Learn Forex Trading
What is Forex ?
The Foreign Exchange market, also referred to as the "Forex" or "FX" market, is the largest financial market in the world, with a daily average turnover of approximately US$1.5 trillion. Foreign Exchange is the simultaneous buying of one currency and selling of another. The world's currencies are on a floating exchange rate and are always traded in pairs, for example Euro/Dollar or Dollar/Yen.
Learn Forex Trading
How do I begin? Please give it to me SIMPLY.
1. The best advice on how to learn to trade profitably is to learn from experts with proven track records. Many learning styles are available to beginners at all levels: books, CDs, online courses, group seminars, even one-on-one mentors who will come right your home for a few days. We outline our Forex-Trader picks in Learning Forex Trading. Learning to trade from experts is worth every penny and has saved us untold thousands in mistakes.We would not recommend starting forex trading without any training. It is not hard to learn, nor difficult to trade successfully, but you must first provide yourself with a basic functioning knowledge of 'the game you're in'.
2. While you are learning you will need charting software to practice reading the Market. Charting is an indispensable tool that shows you in real-time data what the market is doing moment by moment and also what the market has done in the past. As you learn to analyze these charts you can determine what trades to enter and exit, where to set your stop losses, limits etc. There are several good charting software services that you can subscribe to online monthly. See our Forex-Trader tested Charting Software picks in Tools of The Trade.
3. Then, to perform your actual trades online you need a real-time 'trading platform' to execute your 'buys' and 'sells' directly in the Foreign Currency Market. You obtain a trading platform from a Forex Clearinghouse that is connected real-time to the interbank market. There are many good Clearinghouses (also confusingly called Brokerage Firms, Market Makers, etc.) that provide you with the trading platform to trade the funds in the account you have opened with them. Before you begin trading your 'real' money, while you are learning, you will practice on your own 'demo account' with play-money in it, which will be provided to you by the clearinghouse you plan to trade through. The contractual relationship you enter into with your Clearinghouse is a very important one because the Clearinghouse you choose determines many trading features and financial advantages to you both as a trader and as an investor. Forex-Trader tested Clearinghouses are reviewed in Tools of The Trade.
We have outlined a Getting Started path with uncomplicated steps. This is the path that we would take if we were beginning trading over again today with 'what we know now'. The products and services we mention in these steps are all ones that we have personally used for some time with consistent success. As always you are free to forge your own path, and if you do, happy hiking. There is a mountain of products and services try out, and if you find ones you like better we would love to compare notes with you.
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Explain More About Charting Services
To trade successfully you also must have good charting software and instantaneous data feeds critical to helping you analysis and interpret the movement of currencies moment to moment so you know when/why to buy or sell -- this you subscribe to monthly. You can get a 2 week or more demo to familiarize yourself with one that has the features you like. The costs also vary, and some companies require a year commitment. There are some free charting services offered through the clearinghouses, but they tend to lack the tools to be truly useful. There are also some costly proprietary Specialty Software charting 'hybrids' which are market forecasters tools that look more like video games than charts.
Explain More About How Clearinghouses Work
A good clearinghouse (i.e.. your computer access/link to the live Forex Exchange Market) is the partner with which you trade the money you have deposited with them in your trading account. After trying and demo-ing many we have found a small handful that are truly excellent for the beginner (and continue to be excellent as you grow) -- meaning user friendly, legally accountable to regulatory bodies, and offering fair costs (spreads) for their services/trading software platforms. There still are many worrisome ones practicing in this closing era of unregulated forex trading (new Commodities laws are imminent).
The topic of matching the right clearinghouse for your needs is discussed more in Tools of the Trade, because it depends on a number of factors -- how much you can open an account with, how much the clearinghouse profit spread, what your liquidity needs are, your minimum/maximum stop loss and margin requirements, even where you live and how much time you have to give to trading in a 24 hr. day.
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How Much Does it Cost to Begin to Trade?
Learning to trade will entail the cost of books and whatever traiining method you choose. It will also include a reliable computer with a minimum 128 Mb of memory to run the charting software and trading platform. Ongoing 'costs of operation' include the monthly costs of high-speed internet, charting software, the email forecasting subscriptions -- plan on spending $150./mo. up for ongoing costs.
What about Pooled Clearinghouse Accounts to Trade with More Leverage?
We strongly do not recommend pooled accounts in any circumstance. Perhaps you are considering self-trading a pooled- together family account because it would give you a perceived advantage of more leveraged funds to trade (50:1 up to 100:1 leverage) -- any risks of loss represent a potential risk to family relationships, and for this reason alone we do not recommend aggregating with family or friends.
However much worse are the too-numerous negative experiences of people allowing their investment funds to leave their control to become part of a 'managed' pooled account. Not only is it a very risky investment idea, it is illegal for anyone to 'pool' accounts without compliance with SEC (a USA Securities Exchange Commission) or international equivalent license. Never relinquish direct control over your money/trading account to anyone (i.e.. the ability to make withdrawals, deposits etc. directly by your own authority into your own account).
A good fund manager, if you do choose to go the (legitimate) Managed Account route rather than the Self-Trader route, will make certain you have your own 'segregated account' in your own name in a bank or brokerage firm. These individual segregated accounts can still be traded together as though they were in a single account by a designated trader as long as the clearing house uses a trading platform that allows it. You, as the investor/account holder, have direct access online to your account activity at all times, and direct control over your own account in your own name (just like a bank account). The importance of this, for the safety of your funds, cannot be over emphasized.
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Questions From Our Email Inbox
Thank you for inviting people to learn from your experience. I found that to be very generous. I was hoping you may be able to shed little light on just how to go about finding the right currency pairs to buy.
This is where charting software will make it self-evident for you to know what pairs are 'trending'. Technical analysis using charting software: Elliott Wave, Retracements, Fibronacci patterns, short term trending, etc. Good charting software is invaluable! Look at it as one of your 'costs of doing business'.
I have just begun learning how the FOREX works. There are so few opportunities for the lower economic class to achieve financial independence.
It took us a full year to learn to trade forex to achieve consistent profits, but well worth the time and effort. Forex trading can be the great leveler of the self-investor playing field. I and we believe that with dedication to sound, risk-management trading methods you can succeed.
I'm trying to build a financial base, but I just can't find a door in. Is it possible for me to participate directly in the FOREX with smaller amounts - like $1000?
Beginning with $1K. is more of a challenge and more of a risk (but not impossible). $1K represents 1 lot in Forex Trading, and that is the minimum (leveraged) trade that can be made. Perhaps that $1K would be better spent on trading education?
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I have participated in Forex 'Games' and other types of online investments that claim to be investing in Foreign Currency (among other things), with returns of 50% a month and more. I actually did get paid. Opinions please?
We strongly urge you to resist any further temptation to send your money away to an investment-type pool (by this we mean do not send your money away to be under someone else's control and in someone else's account). It is unjustified risk, there are much better ways to begin to experience profits from forex trading. Many such online investments have totally disappeared into the Internet ethers from which they came. Typically these investments give no contact information, claiming to be 'offshore', 'for privacy reasons'. They last a few months, their bulletin boards or email newsletters extoll their climbing numbers of 'members' and pay-outs, then without warning their site goes off-line forever. And you never knew who they were that disappeared with your trust and your money or e-gold.
How do you forecast which currency is next in line to increase?
It is not so much that you want to know when any one currency is going up. You can make profits whether a currency is going up (buy), or down (sell). All Currencies are continually rising and falling relative to other currencies, and forex trading is in fact trading one currency relative to another. Good trading opportunities are always present when you know how to recognize them. Technical analysis using charting software, market sentiment, experience will show you which currencies to pair to trade. Forex Trading is a skill of identifying (and acting on) the probabilities.
How do you choose when to rollover or close positions?
Technical analysis using charting software that (when you learn how to identify what you are seeing) depicts resistance levels (how high it will likely rise to) or support levels (how low it will likely stop dropping at). This is helpful for determining whether to rollover the trade for a bigger forecasted profit the next day. However, a rollover does have additional clearinghouse fees attached. Quick in-and-out trades are closed intentionally with the goal of a smaller profit gain (such as a 4 pip profit).
For example, Beginners, who are learning to read their charts, can do very well closing positions at whatever point they have gained +4 pips profit. This represents a $40. profit (in this example we are trading 1 lot Euro/USD, so 1 pip equals $10.). A $40./4 pip gain is a relatively small move on the chart and may not seem impressive until you consider that If you do this successfully 4 times a day you have made $160. profit. With 4 such daily trades in a four day trading week you will have made $640. (consider also that this is even without the magic of compounding). We leave the monthly and yearly calculations to you.
What indicators do you utilize?
We have tried everything we could ever get our hands on. Over time we have selected the ones that are most consistent and well suited to our trading style. See our review of different indicator tools in Tools of the Trade. You will develop your own trading style (best times of day, favorite currency pairs, best instinctual moving-average chart pattern etc.). But experience with basic technical analysis using charting software is always the starting point. Then you add forex forecasting email subscriptions, Allan Greenspan's body language (no kidding) etc.
Are there any real time & reliable direct (commission free) market maker entry sites online?
Yes. It is not necessary to pay a clearinghouse (also known as a market maker, or forex brokerage house) an additional 'commission' for self-trading using their platform/services. They are usually compensated in the 'spread' between the buy price and sell price.
Source : forex-trader.com
Online Forex Trading
Recommended forex brokers :
GCI Financial Ltd
Online Trading in Forex and Share CFDs. 200:1 leverage, Free demo account. Trade a Standard or Mini account.
Charter FX
Margined trading in Forex and CFDs. Free charts, quotes, and demo account.
Swiss Finance Corp
Trading in Foreign Exchange. FSA regulated broker, offering 2% margin, 2 - 3 pip spreads.
Man Financial
Trade Forex and CFDs on the GNI touch platform. Live prices, fast execution, news and charting
Forex Articles
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Forex FAQ
What is Foreign Exchange?
The Foreign Exchange market, also referred to as the "Forex" or "FX" market, is the largest financial market in the world, with a daily average turnover of approximately US$1.5 trillion. Foreign Exchange is the simultaneous buying of one currency and selling of another. The world's currencies are on a floating exchange rate and are always traded in pairs, for example Euro/Dollar or Dollar/Yen.
Where is the central location of the FX Market?
FX Trading is not centralized on an exchange, as with the stock and futures markets. The FX market is considered an Over the Counter (OTC) or 'Interbank' market, due to the fact that transactions are conducted between two counterparts over the telephone or via an electronic network.
Who are the participants in the FX Market?
The Forex market is called an 'Interbank' market due to the fact that historically it has been dominated by banks, including central banks, commercial banks, and investment banks. However, the percentage of other market participants is rapidly growing, and now includes large multinational corporations, global money managers, registered dealers, international money brokers, futures and options traders, and private speculators.
When is the FX market open for trading?
A true 24-hour market, Forex trading begins each day in Sydney, and moves around the globe as the business day begins in each financial center, first to Tokyo, then London, and New York. Unlike any other financial market, investors can respond to currency fluctuations caused by economic, social and political events at the time they occur - day or night.
What are the most commonly traded currencies in the FX markets?
The most often traded or 'liquid' currencies are those of countries with stable governments, respected central banks, and low inflation. Today, over 85% of all daily transactions involve trading of the major currencies, which include the US Dollar, Japanese Yen, Euro, British Pound, Swiss Franc, Canadian Dollar and the Australian Dollar.
Is Forex trading capital intensive?
No. FXA requires a minimum deposit of $250. FXA allows customers to execute margin trades at up to 200:1 leverage. This means that investors can execute trades of $10,000 with an initial margin requirement of $50. However, it is important to remember that while this type of leverage allows investors to maximize their profit potential, the potential for loss is equally great. A more pragmatic margin trade for someone new to the FX markets would be 20:1 but ultimately depends on the investor's appetite for risk.
What is Margin?
Margin is essentially collateral for a position. If the market moves against a customer's position, FXA will request additional funds through a "margin call." If there are insufficient available funds, FXA will immediately close out the customer's open positions.
What does it mean have a 'long' or 'short' position?
In trading parlance, a long position is one in which a trader buys a currency at one price and aims to sell it later at a higher price. In this scenario, the investor benefits from a rising market. A short position is one in which the trader sells a currency in anticipation that it will depreciate. In this scenario, the investor benefits from a declining market. However, it is important to remember that every FX position requires an investor to go long in one currency and short the other.
What about terms like "bid/ask", "spread", and "rollover"?
FXA has an extensive Glossary that provides detailed definitions of all Forex related terms.
What is the difference between an "intraday" and "overnight position"?
Intraday positions are all positions opened anytime during the 24 hour period AFTER the close of FXA's normal trading hours at 4:30pm EST. Overnight positions are positions that are still on at the end of normal trading hours (4:30pm EST), which are automatically rolled by FXA at competitive rates (based on the currencies interest rate differentials) to the next day's price.
How are currency prices determined?
Currency prices are affected by a variety of economic and political conditions, most importantly interest rates, inflation and political stability. Moreover, governments sometimes participate in the Forex market to influence the value of their currencies, either by flooding the market with their domestic currency in an attempt to lower the price, or conversely buying in order to raise the price. This is known as Central Bank intervention. Any of these factors, as well as large market orders, can cause high volatility in currency prices. However, the size and volume of the Forex market makes it impossible for any one entity to "drive" the market for any length of time.
