delivery and makes payment for the asset within two business days of the contract entry date. Forward and futures contracts are agreements to purchase or sell a given amount of a specified asset, calling for delivery and payment at a specified date in the future. The price to be paid is agreed upon when the contract is made.

What is a forward contract?

Forward contracts are agreements directly entered into between a buyer and a seller, calling for delivery of a specified amount of a specified asset at a specified, future date. The buyer and the seller are direct contractual counterparties to one another.

Let us start with a forward transaction. When a trader quotes a price for an asset - any asset - it must be clearly understood for what delivery date the price is valid: the price depends on the delivery date.

A forward transaction

The Spot Price - the price paid for immediate delivery of an asset today, March 15 - is usually different from the March 15 price for delivery of the asset at some later date, say August 28 - the Forward Price.

The difference can be positive or negative. It can vary depending on a variety of factors, including expectations, interest rates etc.

Both the Spot Price and the Forward Price change over time, usually in the same direction, but not necessarily to the same degree.

Up to now, there are two prices in the game. However, as soon as a forward contract is entered into, there is a third price to be considered by the parties involved: the Contract Price. If the forward contract is made on April 27, the contract price represents the forward price on April 27 for August 28 delivery.

As time goes by, the Contract Price remains fixed while the Spot Price and the Forward Price continue to fluctuate.

Example - Gold

Suppose on June 1st, gold prices are as follows:

for August 15 delivery: Forward Price:   $ 420/oz
                        Spot Price:      $ 410/oz

If a contract to buy (or to sell) a certain amount of Gold for delivery on August 15 is made on June 1st, the Contract Price of this forward contract will:

 a) be equal to the current (June 1) Spot Price
 b) be equal to the current Forward Price
 c) fluctuate in line with the Spot Price
 d) fluctuate in line with the Forward Price.

Forward vs. Contract Price

The above graph shows a falling forward price between the contract date and maturity. The difference between the current forward price and the contract price represents a profit for the seller in this contract, and a loss for the buyer.

However, this one contract is only part of the picture: both the buyer and the seller entered into the contract for a specific reason. On the next screen we will study a possible case.

Case Study - A Swiss Importer

Assume you are a Swiss importer of German cars. It is May 1 and your next delivery is expected on July 15, for which you will have to pay 2 500,000 Deutsche Marks on delivery.

In order to avoid any foreign exchange risk you can:

 a) buy DM 500,000 now, May 1;
 b) buy DM 500,000 in July;
 c) 1 buy DM 500,000 forward for July 15 delivery.

Swiss Importer

You call your bank and they give you the forward rate for July 15 delivery which is 0.85 SFr per DM

Then you enter into a forward contract with your bank, specifying that you will - on July15 - receiveDM 500,000 in exchange for SFr 425,000. (DM 500,000 x 0.85 SFr/DM = SFr 425,000)

May 1: You purchase a DM 500,000 forward contract for July 15 delivery at a forward rate of 0.85 SFr/DM

On June 4, your supplier announces that due to a strike all deliveries are delayed and you will not get your cars before several months from now.

Meanwhile, the forward rate for July 15 delivery has dropped to 0.83 SFr/DM

June 4 The forward rate for July 15 delivery has declined to 0.83 SFr/DM

Here is your problem: You do not need the DM 500,000 which you agreed to buy from your bank.

What should you do?

 a) Take them anyway in July
 b) Call up your bank to cancel the contract.
 c) Negotiate a forward sale of DM 500,000 for July 15.

Situation: June 4, you make an offsetting transaction, selling DM 500,000 for July 15 delivery forward at a rate of 0.83

What is the result?

 a) You are free of any obligation with your bank.
 b) You are free of any obligation and the bank credits your account.
 c) You are free of any obligation and the bank debits your account.

Sometimes the word "futures contract" is mistakenly used instead of "forward contract". Here is the basic difference between the two of them:

FORWARD contracts are agreements specifically between two counterparts, for instance between you and your bank.

FUTURES, however, are standardized contracts for forward delivery. The buying and selling takes place in a centralized market place, an exchange.