How do I manage risk?
The most common risk management tools in FX trading are the limit order and the stop loss order. A limit order places restriction on the maximum price to be paid or the minimum price to be received. 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 an investor's position. The liquidity of the Forex market ensures that limit order and stop loss orders can be easily executed.
What kind of trading strategy should I use?
Currency traders make decisions using both technical factors and economic fundamentals. Technical traders use charts, trend lines, support and resistance levels, and numerous patterns and mathematical analyses to identify trading opportunities, whereas fundamentalists predict price movements by interpreting a wide variety of economic information, including news, government-issued indicators and reports, and even rumor. The most dramatic price movements however, occur when unexpected events happen. The event can range from a Central Bank raising domestic interest rates to the outcome of a political election or even an act of war. Nonetheless, more often it is the expectation of an event that drives the market rather than the event itself.
How often are trades made?
Market conditions dictate trading activity on any given day. As a reference, the average small to medium trader might trade as often as 10 times a day. Most importantly, by not charging commission, FXA customers can take positions as often as necessary without worrying about excessive transaction costs.
How long are positions maintained?
As a general rule, a position is kept open until one of the following occurs: 1) realization of sufficient profits from a position; 2) the specified stop-loss is triggered; 3) another position that has a better potential appears and you need these funds.
I am interested in foreign exchange trading, but would like some additional information. Any suggestions?
In The Forex Market section we describe the foreign exchange market in some detail. In order to gain a practical understanding of foreign exchange trading, there is no better way than to open a demo account, where you can experience what it's like to trade the Forex market without risking any capital.
Source : fxadvantage
Forex Glossary
A
Accrual - The apportionment of premiums and discounts on forward exchange transactions that relate directly to deposit swap (Interest Arbitrage) deals , over the period of each deal.
Adjustment - Official action normally by either change in the internal economic policies to correct a payment imbalance or in the official currency rate or. Adjustment - Official action normally by either change in the internal economic policies to correct a payment imbalance or in the official currency rate or.
Appreciation - A currency is said to 'appreciate' when it strengthens in price in response to market demand.
Arbitrage - The purchase or sale of an instrument and simultaneous taking of an equal and opposite position in a related market, in order to take advantage of small price differentials between markets.
Ask (Offer) Price - The price at which the market is prepared to sell a specific Currency in a Foreign Exchange Contract or Cross Currency Contract. At this price, the trader can buy the base currency. In the quotation, it is shown on the right side of the quotation. For example, in the quote USD/CHF 1.4527/32, the ask price is 1.4532; meaning you can buy one US dollar for 1.4532 Swiss francs.
At Best - An instruction given to a dealer to buy or sell at the best rate that can be obtained.
At or Better - An order to deal at a specific rate or better.
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B
Balance of Trade - The value of a country's exports minus its imports.
Bar Chart - A type of chart which consists of four significant points: the high and the low prices, which form the vertical bar, the opening price, which is marked with a little horizontal line to the left of the bar, and the closing price, which is marked with a little horizontal line of the right of the bar.
Base Currency - The first currency in a Currency Pair. It shows how much the base currency is worth as measured against the second currency. For example, if the USD/CHF rate equals 1.6215 then one USD is worth CHF 1.6215 In the FX markets, the US Dollar is normally considered the 'base' currency for quotes, meaning that quotes are expressed as a unit of $1 USD per the other currency quoted in the pair. The primary exceptions to this rule are the British Pound, the Euro and the Australian Dollar.
Bear Market - A market distinguished by declining prices.
Bid Price - The bid is the the price at which the market is prepared to buy a specific Currency in a Foreign Exchange Contract or Cross Currency Contract. At this price, the trader can sell the base currency. It is shown on the left side of the quotation. For example, in the quote USD/CHF 1.4527/32, the bid price is 1.4527; meaning you can sell one US dollar for 1.4527 Swiss francs.
Bid/Ask Spread - The difference between the bid and offer price. Big Figure Quote - Dealer expression referring to the first few digits of an exchange rate. These digits are often omitted in dealer quotes.. For example, a USD/JPY rate might be 117.30/117.35, but would be quoted verbally without the first three digits i.e. "30/35".
Book - In a professional trading environment, a 'book' is the summary of a trader's or desk's total positions.
Broker - An individual or firm that acts as an intermediary, putting together buyers and sellers for a fee or commission. In contrast, a 'dealer' commits capital and takes one side of a position, hoping to earn a spread (profit) by closing out the position in a subsequent trade with another party.
Bretton Woods Agreement of 1944 - An agreement that established fixed foreign exchange rates for major currencies, provided for central bank intervention in the currency markets, and pegged the price of gold at US $35 per ounce. The agreement lasted until 1971, when President Nixon overturned the Bretton Woods agreement and established a floating exchange rate for the major currencies.
Bull Market - A market distinguished by rising prices.
Bundesbank - Germany's Central Bank.
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C
Cable - Trader jargon referring to the Sterling/US Dollar exchange rate. So called because the rate was originally transmitted via a transatlantic cable beginning in the mid 1800's.
Candlestick Chart - A chart that indicates the trading range for the day as well as the opening and closing price. If the open price is higher than the close price, the rectangle between the open and close price is shaded. If the close price is higher than the open price, that area of the chart is not shaded.
Cash Market - The market in the actual financial instrument on which a futures or options contract is based.
Central Bank - A government or quasi-governmental organization that manages a country's monetary policy. For example, the US central bank is the Federal Reserve, and the German central bank is the Bundesbank.
Chartist - An individual who uses charts and graphs and interprets historical data to find trends and predict future movements. Also referred to as Technical Trader.
Cleared Funds - Funds that are freely available, sent in to settle a trade.
Closed Position - Exposures in Foreign Currencies that no longer exist. The process to close a position is to sell or buy a certain amount of currency to offset an equal amount of the open position. This will 'square' the postion.
Clearing - The process of settling a trade.
Contagion - The tendency of an economic crisis to spread from one market to another. In 1997, political instability in Indonesia caused high volatility in their domestic currency, the Rupiah. From there, the contagion spread to other Asian emerging currencies, and then to Latin America, and is now referred to as the 'Asian Contagion'.
Collateral - Something given to secure a loan or as a guarantee of performance.
Commission - A transaction fee charged by a broker.
Confirmation - A document exchanged by counterparts to a transaction that states the terms of said transaction.
Contract - The standard unit of trading.
Counter Currency - The second listed Currency in a Currency Pair.
Counterparty - One of the participants in a financial transaction.
Country Risk - Risk associated with a cross-border transaction, including but not limited to legal and political conditions.
Cross Currency Pairs or Cross Rate - A foreign exchange transaction in which one foreign currency is traded against a second foreign currency. For example; EUR/GBP
Currency symbols
AUD - Australian Dollar
CAD - Canadian Dollar
EUR - Euro
JPY - Japanese Yen
GBP - British Pound
CHF - Swiss Franc
Currency - Any form of money issued by a government or central bank and used as legal tender and a basis for trade.
Currency Pair - The two currencies that make up a foreign exchange rate. For Example, EUR/USD
Currency Risk - the probability of an adverse change in exchange rates.
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D
Day Trader - Speculators who take positions in commodities which are then liquidated prior to the close of the same trading day.
Dealer - An individual or firm that acts as a principal or counterpart to a transaction. Principals take one side of a position, hoping to earn a spread (profit) by closing out the position in a subsequent trade with another party. In contrast, a broker is an individual or firm that acts as an intermediary, putting together buyers and sellers for a fee or commission.
Deficit - A negative balance of trade or payments.
Delivery - An FX trade where both sides make and take actual delivery of the currencies traded.
Depreciation - A fall in the value of a currency due to market forces.
Derivative - A contract that changes in value in relation to the price movements of a related or underlying security, future or other physical instrument. An Option is the most common derivative instrument.
Devaluation - The deliberate downward adjustment of a currency's price, normally by official announcement.
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E
Economic Indicator - A government issued statistic that indicates current economic growth and stability. Common indicators include employment rates, Gross Domestic Product (GDP), inflation, retail sales, etc.
End Of Day Order (EOD) - An order to buy or sell at a specified price. This order remains open until the end of the trading day which is typically 5PM ET.
European Monetary Union (EMU) - The principal goal of the EMU is to establish a single European currency called the Euro, which will officially replace the national currencies of the member EU countries in 2002. On Janaury1, 1999 the transitional phase to introduce the Euro began. The Euro now exists as a banking currency and paper financial transactions and foreign exchange are made in Euros. This transition period will last for three years, at which time Euro notes an coins will enter circulation. On July 1,2002, only Euros will be legal tender for EMU participants, the national currencies of the member countries will cease to exist. The current members of the EMU are Germany, France, Belgium, Luxembourg, Austria, Finland, Ireland, the Netherlands, Italy, Spain and Portugal.
EURO - the currency of the European Monetary Union (EMU). A replacement for the European Currency Unit (ECU).
European Central Bank (ECB) - the Central Bank for the new European Monetary Union.
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F
Federal Deposit Insurance Corporation (FDIC) - The regulatory agency responsible for administering bank depository insurance in the US.
Federal Reserve (Fed) - The Central Bank for the United States.
First In First Out (FIFO) - Open positions are closed according to the FIFO accounting rule. All positions opened within a particular currency pair are liquidated in the order in which they were originally opened.
Flat/square - Dealer jargon used to describe a position that has been completely reversed, e.g. you bought $500,000 then sold $500,000, thereby creating a neutral (flat) position.
Foreign Exchange - (Forex, FX) - the simultaneous buying of one currency and selling of another.
Forward - The pre-specified exchange rate for a foreign exchange contract settling at some agreed future date, based upon the interest rate differential between the two currencies involved.
Forward Points - The pips added to or subtracted from the current exchange rate to calculate a forward price.
Fundamental Analysis - Analysis of economic and political information with the objective of determining future movements in a financial market.
Futures Contract - An obligation to exchange a good or instrument at a set price on a future date. The primary difference between a Future and a Forward is that Futures are typically traded over an exchange (Exchange- Traded Contacts - ETC), versus forwards, which are considered Over The Counter (OTC) contracts. An OTC is any contract NOT traded on an exchange.
FX - Foreign Exchange.
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G
G7 - The seven leading industrial countries, being US , Germany, Japan, France, UK, Canada, Italy.
Going Long - The purchase of a stock, commodity, or currency for investment or speculation.
Going Short - The selling of a currency or instrument not owned by the seller.
Gross Domestic Product - Total value of a country's output, income or expenditure produced within the country's physical borders.
Gross National Product - Gross domestic product plus income earned from investment or work abroad.
Good 'Til Cancelled Order (GTC) - An order to buy or sell at a specified price. This order remains open until filled or until the client cancels.
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H
Hedge - A position or combination of positions that reduces the risk of your primary position.
"Hit the bid" - Acceptance of purchasing at the offer or selling at the bid.
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I
Inflation - An economic condition whereby prices for consumer goods rise, eroding purchasing power.
Initial Margin - The initial deposit of collateral required to enter into a position as a guarantee on future performance.
Interbank Rates - The Foreign Exchange rates at which large international banks quote other large international banks.
Intervention - Action by a central bank to effect the value of its currency by entering the market. Concerted intervention refers to action by a number of central banks to control exchange rates.
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K
Kiwi - Slang for the New Zealand dollar.
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L
Leading Indicators - Statistics that are considered to predict future economic activity.
Leverage - Also called margin. The ratio of the amount used in a transaction to the required security deposit.
LIBOR - The London Inter-Bank Offered Rate. Banks use LIBOR when borrowing from another bank.
Limit order - An order with restrictions on the maximum price to be paid or the minimum price to be received. As an example, if the current price of USD/YEN is 117.00/05, then a limit order to buy USD would be at a price below 102. (ie 116.50)
Liquidation - The closing of an existing position through the execution of an offsetting transaction.
Liquidity - The ability of a market to accept large transaction with minimal to no impact on price stability.
Long position - A position that appreciates in value if market prices increase. When the base currency in the pair is bought, the position is said to be long.
Lot - A unit to measure the amount of the deal. The value of the deal always corresponds to an integer number of lots.
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M
Margin - The required equity that an investor must deposit to collateralize a position.
Margin Call - A request from a broker or dealer for additional funds or other collateral to guarantee performance on a position that has moved against the customer.
Market Maker - A dealer who regularly quotes both bid and ask prices and is ready to make a two-sided market for any financial instrument.
Market Risk - Exposure to changes in market prices.
Mark-to-Market - Process of re-evaluating all open positions with the current market prices. These new values then determine margin requirements.
Maturity - The date for settlement or expiry of a financial instrument.
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N
Net Position - The amount of currency bought or sold which have not yet been offset by opposite transactions.
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O
Offer (ask) - The rate at which a dealer is willing to sell a currency. See Ask (offer) price
Offsetting transaction - A trade with which serves to cancel or offset some or all of the market risk of an open position.
One Cancels the Other Order (OCO) - A designation for two orders whereby one part of the two orders is executed the other is automatically cancelled.
Open order - An order that will be executed when a market moves to its designated price. Normally associated with Good 'til Cancelled Orders.
Open position - An active trade with corresponding unrealized P&L, which has not been offset by an equal and opposite deal.
Over the Counter (OTC) - Used to describe any transaction that is not conducted over an exchange.
Overnight Position - A trade that remains open until the next business day.
Order - An instruction to execute a trade at a specified rate.
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P
Pips - The smallest unit of price for any foreign currency. Digits added to or subtracted from the fourth decimal place, i.e. 0.0001. Also called Points.
Political Risk - Exposure to changes in governmental policy which will have an adverse effect on an investor's position.
Position - The netted total holdings of a given currency.
Premium - In the currency markets, describes the amount by which the forward or futures price exceed the spot price.
Price Transparency - Describes quotes to which every market participant has equal access.
Profit /Loss or "P/L" or Gain/Loss - The actual "realized" gain or loss resulting fromtrading activities on Closed Positions, plus the theoretical "unrealized" gain or loss on Open Positions that have been Mark-to-Market.
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Q
Quote - An indicative market price, normally used for information purposes only.
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R
Rally - A recovery in price after a period of decline.
Range - The difference between the highest and lowest price of a future recorded during a given trading session.
Rate - The price of one currency in terms of another, typically used for dealing purposes.
Resistance - A term used in technical analysis indicating a specific price level at which analysis concludes people will sell.
Revaluation - An increase in the exchange rate for a currency as a result of central bank intervention. Opposite of Devaluation.
Risk - Exposure to uncertain change, most often used with a negative connotation of adverse change.
Risk Management - the employment of financial analysis and trading techniques to reduce and/or control exposure to various types of risk.
Roll-Over - Process whereby the settlement of a deal is rolled forward to another value date. The cost of this process is based on the interest rate differential of the two currencies.
Round trip - Buying and selling of a specified amount of currency.
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S
Settlement - The process by which a trade is entered into the books and records of the counterparts to a transaction. The settlement of currency trades may or may not involve the actual physical exchange of one currency for another.
Short Position - An investment position that benefits from a decline in market price. When the base currency in the pair is sold, the position is said to be short.
Spot Price - The current market price. Settlement of spot transactions usually occurs within two business days.
Spread - The difference between the bid and offer prices.
Square - Purchase and sales are in balance and thus the dealer has no open position.
Sterling - slang for British Pound.
Stop Loss Order - Order type whereby an open position is automatically liquidated at a specific price. Often used to minimize exposure to losses if the market moves against an investor's position. As an example, if an investor is long USD at 156.27, they might wish to put in a stop loss order for 155.49, which would limit losses should the dollar depreciate, possibly below 155.49.
Support Levels - A technique used in technical analysis that indicates a specific price ceiling and floor at which a given exchange rate will automatically correct itself. Opposite of resistance.
Swap - A currency swap is the simultaneous sale and purchase of the same amount of a given currency at a forward exchange rate.
Swissy - Market slang for Swiss Franc.
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T
Technical Analysis - An effort to forecast prices by analyzing market data, i.e. historical price trends and averages, volumes, open interest, etc.
Tick - A minimum change in price, up or down.
Tomorrow Next (Tom/Next) - Simultaneous buying and selling of a currency for delivery the following day.
Transaction Cost - the cost of buying or selling a financial instrument.
Transaction Date - The date on which a trade occurs.
Turnover - The total money value of all executed transactions in a given time period; volume.
Two-Way Price - When both a bid and offer rate is quoted for a FX transaction.
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U
Unrealized Gain/Loss - The theoretical gain or loss on Open Positions valued at current market rates, as determined by the broker in its sole discretion. Unrealized Gains' Losses become Profits/Losses when position is closed.
Uptick - a new price quote at a price higher than the preceding quote.
Uptick Rule - In the U.S., a regulation whereby a security may not be sold short unless the last trade prior to the short sale was at a price lower than the price at which the short sale is executed.
US Prime Rate - The interest rate at which US banks will lend to their prime corporate customers.
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V
Value Date - The date on which counterparts to a financial transaction agree to settle their respective obligations, i.e., exchanging payments. For spot currency transactions, the value date is normally two business days forward. Also known as maturity date.
Variation Margin - Funds a broker must request from the client to have the required margin deposited. The term usually refers to additional funds that must be deposited as a result of unfavorable price movements.
Volatility (Vol) - A statistical measure of a market's price movements over time.
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W
Whipsaw - slang for a condition of a highly volatile market where a sharp price movement is quickly followed by a sharp reversal.
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Y
Yard - Slang for a billion.
Forex Links
Forex Related Sites
Forex Made Easy
Forex Made Easy - The Foreign Exchange Market Explained
Forex Tips and Techniques
Information and resources for people interested in learning about the highly profitable world of foreign exchange (forex) and currency trading.
Forex Trading
Forex Trading with FXTSP, provides real-time execution, managed forex accounts, forex news, free charts and quotes, and 24 hour commission-free currency trading with a free forex trading course.
The Foreign Exchange market, also referred to as the "Forex" or "FX" market, is the largest financial market in the world, with a daily average turnover of approximately US$1.5 trillion. Foreign Exchange is the simultaneous buying of one currency and selling of another. The world's currencies are on a floating exchange rate and are always traded in pairs, for example Euro/Dollar or Dollar/Yen.
Learn Forex Trading
How do I begin? Please give it to me SIMPLY.
1. The best advice on how to learn to trade profitably is to learn from experts with proven track records. Many learning styles are available to beginners at all levels: books, CDs, online courses, group seminars, even one-on-one mentors who will come right your home for a few days. We outline our Forex-Trader picks in Learning Forex Trading. Learning to trade from experts is worth every penny and has saved us untold thousands in mistakes.We would not recommend starting forex trading without any training. It is not hard to learn, nor difficult to trade successfully, but you must first provide yourself with a basic functioning knowledge of 'the game you're in'.
2. While you are learning you will need charting software to practice reading the Market. Charting is an indispensable tool that shows you in real-time data what the market is doing moment by moment and also what the market has done in the past. As you learn to analyze these charts you can determine what trades to enter and exit, where to set your stop losses, limits etc. There are several good charting software services that you can subscribe to online monthly. See our Forex-Trader tested Charting Software picks in Tools of The Trade.
3. Then, to perform your actual trades online you need a real-time 'trading platform' to execute your 'buys' and 'sells' directly in the Foreign Currency Market. You obtain a trading platform from a Forex Clearinghouse that is connected real-time to the interbank market. There are many good Clearinghouses (also confusingly called Brokerage Firms, Market Makers, etc.) that provide you with the trading platform to trade the funds in the account you have opened with them. Before you begin trading your 'real' money, while you are learning, you will practice on your own 'demo account' with play-money in it, which will be provided to you by the clearinghouse you plan to trade through. The contractual relationship you enter into with your Clearinghouse is a very important one because the Clearinghouse you choose determines many trading features and financial advantages to you both as a trader and as an investor. Forex-Trader tested Clearinghouses are reviewed in Tools of The Trade.
We have outlined a Getting Started path with uncomplicated steps. This is the path that we would take if we were beginning trading over again today with 'what we know now'. The products and services we mention in these steps are all ones that we have personally used for some time with consistent success. As always you are free to forge your own path, and if you do, happy hiking. There is a mountain of products and services try out, and if you find ones you like better we would love to compare notes with you.
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Explain More About Charting Services
To trade successfully you also must have good charting software and instantaneous data feeds critical to helping you analysis and interpret the movement of currencies moment to moment so you know when/why to buy or sell -- this you subscribe to monthly. You can get a 2 week or more demo to familiarize yourself with one that has the features you like. The costs also vary, and some companies require a year commitment. There are some free charting services offered through the clearinghouses, but they tend to lack the tools to be truly useful. There are also some costly proprietary Specialty Software charting 'hybrids' which are market forecasters tools that look more like video games than charts.
Explain More About How Clearinghouses Work
A good clearinghouse (i.e.. your computer access/link to the live Forex Exchange Market) is the partner with which you trade the money you have deposited with them in your trading account. After trying and demo-ing many we have found a small handful that are truly excellent for the beginner (and continue to be excellent as you grow) -- meaning user friendly, legally accountable to regulatory bodies, and offering fair costs (spreads) for their services/trading software platforms. There still are many worrisome ones practicing in this closing era of unregulated forex trading (new Commodities laws are imminent).
The topic of matching the right clearinghouse for your needs is discussed more in Tools of the Trade, because it depends on a number of factors -- how much you can open an account with, how much the clearinghouse profit spread, what your liquidity needs are, your minimum/maximum stop loss and margin requirements, even where you live and how much time you have to give to trading in a 24 hr. day.
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How Much Does it Cost to Begin to Trade?
Learning to trade will entail the cost of books and whatever traiining method you choose. It will also include a reliable computer with a minimum 128 Mb of memory to run the charting software and trading platform. Ongoing 'costs of operation' include the monthly costs of high-speed internet, charting software, the email forecasting subscriptions -- plan on spending $150./mo. up for ongoing costs.
What about Pooled Clearinghouse Accounts to Trade with More Leverage?
We strongly do not recommend pooled accounts in any circumstance. Perhaps you are considering self-trading a pooled- together family account because it would give you a perceived advantage of more leveraged funds to trade (50:1 up to 100:1 leverage) -- any risks of loss represent a potential risk to family relationships, and for this reason alone we do not recommend aggregating with family or friends.
However much worse are the too-numerous negative experiences of people allowing their investment funds to leave their control to become part of a 'managed' pooled account. Not only is it a very risky investment idea, it is illegal for anyone to 'pool' accounts without compliance with SEC (a USA Securities Exchange Commission) or international equivalent license. Never relinquish direct control over your money/trading account to anyone (i.e.. the ability to make withdrawals, deposits etc. directly by your own authority into your own account).
A good fund manager, if you do choose to go the (legitimate) Managed Account route rather than the Self-Trader route, will make certain you have your own 'segregated account' in your own name in a bank or brokerage firm. These individual segregated accounts can still be traded together as though they were in a single account by a designated trader as long as the clearing house uses a trading platform that allows it. You, as the investor/account holder, have direct access online to your account activity at all times, and direct control over your own account in your own name (just like a bank account). The importance of this, for the safety of your funds, cannot be over emphasized.
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Questions From Our Email Inbox
Thank you for inviting people to learn from your experience. I found that to be very generous. I was hoping you may be able to shed little light on just how to go about finding the right currency pairs to buy.
This is where charting software will make it self-evident for you to know what pairs are 'trending'. Technical analysis using charting software: Elliott Wave, Retracements, Fibronacci patterns, short term trending, etc. Good charting software is invaluable! Look at it as one of your 'costs of doing business'.
I have just begun learning how the FOREX works. There are so few opportunities for the lower economic class to achieve financial independence.
It took us a full year to learn to trade forex to achieve consistent profits, but well worth the time and effort. Forex trading can be the great leveler of the self-investor playing field. I and we believe that with dedication to sound, risk-management trading methods you can succeed.
I'm trying to build a financial base, but I just can't find a door in. Is it possible for me to participate directly in the FOREX with smaller amounts - like $1000?
Beginning with $1K. is more of a challenge and more of a risk (but not impossible). $1K represents 1 lot in Forex Trading, and that is the minimum (leveraged) trade that can be made. Perhaps that $1K would be better spent on trading education?
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I have participated in Forex 'Games' and other types of online investments that claim to be investing in Foreign Currency (among other things), with returns of 50% a month and more. I actually did get paid. Opinions please?
We strongly urge you to resist any further temptation to send your money away to an investment-type pool (by this we mean do not send your money away to be under someone else's control and in someone else's account). It is unjustified risk, there are much better ways to begin to experience profits from forex trading. Many such online investments have totally disappeared into the Internet ethers from which they came. Typically these investments give no contact information, claiming to be 'offshore', 'for privacy reasons'. They last a few months, their bulletin boards or email newsletters extoll their climbing numbers of 'members' and pay-outs, then without warning their site goes off-line forever. And you never knew who they were that disappeared with your trust and your money or e-gold.
How do you forecast which currency is next in line to increase?
It is not so much that you want to know when any one currency is going up. You can make profits whether a currency is going up (buy), or down (sell). All Currencies are continually rising and falling relative to other currencies, and forex trading is in fact trading one currency relative to another. Good trading opportunities are always present when you know how to recognize them. Technical analysis using charting software, market sentiment, experience will show you which currencies to pair to trade. Forex Trading is a skill of identifying (and acting on) the probabilities.
How do you choose when to rollover or close positions?
Technical analysis using charting software that (when you learn how to identify what you are seeing) depicts resistance levels (how high it will likely rise to) or support levels (how low it will likely stop dropping at). This is helpful for determining whether to rollover the trade for a bigger forecasted profit the next day. However, a rollover does have additional clearinghouse fees attached. Quick in-and-out trades are closed intentionally with the goal of a smaller profit gain (such as a 4 pip profit).
For example, Beginners, who are learning to read their charts, can do very well closing positions at whatever point they have gained +4 pips profit. This represents a $40. profit (in this example we are trading 1 lot Euro/USD, so 1 pip equals $10.). A $40./4 pip gain is a relatively small move on the chart and may not seem impressive until you consider that If you do this successfully 4 times a day you have made $160. profit. With 4 such daily trades in a four day trading week you will have made $640. (consider also that this is even without the magic of compounding). We leave the monthly and yearly calculations to you.
What indicators do you utilize?
We have tried everything we could ever get our hands on. Over time we have selected the ones that are most consistent and well suited to our trading style. See our review of different indicator tools in Tools of the Trade. You will develop your own trading style (best times of day, favorite currency pairs, best instinctual moving-average chart pattern etc.). But experience with basic technical analysis using charting software is always the starting point. Then you add forex forecasting email subscriptions, Allan Greenspan's body language (no kidding) etc.
Are there any real time & reliable direct (commission free) market maker entry sites online?
Yes. It is not necessary to pay a clearinghouse (also known as a market maker, or forex brokerage house) an additional 'commission' for self-trading using their platform/services. They are usually compensated in the 'spread' between the buy price and sell price.
Source : forex-trader.com
Online Forex Trading
Recommended forex brokers :
GCI Financial Ltd
Online Trading in Forex and Share CFDs. 200:1 leverage, Free demo account. Trade a Standard or Mini account.
Charter FX
Margined trading in Forex and CFDs. Free charts, quotes, and demo account.
Swiss Finance Corp
Trading in Foreign Exchange. FSA regulated broker, offering 2% margin, 2 - 3 pip spreads.
Man Financial
Trade Forex and CFDs on the GNI touch platform. Live prices, fast execution, news and charting
Forex Articles
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Forex FAQ
What is Foreign Exchange?
The Foreign Exchange market, also referred to as the "Forex" or "FX" market, is the largest financial market in the world, with a daily average turnover of approximately US$1.5 trillion. Foreign Exchange is the simultaneous buying of one currency and selling of another. The world's currencies are on a floating exchange rate and are always traded in pairs, for example Euro/Dollar or Dollar/Yen.
Where is the central location of the FX Market?
FX Trading is not centralized on an exchange, as with the stock and futures markets. The FX market is considered an Over the Counter (OTC) or 'Interbank' market, due to the fact that transactions are conducted between two counterparts over the telephone or via an electronic network.
Who are the participants in the FX Market?
The Forex market is called an 'Interbank' market due to the fact that historically it has been dominated by banks, including central banks, commercial banks, and investment banks. However, the percentage of other market participants is rapidly growing, and now includes large multinational corporations, global money managers, registered dealers, international money brokers, futures and options traders, and private speculators.
When is the FX market open for trading?
A true 24-hour market, Forex trading begins each day in Sydney, and moves around the globe as the business day begins in each financial center, first to Tokyo, then London, and New York. Unlike any other financial market, investors can respond to currency fluctuations caused by economic, social and political events at the time they occur - day or night.
What are the most commonly traded currencies in the FX markets?
The most often traded or 'liquid' currencies are those of countries with stable governments, respected central banks, and low inflation. Today, over 85% of all daily transactions involve trading of the major currencies, which include the US Dollar, Japanese Yen, Euro, British Pound, Swiss Franc, Canadian Dollar and the Australian Dollar.
Is Forex trading capital intensive?
No. FXA requires a minimum deposit of $250. FXA allows customers to execute margin trades at up to 200:1 leverage. This means that investors can execute trades of $10,000 with an initial margin requirement of $50. However, it is important to remember that while this type of leverage allows investors to maximize their profit potential, the potential for loss is equally great. A more pragmatic margin trade for someone new to the FX markets would be 20:1 but ultimately depends on the investor's appetite for risk.
What is Margin?
Margin is essentially collateral for a position. If the market moves against a customer's position, FXA will request additional funds through a "margin call." If there are insufficient available funds, FXA will immediately close out the customer's open positions.
What does it mean have a 'long' or 'short' position?
In trading parlance, a long position is one in which a trader buys a currency at one price and aims to sell it later at a higher price. In this scenario, the investor benefits from a rising market. A short position is one in which the trader sells a currency in anticipation that it will depreciate. In this scenario, the investor benefits from a declining market. However, it is important to remember that every FX position requires an investor to go long in one currency and short the other.
What about terms like "bid/ask", "spread", and "rollover"?
FXA has an extensive Glossary that provides detailed definitions of all Forex related terms.
What is the difference between an "intraday" and "overnight position"?
Intraday positions are all positions opened anytime during the 24 hour period AFTER the close of FXA's normal trading hours at 4:30pm EST. Overnight positions are positions that are still on at the end of normal trading hours (4:30pm EST), which are automatically rolled by FXA at competitive rates (based on the currencies interest rate differentials) to the next day's price.
How are currency prices determined?
Currency prices are affected by a variety of economic and political conditions, most importantly interest rates, inflation and political stability. Moreover, governments sometimes participate in the Forex market to influence the value of their currencies, either by flooding the market with their domestic currency in an attempt to lower the price, or conversely buying in order to raise the price. This is known as Central Bank intervention. Any of these factors, as well as large market orders, can cause high volatility in currency prices. However, the size and volume of the Forex market makes it impossible for any one entity to "drive" the market for any length of time.
How do I manage risk?
The most common risk management tools in FX trading are the limit order and the stop loss order. A limit order places restriction on the maximum price to be paid or the minimum price to be received. 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 an investor's position. The liquidity of the Forex market ensures that limit order and stop loss orders can be easily executed.
What kind of trading strategy should I use?
Currency traders make decisions using both technical factors and economic fundamentals. Technical traders use charts, trend lines, support and resistance levels, and numerous patterns and mathematical analyses to identify trading opportunities, whereas fundamentalists predict price movements by interpreting a wide variety of economic information, including news, government-issued indicators and reports, and even rumor. The most dramatic price movements however, occur when unexpected events happen. The event can range from a Central Bank raising domestic interest rates to the outcome of a political election or even an act of war. Nonetheless, more often it is the expectation of an event that drives the market rather than the event itself.
How often are trades made?
Market conditions dictate trading activity on any given day. As a reference, the average small to medium trader might trade as often as 10 times a day. Most importantly, by not charging commission, FXA customers can take positions as often as necessary without worrying about excessive transaction costs.
How long are positions maintained?
As a general rule, a position is kept open until one of the following occurs: 1) realization of sufficient profits from a position; 2) the specified stop-loss is triggered; 3) another position that has a better potential appears and you need these funds.
I am interested in foreign exchange trading, but would like some additional information. Any suggestions?
In The Forex Market section we describe the foreign exchange market in some detail. In order to gain a practical understanding of foreign exchange trading, there is no better way than to open a demo account, where you can experience what it's like to trade the Forex market without risking any capital.
Source : fxadvantage
Forex Glossary
A
Accrual - The apportionment of premiums and discounts on forward exchange transactions that relate directly to deposit swap (Interest Arbitrage) deals , over the period of each deal.
Adjustment - Official action normally by either change in the internal economic policies to correct a payment imbalance or in the official currency rate or. Adjustment - Official action normally by either change in the internal economic policies to correct a payment imbalance or in the official currency rate or.
Appreciation - A currency is said to 'appreciate' when it strengthens in price in response to market demand.
Arbitrage - The purchase or sale of an instrument and simultaneous taking of an equal and opposite position in a related market, in order to take advantage of small price differentials between markets.
Ask (Offer) Price - The price at which the market is prepared to sell a specific Currency in a Foreign Exchange Contract or Cross Currency Contract. At this price, the trader can buy the base currency. In the quotation, it is shown on the right side of the quotation. For example, in the quote USD/CHF 1.4527/32, the ask price is 1.4532; meaning you can buy one US dollar for 1.4532 Swiss francs.
At Best - An instruction given to a dealer to buy or sell at the best rate that can be obtained.
At or Better - An order to deal at a specific rate or better.
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B
Balance of Trade - The value of a country's exports minus its imports.
Bar Chart - A type of chart which consists of four significant points: the high and the low prices, which form the vertical bar, the opening price, which is marked with a little horizontal line to the left of the bar, and the closing price, which is marked with a little horizontal line of the right of the bar.
Base Currency - The first currency in a Currency Pair. It shows how much the base currency is worth as measured against the second currency. For example, if the USD/CHF rate equals 1.6215 then one USD is worth CHF 1.6215 In the FX markets, the US Dollar is normally considered the 'base' currency for quotes, meaning that quotes are expressed as a unit of $1 USD per the other currency quoted in the pair. The primary exceptions to this rule are the British Pound, the Euro and the Australian Dollar.
Bear Market - A market distinguished by declining prices.
Bid Price - The bid is the the price at which the market is prepared to buy a specific Currency in a Foreign Exchange Contract or Cross Currency Contract. At this price, the trader can sell the base currency. It is shown on the left side of the quotation. For example, in the quote USD/CHF 1.4527/32, the bid price is 1.4527; meaning you can sell one US dollar for 1.4527 Swiss francs.
Bid/Ask Spread - The difference between the bid and offer price. Big Figure Quote - Dealer expression referring to the first few digits of an exchange rate. These digits are often omitted in dealer quotes.. For example, a USD/JPY rate might be 117.30/117.35, but would be quoted verbally without the first three digits i.e. "30/35".
Book - In a professional trading environment, a 'book' is the summary of a trader's or desk's total positions.
Broker - An individual or firm that acts as an intermediary, putting together buyers and sellers for a fee or commission. In contrast, a 'dealer' commits capital and takes one side of a position, hoping to earn a spread (profit) by closing out the position in a subsequent trade with another party.
Bretton Woods Agreement of 1944 - An agreement that established fixed foreign exchange rates for major currencies, provided for central bank intervention in the currency markets, and pegged the price of gold at US $35 per ounce. The agreement lasted until 1971, when President Nixon overturned the Bretton Woods agreement and established a floating exchange rate for the major currencies.
Bull Market - A market distinguished by rising prices.
Bundesbank - Germany's Central Bank.
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C
Cable - Trader jargon referring to the Sterling/US Dollar exchange rate. So called because the rate was originally transmitted via a transatlantic cable beginning in the mid 1800's.
Candlestick Chart - A chart that indicates the trading range for the day as well as the opening and closing price. If the open price is higher than the close price, the rectangle between the open and close price is shaded. If the close price is higher than the open price, that area of the chart is not shaded.
Cash Market - The market in the actual financial instrument on which a futures or options contract is based.
Central Bank - A government or quasi-governmental organization that manages a country's monetary policy. For example, the US central bank is the Federal Reserve, and the German central bank is the Bundesbank.
Chartist - An individual who uses charts and graphs and interprets historical data to find trends and predict future movements. Also referred to as Technical Trader.
Cleared Funds - Funds that are freely available, sent in to settle a trade.
Closed Position - Exposures in Foreign Currencies that no longer exist. The process to close a position is to sell or buy a certain amount of currency to offset an equal amount of the open position. This will 'square' the postion.
Clearing - The process of settling a trade.
Contagion - The tendency of an economic crisis to spread from one market to another. In 1997, political instability in Indonesia caused high volatility in their domestic currency, the Rupiah. From there, the contagion spread to other Asian emerging currencies, and then to Latin America, and is now referred to as the 'Asian Contagion'.
Collateral - Something given to secure a loan or as a guarantee of performance.
Commission - A transaction fee charged by a broker.
Confirmation - A document exchanged by counterparts to a transaction that states the terms of said transaction.
Contract - The standard unit of trading.
Counter Currency - The second listed Currency in a Currency Pair.
Counterparty - One of the participants in a financial transaction.
Country Risk - Risk associated with a cross-border transaction, including but not limited to legal and political conditions.
Cross Currency Pairs or Cross Rate - A foreign exchange transaction in which one foreign currency is traded against a second foreign currency. For example; EUR/GBP
Currency symbols
AUD - Australian Dollar
CAD - Canadian Dollar
EUR - Euro
JPY - Japanese Yen
GBP - British Pound
CHF - Swiss Franc
Currency - Any form of money issued by a government or central bank and used as legal tender and a basis for trade.
Currency Pair - The two currencies that make up a foreign exchange rate. For Example, EUR/USD
Currency Risk - the probability of an adverse change in exchange rates.
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D
Day Trader - Speculators who take positions in commodities which are then liquidated prior to the close of the same trading day.
Dealer - An individual or firm that acts as a principal or counterpart to a transaction. Principals take one side of a position, hoping to earn a spread (profit) by closing out the position in a subsequent trade with another party. In contrast, a broker is an individual or firm that acts as an intermediary, putting together buyers and sellers for a fee or commission.
Deficit - A negative balance of trade or payments.
Delivery - An FX trade where both sides make and take actual delivery of the currencies traded.
Depreciation - A fall in the value of a currency due to market forces.
Derivative - A contract that changes in value in relation to the price movements of a related or underlying security, future or other physical instrument. An Option is the most common derivative instrument.
Devaluation - The deliberate downward adjustment of a currency's price, normally by official announcement.
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E
Economic Indicator - A government issued statistic that indicates current economic growth and stability. Common indicators include employment rates, Gross Domestic Product (GDP), inflation, retail sales, etc.
End Of Day Order (EOD) - An order to buy or sell at a specified price. This order remains open until the end of the trading day which is typically 5PM ET.
European Monetary Union (EMU) - The principal goal of the EMU is to establish a single European currency called the Euro, which will officially replace the national currencies of the member EU countries in 2002. On Janaury1, 1999 the transitional phase to introduce the Euro began. The Euro now exists as a banking currency and paper financial transactions and foreign exchange are made in Euros. This transition period will last for three years, at which time Euro notes an coins will enter circulation. On July 1,2002, only Euros will be legal tender for EMU participants, the national currencies of the member countries will cease to exist. The current members of the EMU are Germany, France, Belgium, Luxembourg, Austria, Finland, Ireland, the Netherlands, Italy, Spain and Portugal.
EURO - the currency of the European Monetary Union (EMU). A replacement for the European Currency Unit (ECU).
European Central Bank (ECB) - the Central Bank for the new European Monetary Union.
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F
Federal Deposit Insurance Corporation (FDIC) - The regulatory agency responsible for administering bank depository insurance in the US.
Federal Reserve (Fed) - The Central Bank for the United States.
First In First Out (FIFO) - Open positions are closed according to the FIFO accounting rule. All positions opened within a particular currency pair are liquidated in the order in which they were originally opened.
Flat/square - Dealer jargon used to describe a position that has been completely reversed, e.g. you bought $500,000 then sold $500,000, thereby creating a neutral (flat) position.
Foreign Exchange - (Forex, FX) - the simultaneous buying of one currency and selling of another.
Forward - The pre-specified exchange rate for a foreign exchange contract settling at some agreed future date, based upon the interest rate differential between the two currencies involved.
Forward Points - The pips added to or subtracted from the current exchange rate to calculate a forward price.
Fundamental Analysis - Analysis of economic and political information with the objective of determining future movements in a financial market.
Futures Contract - An obligation to exchange a good or instrument at a set price on a future date. The primary difference between a Future and a Forward is that Futures are typically traded over an exchange (Exchange- Traded Contacts - ETC), versus forwards, which are considered Over The Counter (OTC) contracts. An OTC is any contract NOT traded on an exchange.
FX - Foreign Exchange.
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G
G7 - The seven leading industrial countries, being US , Germany, Japan, France, UK, Canada, Italy.
Going Long - The purchase of a stock, commodity, or currency for investment or speculation.
Going Short - The selling of a currency or instrument not owned by the seller.
Gross Domestic Product - Total value of a country's output, income or expenditure produced within the country's physical borders.
Gross National Product - Gross domestic product plus income earned from investment or work abroad.
Good 'Til Cancelled Order (GTC) - An order to buy or sell at a specified price. This order remains open until filled or until the client cancels.
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H
Hedge - A position or combination of positions that reduces the risk of your primary position.
"Hit the bid" - Acceptance of purchasing at the offer or selling at the bid.
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I
Inflation - An economic condition whereby prices for consumer goods rise, eroding purchasing power.
Initial Margin - The initial deposit of collateral required to enter into a position as a guarantee on future performance.
Interbank Rates - The Foreign Exchange rates at which large international banks quote other large international banks.
Intervention - Action by a central bank to effect the value of its currency by entering the market. Concerted intervention refers to action by a number of central banks to control exchange rates.
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K
Kiwi - Slang for the New Zealand dollar.
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L
Leading Indicators - Statistics that are considered to predict future economic activity.
Leverage - Also called margin. The ratio of the amount used in a transaction to the required security deposit.
LIBOR - The London Inter-Bank Offered Rate. Banks use LIBOR when borrowing from another bank.
Limit order - An order with restrictions on the maximum price to be paid or the minimum price to be received. As an example, if the current price of USD/YEN is 117.00/05, then a limit order to buy USD would be at a price below 102. (ie 116.50)
Liquidation - The closing of an existing position through the execution of an offsetting transaction.
Liquidity - The ability of a market to accept large transaction with minimal to no impact on price stability.
Long position - A position that appreciates in value if market prices increase. When the base currency in the pair is bought, the position is said to be long.
Lot - A unit to measure the amount of the deal. The value of the deal always corresponds to an integer number of lots.
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M
Margin - The required equity that an investor must deposit to collateralize a position.
Margin Call - A request from a broker or dealer for additional funds or other collateral to guarantee performance on a position that has moved against the customer.
Market Maker - A dealer who regularly quotes both bid and ask prices and is ready to make a two-sided market for any financial instrument.
Market Risk - Exposure to changes in market prices.
Mark-to-Market - Process of re-evaluating all open positions with the current market prices. These new values then determine margin requirements.
Maturity - The date for settlement or expiry of a financial instrument.
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N
Net Position - The amount of currency bought or sold which have not yet been offset by opposite transactions.
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O
Offer (ask) - The rate at which a dealer is willing to sell a currency. See Ask (offer) price
Offsetting transaction - A trade with which serves to cancel or offset some or all of the market risk of an open position.
One Cancels the Other Order (OCO) - A designation for two orders whereby one part of the two orders is executed the other is automatically cancelled.
Open order - An order that will be executed when a market moves to its designated price. Normally associated with Good 'til Cancelled Orders.
Open position - An active trade with corresponding unrealized P&L, which has not been offset by an equal and opposite deal.
Over the Counter (OTC) - Used to describe any transaction that is not conducted over an exchange.
Overnight Position - A trade that remains open until the next business day.
Order - An instruction to execute a trade at a specified rate.
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P
Pips - The smallest unit of price for any foreign currency. Digits added to or subtracted from the fourth decimal place, i.e. 0.0001. Also called Points.
Political Risk - Exposure to changes in governmental policy which will have an adverse effect on an investor's position.
Position - The netted total holdings of a given currency.
Premium - In the currency markets, describes the amount by which the forward or futures price exceed the spot price.
Price Transparency - Describes quotes to which every market participant has equal access.
Profit /Loss or "P/L" or Gain/Loss - The actual "realized" gain or loss resulting fromtrading activities on Closed Positions, plus the theoretical "unrealized" gain or loss on Open Positions that have been Mark-to-Market.
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Q
Quote - An indicative market price, normally used for information purposes only.
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R
Rally - A recovery in price after a period of decline.
Range - The difference between the highest and lowest price of a future recorded during a given trading session.
Rate - The price of one currency in terms of another, typically used for dealing purposes.
Resistance - A term used in technical analysis indicating a specific price level at which analysis concludes people will sell.
Revaluation - An increase in the exchange rate for a currency as a result of central bank intervention. Opposite of Devaluation.
Risk - Exposure to uncertain change, most often used with a negative connotation of adverse change.
Risk Management - the employment of financial analysis and trading techniques to reduce and/or control exposure to various types of risk.
Roll-Over - Process whereby the settlement of a deal is rolled forward to another value date. The cost of this process is based on the interest rate differential of the two currencies.
Round trip - Buying and selling of a specified amount of currency.
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S
Settlement - The process by which a trade is entered into the books and records of the counterparts to a transaction. The settlement of currency trades may or may not involve the actual physical exchange of one currency for another.
Short Position - An investment position that benefits from a decline in market price. When the base currency in the pair is sold, the position is said to be short.
Spot Price - The current market price. Settlement of spot transactions usually occurs within two business days.
Spread - The difference between the bid and offer prices.
Square - Purchase and sales are in balance and thus the dealer has no open position.
Sterling - slang for British Pound.
Stop Loss Order - Order type whereby an open position is automatically liquidated at a specific price. Often used to minimize exposure to losses if the market moves against an investor's position. As an example, if an investor is long USD at 156.27, they might wish to put in a stop loss order for 155.49, which would limit losses should the dollar depreciate, possibly below 155.49.
Support Levels - A technique used in technical analysis that indicates a specific price ceiling and floor at which a given exchange rate will automatically correct itself. Opposite of resistance.
Swap - A currency swap is the simultaneous sale and purchase of the same amount of a given currency at a forward exchange rate.
Swissy - Market slang for Swiss Franc.
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T
Technical Analysis - An effort to forecast prices by analyzing market data, i.e. historical price trends and averages, volumes, open interest, etc.
Tick - A minimum change in price, up or down.
Tomorrow Next (Tom/Next) - Simultaneous buying and selling of a currency for delivery the following day.
Transaction Cost - the cost of buying or selling a financial instrument.
Transaction Date - The date on which a trade occurs.
Turnover - The total money value of all executed transactions in a given time period; volume.
Two-Way Price - When both a bid and offer rate is quoted for a FX transaction.
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U
Unrealized Gain/Loss - The theoretical gain or loss on Open Positions valued at current market rates, as determined by the broker in its sole discretion. Unrealized Gains' Losses become Profits/Losses when position is closed.
Uptick - a new price quote at a price higher than the preceding quote.
Uptick Rule - In the U.S., a regulation whereby a security may not be sold short unless the last trade prior to the short sale was at a price lower than the price at which the short sale is executed.
US Prime Rate - The interest rate at which US banks will lend to their prime corporate customers.
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V
Value Date - The date on which counterparts to a financial transaction agree to settle their respective obligations, i.e., exchanging payments. For spot currency transactions, the value date is normally two business days forward. Also known as maturity date.
Variation Margin - Funds a broker must request from the client to have the required margin deposited. The term usually refers to additional funds that must be deposited as a result of unfavorable price movements.
Volatility (Vol) - A statistical measure of a market's price movements over time.
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W
Whipsaw - slang for a condition of a highly volatile market where a sharp price movement is quickly followed by a sharp reversal.
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Y
Yard - Slang for a billion.
Forex Links
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Bird Watching in Lion Country - Retail Forex Trading Explained
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5 EMA's Forex Trading System
Follow, in detail, the author's 5 EMAs FOREX trading system that will allow you to identify both entry and exit points with incredible accuracy. Depending upon the exit strategy selected, the system generates monthly returns of between 30% and 55%. Read more
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Bird Watching in Lion Country - Retail Forex Trading Explained
Bird Watching in Lion Country - Retail Forex Trading Explained
When I wrote BWILC I knew it would be great, revolutionary and eye popping. What I didn't expect in my wildest fantasies was that individual readers would compare it favourably with Reminiscences of a Stock Operator and Trading for a Living. Read more
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Learn how to trade EUR/USD, USD/CAD, GBP/USD or any other major currency pair by mastering a system that combines top level mathematics with the fundamental principles of human behaviour. Read More
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The Affluent Desktop Currency Trader
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The Affluent Desktop Currency Trader is a step-by-step training manual that includes 9 separate trading strategies you can learn to apply to your everyday forex trading. Read More
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A Detailed Overview of the Forex Market
Introduction
The following facts and figures relate to the foreign exchange market. Much of the information is drawn from the Triennial Central Bank Survey of Foreign Exchange and Derivatives Market Activity conducted by the Bank for International Settlements (BIS) in April 2004, and published in March 2005. 52 central banks and monetary authorities participated in the survey, collecting information from approximately 1200 market participants.
Structure
* Decentralised, over-the-counter market, also known as the 'interbank' market
* Main participants: Central Banks, commercial and investment banks, hedge funds, pension funds, corporations & private speculators
* The free-floating currency system began in 1973, and was officially mandated in 1978
* Online trading began in the mid to late 1990's
Source: BIS Triennial Survey 2004
Trading Hours
* 24 hour market
* Sunday 5pm EST through Friday 4pm EST.
* Trading begins in New Zealand, followed by Australia, Asia, the Middle East, Europe, and America
Size
* Largest financial market in the world
* $1.9 trillion average daily turnover, equivalent to:
o More than 10 times the average daily turnover of global equity markets1
o 40 times the average daily turnover of the NYSE2
o $300 a day for every man, woman, and child on earth
o An annual turnover more than 10 times the value of all the world's goods and services combined (GDP)3
* The spot market accounts for about one-third of daily turnover
1. About $167 billion - World Federation of Exchanges aggregate 2004
2. About $46 billion - NYSE 2004
3. About $36 trillion - World Bank 2003
Source: BIS Triennial Survey 2004
Major Markets
* The US & UK markets account for more than 50% of turnover
* Major markets: London, New York, Tokyo
* Trading activity is heaviest when major markets overlap4
* Nearly two-thirds of NY activity occurs in the morning hours while European markets are open5
4. NY Federal Reserve 5. NY Federal Reserve
Average Daily Turnover by Country
Concentration in the Banking Industry
* 16 banks account for 75% of turnover in the U.K.
* 11 banks account for 75% of turnover in the U.S.
* 11 banks account for 75% of turnover in Japan
Note: The reference here is to individual banking offices rather than banking organisations.
Source: BIS Triennial Survey 2004
Trading
* An estimated 95% of transactions are speculative
* Retail brokers research: 90% of traders lose money, 5% break even, 5% make money
Technical Analysis
Commonly used technical indicators:
* Moving averages
* RSI
* Fibonacci retracements
* Stochastics
* MACD
* Momentum
* Bollinger bands
* Pivot point
* Elliott Wave
Currencies
* The US dollar is involved in approximately 90% of all foreign exchange transactions, equivalent to over US$1.5 trillion per day
Currency Codes
* USD = US Dollar
* EUR = Euro
* JPY = Japanese Yen
* GBP = British Pound
* CHF = Swiss Franc
* CAD = Canadian Dollar
* AUD = Australian Dollar
* NZD = New Zealand Dollar
Average Daily Turnover by Currency
N.B. Because two currencies are involved in each transaction, the sum of the percentage shares of individual currencies totals 200% instead of 100%.
Source: BIS Triennial Survey 2004
Currency Pairs
* Majors: EUR/USD, USD/JPY, GBP/USD, USD/CHF
* Dollar bloc: USD/CAD, AUD/USD, NZD/USD
* Major crosses: EUR/JPY, EUR/GBP, EUR/CHF
Average Daily Turnover by Currency Pair
Source: BIS Triennial Survey 2004
# Related Links Foreign exchange market - From Wikipedia
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The following facts and figures relate to the foreign exchange market. Much of the information is drawn from the Triennial Central Bank Survey of Foreign Exchange and Derivatives Market Activity conducted by the Bank for International Settlements (BIS) in April 2004, and published in March 2005. 52 central banks and monetary authorities participated in the survey, collecting information from approximately 1200 market participants.
Structure
* Decentralised, over-the-counter market, also known as the 'interbank' market
* Main participants: Central Banks, commercial and investment banks, hedge funds, pension funds, corporations & private speculators
* The free-floating currency system began in 1973, and was officially mandated in 1978
* Online trading began in the mid to late 1990's
Source: BIS Triennial Survey 2004
Trading Hours
* 24 hour market
* Sunday 5pm EST through Friday 4pm EST.
* Trading begins in New Zealand, followed by Australia, Asia, the Middle East, Europe, and America
Size
* Largest financial market in the world
* $1.9 trillion average daily turnover, equivalent to:
o More than 10 times the average daily turnover of global equity markets1
o 40 times the average daily turnover of the NYSE2
o $300 a day for every man, woman, and child on earth
o An annual turnover more than 10 times the value of all the world's goods and services combined (GDP)3
* The spot market accounts for about one-third of daily turnover
1. About $167 billion - World Federation of Exchanges aggregate 2004
2. About $46 billion - NYSE 2004
3. About $36 trillion - World Bank 2003
Source: BIS Triennial Survey 2004
Major Markets
* The US & UK markets account for more than 50% of turnover
* Major markets: London, New York, Tokyo
* Trading activity is heaviest when major markets overlap4
* Nearly two-thirds of NY activity occurs in the morning hours while European markets are open5
4. NY Federal Reserve 5. NY Federal Reserve
Average Daily Turnover by Country
Concentration in the Banking Industry
* 16 banks account for 75% of turnover in the U.K.
* 11 banks account for 75% of turnover in the U.S.
* 11 banks account for 75% of turnover in Japan
Note: The reference here is to individual banking offices rather than banking organisations.
Source: BIS Triennial Survey 2004
Trading
* An estimated 95% of transactions are speculative
* Retail brokers research: 90% of traders lose money, 5% break even, 5% make money
Technical Analysis
Commonly used technical indicators:
* Moving averages
* RSI
* Fibonacci retracements
* Stochastics
* MACD
* Momentum
* Bollinger bands
* Pivot point
* Elliott Wave
Currencies
* The US dollar is involved in approximately 90% of all foreign exchange transactions, equivalent to over US$1.5 trillion per day
Currency Codes
* USD = US Dollar
* EUR = Euro
* JPY = Japanese Yen
* GBP = British Pound
* CHF = Swiss Franc
* CAD = Canadian Dollar
* AUD = Australian Dollar
* NZD = New Zealand Dollar
Average Daily Turnover by Currency
N.B. Because two currencies are involved in each transaction, the sum of the percentage shares of individual currencies totals 200% instead of 100%.
Source: BIS Triennial Survey 2004
Currency Pairs
* Majors: EUR/USD, USD/JPY, GBP/USD, USD/CHF
* Dollar bloc: USD/CAD, AUD/USD, NZD/USD
* Major crosses: EUR/JPY, EUR/GBP, EUR/CHF
Average Daily Turnover by Currency Pair
Source: BIS Triennial Survey 2004
# Related Links Foreign exchange market - From Wikipedia
# Forex Articles
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Foreign exchange market
he foreign exchange (currency or forex or FX) market exists wherever one currency is traded for another. It is by far the largest market in the world, in terms of cash value traded, and includes trading between large banks, central banks, currency speculators, multinational corporations, governments, and other financial markets and institutions. Retail traders (small speculators) are a small part of this market. They may only participate indirectly through brokers or banks and may be targets of forex scams.
Market size and liquidityThe foreign exchange market is unique because of:
Average daily international foreign exchange trading volume was $1.9 trillion in April 2004 according to the BIS study Triennial Central Bank Survey 2004
Exchange-traded forex futures contracts were introduced in 1972 at the Chicago Mercantile Exchange and are actively traded relative to most other futures contracts. Forex futures volume has grown rapidly in recent years, but only accounts for about 7% of the total foreign exchange market volume, according to The Wall Street Journal Europe (5/5/06, p. 20).
These spreads might not apply to retail customers at banks, which will routinely mark up the difference to say 1.2100 / 1.2300 for transfers, or say 1.2000 / 1.2400 for banknotes or travelers' cheques. Spot prices at market makers vary, but on EUR/USD are usually no more than 5 pips wide (i.e. 0.0005). Competition has greatly increased with pip spreads shrinking on the majors to as little as 1 to 1.5 pips. Trading characteristicsThere is no single unified foreign exchange market. Due to the over-the-counter (OTC) nature of currency markets, there are rather a number of interconnected marketplaces, where different currency instruments are traded. This implies that there is no such thing as a single dollar rate - but rather a number of different rates (prices), depending on what bank or market maker is trading. In practice the rates are often very close, otherwise they could be exploited by arbitrageurs.
The main trading centers are in London, New York, and Tokyo, but banks throughout the world participate. As the Asian trading session ends, the European session begins, then the US session, and then the Asian begin in their turns. Traders can react to news when it breaks, rather than waiting for the market to open. There is little or no 'inside information' in the foreign exchange markets. Exchange rate fluctuations are usually caused by actual monetary flows as well as by expectations of changes in monetary flows caused by changes in GDP growth, inflation, interest rates, budget and trade deficits or surpluses, and other macroeconomic conditions. Major news is released publicly, often on scheduled dates, so many people have access to the same news at the same time. However, the large banks have an important advantage; they can see their customers order flow. Trading legend Richard Dennis has accused central bankers of leaking information to hedge funds. [1] Currencies are traded against one another. Each pair of currencies thus constitutes an individual product and is traditionally noted XXX/YYY, where YYY is the ISO 4217 international three-letter code of the currency into which the price of one unit of XXX currency is expressed. For instance, EUR/USD is the price of the euro expressed in US dollars, as in 1 euro = 1.2045 dollar. On the spot market, according to the BIS study, the most heavily traded products were:
and the US currency was involved in 89% of transactions, followed by the euro (37%), the yen (20%) and sterling (17%). (Note that volume percentages should add up to 200% - 100% for all the sellers, and 100% for all the buyers). Although trading in the euro has grown considerably since the currency's creation in January 1999, the foreign exchange market is thus still largely dollar-centered. For instance, trading the euro versus a non-European currency ZZZ will usually involve two trades: EUR/USD and USD/ZZZ. The only exception to this is EUR/JPY, which is an established traded currency pair in the interbank spot market. Market participantsAccording to the BIS study Triennial Central Bank Survey 2004
BanksThe interbank market caters for both the majority of commercial turnover and large amounts of speculative trading every day. A large bank may trade billions of dollars daily. Some of this trading is undertaken on behalf of customers, but much is conducted by proprietary desks, trading for the bank's own account. Until recently, foreign exchange brokers did large amounts of business, facilitating interbank trading and matching anonymous counterparts for small fees. Today, however, much of this business has moved on to more efficient electronic systems, such as EBS, Reuters Dealing 3000 Matching (D2), the Chicago Mercantile Exchange, Bloomberg and TradeBook(R). The broker squawk box lets traders listen in on ongoing interbank trading and is heard in most trading rooms, but turnover is noticeably smaller than just a few years ago. Commercial CompaniesAn important part of this market comes from the financial activities of companies seeking foreign exchange to pay for goods or services. Commercial companies often trade fairly small amounts compared to those of banks or speculators, and their trades often have little short term impact on market rates. Nevertheless, trade flows are an important factor in the long-term direction of a currency's exchange rate. Some multinational companies can have an unpredictable impact when very large positions are covered due to exposures that are not widely known by other market participants. Central BanksNational central banks play an important role in the foreign exchange markets. They try to control the money supply, inflation, and/or interest rates and often have official or unofficial target rates for their currencies. They can use their often substantial foreign exchange reserves, to stabilize the market. Milton Friedman argued that the best stabilization strategy would be for central banks to buy when the exchange rate is too low, and to sell when the rate is too high - that is, to trade for a profit. Nevertheless, central banks do not go bankrupt if they make large losses, like other traders would, and there is no convincing evidence that they do make a profit trading. The mere expectation or rumor of central bank intervention might be enough to stabilize a currency, but aggressive intervention might be used several times each year in countries with a dirty float currency regime. Central banks do not always achieve their objectives, however. The combined resources of the market can easily overwhelm any central bank. Several scenarios of this nature were seen in the 1992-93 ERM collapse, and in more recent times in South East Asia. Investment Management FirmsInvestment Management firms (who typically manage large accounts on behalf of customers such as pension funds, endowments etc.) use the Foreign exchange market to facilitate transactions in foreign securities. For example, an investment manager with an international equity portfolio will need to buy and sell foreign currencies in the spot market in order to pay for purchases of foreign equities. Since the forex transactions are secondary to the actual investment decision, they are not seen as speculative or aimed at profit-maximisation. Some investment management firms also have more speculative specialist currency overlay units, which manage clients' currency exposures with the aim of generating profits as well as limiting risk. The number of this type of specialist is quite small, their large assets under management (AUM) can lead to large trades. Hedge FundsHedge funds, such as George Soros's Quantum fund have gained a reputation for aggressive currency speculation since 1990. They control billions of dollars of equity and may borrow billions more, and thus may overwhelm intervention by central banks to support almost any currency, if the economic fundamentals are in the hedge funds' favor. Retail Forex BrokersRetail forex brokers or market makers handle a minute fraction of the total volume of the foreign exchange market. According to CNN, one retail broker estimates retail volume at $25-50 billion daily, [2]which is about 2% of the whole market. CNN also quotes an official of the National Futures Association "Retail forex trading has increased dramatically over the past few years. Unfortunately, the amount of forex fraud has also increased dramatically." All firms offering foreign exchange trading online are either market makers or facilitate the placing of trades with market makers. In the retail forex industry market makers often have two separate trading desks- one that actually trades foreign exchange (which determines the firm's own net position in the market, serving as both a proprietary trading desk and a means of offsetting client trades on the interbank market) and one used for off-exchange trading with retail customers (called the "dealing desk" or "trading desk"). Many retail FX market makers claim to "offset" clients' trades on the interbank market (that is, with other larger market makers), e.g. after buying from the client, they sell to a bank. Nevertheless, the large majority of retail currency speculators are novices and who lose money [3], so that the market makers would be giving up large profits by offsetting. Offsetting does occur, but only when the market maker judges its clients' net position as being very risky. The dealing desk operates much like the currency exchange counter at a bank. Interbank exchange rates, which are displayed at the dealing desk, are adjusted to incorporate spreads (so that the market maker will make a profit) before they are displayed to retail customers. Prices shown by the market maker do not neccesarily reflect interbank market rates. Arbitrage opportunities may exist, but retail market makers are efficient at removing arbitrageurs from their systems or limiting their trades. A limited number of retail forex brokers offer consumers direct access to the interbank forex market. But most do not because of the limited number of clearing banks willing to process small orders. More importantly, the dealing desk model can be far more profitable, as a large portion of retail traders' losses are directly turned into market maker profits. While the income of a marketmaker that offsets trades or a broker that facilitates transactions is limited to transaction fees (commissions), dealing desk brokers can generate income in a variety of ways because they not only control the trading process, they also control pricing which they can skew at any time to maximize profits. The rules of the game in trading FX are highly disadvantageous for retail speculators. Most retail speculators in FX lack trading experience and and capital (account minimums at some firms are as low as 250-500 USD). Large minimum position sizes, which on most retail platforms ranges from $10,000 to $100,000, force small traders to take imprudently large positions using extremely high leverage. Professional forex traders rarely use more than 10:1 leverage, yet many retail Forex firms default client accounts to 100:1 or even 200:1, without disclosing that this is highly unusual for currency traders. This drastically increases the risk of a margin call (which, if the speculator's trade is not offset, is pure profit for the market maker). According to the Wall Street Journal (Currency Markets Draw Speculation, Fraud July 26, 2005) "Even people running the trading shops warn clients against trying to time the market. 'If 15% of day traders are profitable,' says Drew Niv, chief executive of FXCM, 'I'd be surprised.' " [4] In the US, "it is unlawful to offer foreign currency futures and option contracts to retail customers unless the offeror is a regulated financial entity" according to the Commodity Futures Trading Commission [5]. Legitimate retail brokers serving traders in the U.S. are most often registered with the CFTC as "futures commission merchants" (FCMs) and are members of the National Futures Association (NFA). Potential clients can check the broker's FCM status at the NFA. Retail forex brokers are much less regulated than stock brokers and there is no protection similar to that from the Securities Investor Protection Corporation. The CFTC has noted an increase in forex scams [6]. SpeculationControversy about currency speculators and their effect on currency devaluations and national economies recurs regularly. Nevertheless, many economists (e.g. Milton Friedman) argue that speculators perform the important function of providing a market for hedgers and transferring risk from those people who don't wish to bear it, to those who do. Other economists (e.g. Joseph Stiglitz) however, may consider this argument to be based more on politics and a free market philosophy than on economics. Large hedge funds and other well capitalized "position traders" are the main professional speculators. Currency speculation is considered a highly suspect activity in many countries. While investment in traditional financial instruments like bonds or stocks often is considered to contribute positively to economic growth by providing capital, currency speculation does not, according to this view. It is simply gambling, that often interferes with economic policy. For example, in 1992, currency speculation forced the Central Bank of Sweden to raise interest rates for a few days to 150% per annum, and later to devalue the krona. Former Malaysian Prime Minister Mahathir Mohamad is one well known proponent of this view [7]. He blamed the devaluation of the Malaysian ringgit in 1997 on George Soros and other speculators. Gregory Millman reports on an opposing view, comparing speculators to "vigilantes" who simply help "enforce" international agreements and anticipate the effects of basic economic "laws" in order to profit. In this view, countries may develop unsustainable financial bubbles or otherwise mishandle their national economies, and forex speculators only made the inevitable collapse happen sooner. A relatively quick collapse might even be preferable to continued economic mishandling. Mahathir Mohamad and other critics of speculation are viewed as trying to deflect the blame from themselves for having caused the unsustainable economic conditions. ReferenceGregory J. Millman, Around the World on a Trillion Dollars a Day, Bantam Press, New York, 1995. See also
External links
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Introduction
Welcome to National Futures Association’s e-learning program for retail off-exchange foreign currency trading. As the industrywide self-regulatory organization for the U.S. futures industry, NFA is committed to providing innovative programs and services that protect investors and ensure market integrity. We’ve always believed that one of the best ways to protect investors is to provide them with the materials they need to make informed trading decisions.
he off-exchange foreign currency, or forex, market is a large, growing and liquid financial market that operates 24 hours a day. It has no central trading location or exchange with many buyers and sellers. Most of the trading is conducted by telephone or through electronic trading networks. Banks, insurance companies, large corporations and other large financial institutions all use the forex markets to manage the risks associated with fluctuations in currency rates. In recent years, however, a number of firms have begun offering forex contracts to individual investors. NFA regulates some, but not all, of these forex firms. Before you open an account with a forex firm, you should ask the firm if NFA regulates its forex activities. If the answer is no, find out who does regulate them.
he off-exchange foreign currency, or forex, market is a large, growing and liquid financial market that operates 24 hours a day. It has no central trading location or exchange with many buyers and sellers. Most of the trading is conducted by telephone or through electronic trading networks. Banks, insurance companies, large corporations and other large financial institutions all use the forex markets to manage the risks associated with fluctuations in currency rates. In recent years, however, a number of firms have begun offering forex contracts to individual investors. NFA regulates some, but not all, of these forex firms. Before you open an account with a forex firm, you should ask the firm if NFA regulates its forex activities. If the answer is no, find out who does regulate them.
Like many other investments, forex trading carries a high level of risk and may not be suitable for all investors. Forex trading requires constant monitoring and an understanding of the relationship between currencies, as well as what factors influence the currencies' value. If you are a retail investor considering trading in this market, you need to understand fully the market and some of its unique features.
One final note before we begin. This program does not suggest that you should or should not trade in the retail off-exchange foreign currency market. You should make that decision after consulting with your financial advisor and considering your own financial situation and objectives.
This program should serve as just one element of your due diligence.
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The foreign exchange market
The foreign exchange market enables companies, fund
managers and banks to buy and sell foreign currencies, if
necessary in large amounts. The motivations behind this
demand for foreign currency include capital flows arising
from trade in goods and services, cross-border
investment and loans and speculation on the future level
of exchange rates. The sums involved are very large:
estimated global turnover in all currencies in April 1998
was $1,490 billion, an increase of 26 percent over the
past three years. Deals are typically for amounts
between $3 million and $10 million, though much larger
transactions are often done.
Foreign exchange trading may be for spot or forward
delivery. Generally, spot transactions are undertaken
for an actual exchange of currencies (delivery or
settlement) two business days later (the value date).
Forward transactions involve a delivery date further
into the future, possibly as far as a year or more ahead.
By buying or selling in the forward market a bank can,
on its own behalf or that of a customer, protect the
value of anticipated flows of foreign currency, in
terms of its domestic currency, from exchange rate
volatility.
Unlike some financial markets, the foreign exchange
market has no single location - foreign exchange is not
dealt across a trading floor. Instead, trading is via
telephone and computer links between dealers in
different centres and, indeed, different continents.
London is the world’s largest foreign exchange centre:
average daily turnover is $637 billion. This is
approximately the same as the combined level of
trading in the United States, Japan and Singapore
(see Box 1).
London’s leading position arises partly from the large
volume of international financial business generated
here - insurance, bonds, shipping, equities,
commodities and banking. London also benefits from
its geographical location which enables firms located
here to trade not only with each other and with firms
based in Europe throughout the day, but also with the
US and the Far East, whereas their time difference
makes it difficult for firms in those two centres to trade
with each other. When banks in London begin trading
at 8 am they can deal with banks in Tokyo, Hong Kong
or Singapore whose trading day is just ending. From
about 1 pm onwards, London banks can trade with
banks in New York; before they close at 4 pm their
counterparties may be in Los Angeles or San Francisco.
This is important because the foreign exchange market
trades 24 hours a day: 66 percent of trades involving a
firm in London are transacted with a counterparty
located abroad.
THE PARTICIPANTS
Broadly speaking, there are three types of participant in the
market: customers, banks and brokers. Customers, such as
multinational corporations, are in the market because they
require foreign currency in the course of their cross border
trade or investment business. For example, an engineering
firm based in the United Kingdom might use the foreign
exchange market to buy the dollars it needs to pay to a firm in
America selling it raw materials; in this instance it would sell
sterling and buy dollars. Commercial banks are by far the
most active participants in the foreign exchange market
(see Box 4). Some deal with other financial institutions and
corporations who contact them, typically by telephone, to ask
for their rates, and may then buy foreign currency from, or
sell, to the bank at those rates. This is known as market
making: the banks will at all times quote buying or selling
rates for pairs of currencies - dollars to the pound, Japanese
yen to the dollar and so on. The market makers earn a profit
on the difference between their buying and selling rates, but
THE FOREIGN
EXCHANGE MARKET
AVERAGE DAILY FOREIGN EXCHANGE Box 1
MARKET TURNOVER IN THE MAIN CENTRES
April 1998 US$ Billions
United Kingdom 637
United States 351
Japan 149
Singapore 139
Germany 94
Switzerland 82
Hong Kong 79
France 72
Source: Surveys conducted by national central banks,
co-ordinated by the Bank for International Settlements
A P R I L 2 0 0 0
FACT SHEET
they have to be ready to change their prices very quickly in
order to avoid holding a currency whose value is falling
(depreciating), or being short of a currency which is rising
(appreciating). Banks also deal on behalf of corporations and
other, typically smaller, banks. The third type of participant,
the brokers, act as intermediaries between the banks. They
are specialist companies with computer links or telephone
lines to banks throughout the world so that at any time they
should know which bank has the highest bid (buying) rate for
a currency, and which the lowest offer (selling) rate. By
using a broker it should, therefore, be possible for banks to
find the best dealing rate currently available. The broker
does not deal on its own account, but charges a commission
for its services.
DEALING IN THE SPOT & FORWARD MARKETS
To execute a spot deal in the market, a dealer contacts his
counterpart at a market-making bank and asks for his price in,
for example “sterling-dollar” (i.e US dollars to the British
pound). The market maker normally quotes a two-way price -
that is he stands ready to bid for or offer up to some standard
amount. The difference between these two prices is known as
the spread. For the sake of convenience, the market
convention where trading is between banks is not to quote the
“big figures” (i.e pounds and pence, dollars and cents); instead,
dealers tend to quote only the points (the last two figures of the
price). For example, if the rate for pounds against the dollar
was £1 = US$ 1.6315-25 then the market maker would quote
“fifteen-twenty five”: he bids for pounds at $1.6315 and offers
them at $1.6325. If the market maker wishes to deal he will
hit, that is accept, one side of the price. Written confirmation
of this oral contract will be exchanged and instructions
concerning payment given, and passed on to the settlements
staff who ensure that the respective currency amounts are
transferred into the designated accounts on the value date.
Quotation of prices and dealing in the forward market are
rather different from spot dealing. Theoretically it is possible
for the forward price of a currency to equal its spot price. But
because the interest rate that can be earned by holding different
currencies usually varies, in practice the forward price is
normally higher or lower than (at a premium or a discount to)
the spot rate (see Box 2 for the method of calculation). For
convenience, forward prices are not quoted outright, and
instead dealers quote the differential (the premium or
discount). This practice has a number of benefits. Premiums
and discounts are subject to much less fluctuation than are spot
rates, so quoting the differentials requires far fewer changes to
published prices. Furthermore, foreign exchange swaps
(combining a spot purchase with a simultaneous forward sale,
or vice-versa) are based on the differentials with the actual spot
rate being of relatively little consequence.
Premiums and discounts reflect the interest rate differentials
between currencies at the time the deal is done; the
determination of the forward rate does not depend directly on
THE DETERMINATION OF FORWARD RATES Box 2
The forward rate is equivalent to the spot rate plus a
premium or minus a discount. The forward premium or
discount is determined by means of the following general
equation which is adjusted to take account of whether the
discount/premium or the bid/offered rate is being
calculated:
Spot rate x (interest rate differential, i.e. $ interest rate - EUR interest rate) x days/360
1 + (EUR interest rate x days/360)
To calculate, for example, the six month forward rate for
the Euro against the Dollar by determining the necessary
adjustment (premium/discount), the following information
is also needed:
BID OFFER
Spot exchange rate (€/=$US) 0.9720 0.9725
6 month $ interest rate 61/4% 63/8%
6 month Euro interest rate 35/8% 33/4%
So offer rate equation is:
0.9725 x (.06375 - .03625) x 182/360)
1 + (.003625 x 182/360)
= -.013280
And the bid rate equation is:
0.9720 x (.0625 - .0375) x 182/360
1 + (.0375 x 182/360)
= -.012056
So the forward rates are 0.9841 (bid) and 0.9858 (offered)
FUTURES AND OPTIONS Box 3
Currency futures are forward transactions with standard
contract sizes and maturity dates (e.g US dollars 125,000
for settlement in December) which are traded on a
formal exchange. Because futures contracts are
standardised, they are less flexible than forward
contracts. Dealing in futures also involves certain
transactions costs, such as the costs of being, or trading
through, a member of the exchange. But, futures do
provide the opportunity to deal in smaller amounts than
in the spot/forward markets and to obtain a considerable
exposure with a small capital outlay, since the initial
capital outlay is small relative to the contract size.
Currency options provide the buyer with the right, but
not the obligation, to sell or buy an amount of foreign
currency at an exchange rate and date specified in
advance. The buyer must pay a premium to the writer of
the option (which is often a bank). Currency options
allow the user to guarantee the buying price (call) or
selling price (put) of a currency without foregoing the
opportunity to benefit from favourable exchange rate
movements, as the user can buy or sell in the spot market
if the price is better. The writer of an option benefits
from the premiums received but, because it stands
committed to buy or sell currency at the pre-agreed
exchange, it faces the risk of losses arising from
exchange rate movements.
any estimation of what the future exchange rates in question
are likely to be. Thus, if a currency with a high interest rate
is sold forward in exchange for a currency with a lower
interest rate, then the seller continues to enjoy the benefit of
the higher interest rate for the period until the value date.
However, the buyer must wait to obtain the currency on
which it can earn the higher interest rate. This imbalance is
compensated by the purchaser receiving a discount on the
spot exchange rate in a deal undertaken for forward
settlement.
A forward transaction can be “closed out” at any time by
means of another forward transaction to sell or repurchase the
foreign currency for the original value date.
Forward transactions are a flexible and commonly used
method of protecting the value of future flows of foreign
currency in terms of the domestic currency of a firm or bank.
As the foreign exchange market has grown, so other
instruments such as futures and options (see Box 3) have
developed to facilitate the protection, or hedging, of foreign
exchange commitments.
THE DETERMINATION OF EXCHANGE RATES
In the long run, the demand for one country’s currency in
terms of another country’s currency is determined by real
economic factors. The exchange rate is influenced by relative
inflation, growth and interest rates and trade and investment
flows between countries. Foreign exchange dealers therefore
closely monitor announcements of new economic statistics on
the major world economies. When economic releases are out
of line with forecasts, dealers alter the rates they are quoting
to reflect the implied change in their assessment of the
currency’s value.
Since changes within and between different governments
often lead to changes in economic and financial policies,
political developments can also affect the foreign exchange
market. The market may therefore react to changes in public
opinion polls or other news items which have implications for
future political developments. But expected news, whether
economic or political, rarely moves exchange rates - the
effect will already have been anticipated or “discounted”.
Unexpected news, such as a country changing the regime it
favours for managing its currency, or unanticipated problems
in a nation’s economy, however, can lead to sudden and sharp
exchange rate movements.
Alongside these fundamental considerations, banks and
brokers undertake “technical analysis”, studying market
movements by means of charts showing the movement of
exchange rates over time. Charts can be used to extrapolate
from past movements. Technical analysis is based on the
underlying assumption that price movements follow broadly
predictable patterns which reflect market psychology, and
that past patterns can thus give an indication to possible
future trends.
THE MARKET IN LONDON Box 4
Participants
The vast majority of foreign exchange business in London
is accounted for by trading between banks: in April 1998,
domestic and international inter-bank transactions
accounted for 83 percent of trading, up from 75 percent in
1995. Of the remainder of banks’ trading activity, 9.5
percent was with other, non-bank financial institutions such
as pension funds and asset managers; non-financial
institutions, such as multinational corporations, account for
just over 7 percent.
The proportion of principals’ business handled by brokers
is now 27 percent, down from 35 percent in 1995.
However, electronic broking systems have continued to
take market share away from traditional, telephone-based,
voice brokers: the proportion of business conducted by
voice brokers has fallen to 16 percent, from 30 percent in
1995; the share of electronic brokers such as Reuters and
EBS has risen from 5 percent to 11 percent.
Spot transactions
Over the past 15 years, spot business has not grown as fast
as forward business: forward transactions now account for
65 percent of turnover, compared with 27 percent in 1986.
In the forward market, most of the transactions are swaps,
which are often used to hedge currency risk and manage
liquidity.
Currency composition
The most widely traded currency pairs are US$/€, US$/¥
and £/US$. A wide range of currencies are traded in
London; unlike other European financial centres, trading in
the domestic currency accounts for a small proportion of
turnover. Only 18 percent of turnover in the UK involves
sterling; this compares with domestic currency trading
accounting for 66 percent of turnover in Germany,
41 percent in France and 39 percent in Switzerland.
Market share of overseas banks
About 15 percent of the foreign exchange business in
London transacted by banks is done by UK institutions and
the remaining 85 percent by overseas banks. North
American principals are the most active, with a 49 percent
share, followed by UK principals (15 percent) and Japanese
(7 percent)
Source: Bank of England Survey, April 1998
Cross-border interbank 57.9%
(approx. $369.3 bn per day)
Domestic interbank 25.2%
(approx. $160.9 bn per day)
Other financial institutions 9.5%
(approx. $60.5 bn per day)
Non-financial institutions 7.3%
(approx. $46.6 bn per day)
Average daily turnover by counterparty
THE ROLE OF GOVERNMENT AND CENTRAL BANKS
Not only is the exchange rate influenced by real economic
variables, but its level and volatility also have an impact (both
direct and indirect) on these same economic factors. Even
modest changes in the value of a currency can have significant
effects on business and the national economy more generally.
If a currency were to weaken excessively, it would put
upward pressure on domestic inflation as imports and
internationally tradeable goods produced domestically rose in
price: the cost, in terms of the domestic currency, of buying
foreign currency is higher at a weaker exchange rate.
Conversely, a strengthening currency might lead to a fall in
import prices and lower domestic inflation: the cost of
buying foreign currency in terms of the domestic currency is
lower at a stronger exchange rate. Domestic producers
would need to contain their costs in order to remain
internationally competitive. Otherwise their profitability and
the level of growth and employemnt in the economy as a
whole might fall.
The pound (‘sterling’) is currently allowed to “float” freely
against all other currencies. This means that the authorities
are not committed to maintaining the market value of sterling
within a pre-announced range against any other currency.
Sterling was a member of the Exchange Rate Mechanism of
the European Monetary System from 8 October 1990 until
16 September 1992. During this period sterling’s ability to
fluctuate against the other participating currencies was
constrained by the central banks of participating countries,
who were committed to holding sterling within a margin of
6 percent on either side of its agreed central rates against each
of the other participating currencies.
The authorities have a number of means of influencing the
exchange rate. The Bank of England can intervene in the
foreign exchange market by buying or selling pounds which
would alter the supply of sterling relative to other currencies.
However, although intervention could be effective in
smoothing short-term fluctuations in the value of the pound,
it cannot resolve underlying economic problems, which have
to be addressed by more fundamental policy measures.
Although monetary policy can influence the level of the
exchange rate, the overall objective of monetary policy in the
UK is the achievement of domestic price stability, as defined
by the inflation target set by the Government.
The Government’s foreign exchange reserves are
approximately $35 billion; in addition, the Bank of England
has approximately $4 billion of holdings of foreign currency
and gold. A principal source of the reserves is borrowing by
the government in foreign currency. The other main source is
intervention. When the Bank of England intervenes to buy
foreign currencies (and sells sterling), the proceeds will be
added to the reserves. On the other hand, sales of foreign
currencies to protect the value of sterling will reduce the
reserves. However, this does not mean that the reserves have
been spent: the foreign exchange reserve “asset” has merely
been converted into a sterling one.
THE EFFECTIVE EXCHANGE RATE Box 5
An effective exchange rate is a measure of the value of a
currency against several other currencies (a “basket”) at
once. It is calculated as a weighted geometric average of
exchange rates and expressed as an index relative to a
base year. (In the chart below the base year is 1990,
when the sterling’s average level was 100). Because the
effective exchange rate is an average of a currency’s
exchange rates, it is often more useful when looking at
the value of a currency over a long period than a single
exchange rate (such as sterling-dollar). The higher the
index figure, the stronger the currency. In the chart
below the weight given to each currency in the basket is
derived from the trade flows in manufactured goods and
represents the relative importance of the country in
question as a competitor in export markets. The weights
are revised periodically to accommodate countries’
changing economic circumstances.
© Bank of England 1999 Reproduction in whole part is permitted for education purposes provided the source is acknowledged.
Sterling's effective exchange rate (January 1992-March 2000)
70
80
90
100
110
120
Jan-92 Jan-94 Jan-96 Jan-98 Jan-00
managers and banks to buy and sell foreign currencies, if
necessary in large amounts. The motivations behind this
demand for foreign currency include capital flows arising
from trade in goods and services, cross-border
investment and loans and speculation on the future level
of exchange rates. The sums involved are very large:
estimated global turnover in all currencies in April 1998
was $1,490 billion, an increase of 26 percent over the
past three years. Deals are typically for amounts
between $3 million and $10 million, though much larger
transactions are often done.
Foreign exchange trading may be for spot or forward
delivery. Generally, spot transactions are undertaken
for an actual exchange of currencies (delivery or
settlement) two business days later (the value date).
Forward transactions involve a delivery date further
into the future, possibly as far as a year or more ahead.
By buying or selling in the forward market a bank can,
on its own behalf or that of a customer, protect the
value of anticipated flows of foreign currency, in
terms of its domestic currency, from exchange rate
volatility.
Unlike some financial markets, the foreign exchange
market has no single location - foreign exchange is not
dealt across a trading floor. Instead, trading is via
telephone and computer links between dealers in
different centres and, indeed, different continents.
London is the world’s largest foreign exchange centre:
average daily turnover is $637 billion. This is
approximately the same as the combined level of
trading in the United States, Japan and Singapore
(see Box 1).
London’s leading position arises partly from the large
volume of international financial business generated
here - insurance, bonds, shipping, equities,
commodities and banking. London also benefits from
its geographical location which enables firms located
here to trade not only with each other and with firms
based in Europe throughout the day, but also with the
US and the Far East, whereas their time difference
makes it difficult for firms in those two centres to trade
with each other. When banks in London begin trading
at 8 am they can deal with banks in Tokyo, Hong Kong
or Singapore whose trading day is just ending. From
about 1 pm onwards, London banks can trade with
banks in New York; before they close at 4 pm their
counterparties may be in Los Angeles or San Francisco.
This is important because the foreign exchange market
trades 24 hours a day: 66 percent of trades involving a
firm in London are transacted with a counterparty
located abroad.
THE PARTICIPANTS
Broadly speaking, there are three types of participant in the
market: customers, banks and brokers. Customers, such as
multinational corporations, are in the market because they
require foreign currency in the course of their cross border
trade or investment business. For example, an engineering
firm based in the United Kingdom might use the foreign
exchange market to buy the dollars it needs to pay to a firm in
America selling it raw materials; in this instance it would sell
sterling and buy dollars. Commercial banks are by far the
most active participants in the foreign exchange market
(see Box 4). Some deal with other financial institutions and
corporations who contact them, typically by telephone, to ask
for their rates, and may then buy foreign currency from, or
sell, to the bank at those rates. This is known as market
making: the banks will at all times quote buying or selling
rates for pairs of currencies - dollars to the pound, Japanese
yen to the dollar and so on. The market makers earn a profit
on the difference between their buying and selling rates, but
THE FOREIGN
EXCHANGE MARKET
AVERAGE DAILY FOREIGN EXCHANGE Box 1
MARKET TURNOVER IN THE MAIN CENTRES
April 1998 US$ Billions
United Kingdom 637
United States 351
Japan 149
Singapore 139
Germany 94
Switzerland 82
Hong Kong 79
France 72
Source: Surveys conducted by national central banks,
co-ordinated by the Bank for International Settlements
A P R I L 2 0 0 0
FACT SHEET
they have to be ready to change their prices very quickly in
order to avoid holding a currency whose value is falling
(depreciating), or being short of a currency which is rising
(appreciating). Banks also deal on behalf of corporations and
other, typically smaller, banks. The third type of participant,
the brokers, act as intermediaries between the banks. They
are specialist companies with computer links or telephone
lines to banks throughout the world so that at any time they
should know which bank has the highest bid (buying) rate for
a currency, and which the lowest offer (selling) rate. By
using a broker it should, therefore, be possible for banks to
find the best dealing rate currently available. The broker
does not deal on its own account, but charges a commission
for its services.
DEALING IN THE SPOT & FORWARD MARKETS
To execute a spot deal in the market, a dealer contacts his
counterpart at a market-making bank and asks for his price in,
for example “sterling-dollar” (i.e US dollars to the British
pound). The market maker normally quotes a two-way price -
that is he stands ready to bid for or offer up to some standard
amount. The difference between these two prices is known as
the spread. For the sake of convenience, the market
convention where trading is between banks is not to quote the
“big figures” (i.e pounds and pence, dollars and cents); instead,
dealers tend to quote only the points (the last two figures of the
price). For example, if the rate for pounds against the dollar
was £1 = US$ 1.6315-25 then the market maker would quote
“fifteen-twenty five”: he bids for pounds at $1.6315 and offers
them at $1.6325. If the market maker wishes to deal he will
hit, that is accept, one side of the price. Written confirmation
of this oral contract will be exchanged and instructions
concerning payment given, and passed on to the settlements
staff who ensure that the respective currency amounts are
transferred into the designated accounts on the value date.
Quotation of prices and dealing in the forward market are
rather different from spot dealing. Theoretically it is possible
for the forward price of a currency to equal its spot price. But
because the interest rate that can be earned by holding different
currencies usually varies, in practice the forward price is
normally higher or lower than (at a premium or a discount to)
the spot rate (see Box 2 for the method of calculation). For
convenience, forward prices are not quoted outright, and
instead dealers quote the differential (the premium or
discount). This practice has a number of benefits. Premiums
and discounts are subject to much less fluctuation than are spot
rates, so quoting the differentials requires far fewer changes to
published prices. Furthermore, foreign exchange swaps
(combining a spot purchase with a simultaneous forward sale,
or vice-versa) are based on the differentials with the actual spot
rate being of relatively little consequence.
Premiums and discounts reflect the interest rate differentials
between currencies at the time the deal is done; the
determination of the forward rate does not depend directly on
THE DETERMINATION OF FORWARD RATES Box 2
The forward rate is equivalent to the spot rate plus a
premium or minus a discount. The forward premium or
discount is determined by means of the following general
equation which is adjusted to take account of whether the
discount/premium or the bid/offered rate is being
calculated:
Spot rate x (interest rate differential, i.e. $ interest rate - EUR interest rate) x days/360
1 + (EUR interest rate x days/360)
To calculate, for example, the six month forward rate for
the Euro against the Dollar by determining the necessary
adjustment (premium/discount), the following information
is also needed:
BID OFFER
Spot exchange rate (€/=$US) 0.9720 0.9725
6 month $ interest rate 61/4% 63/8%
6 month Euro interest rate 35/8% 33/4%
So offer rate equation is:
0.9725 x (.06375 - .03625) x 182/360)
1 + (.003625 x 182/360)
= -.013280
And the bid rate equation is:
0.9720 x (.0625 - .0375) x 182/360
1 + (.0375 x 182/360)
= -.012056
So the forward rates are 0.9841 (bid) and 0.9858 (offered)
FUTURES AND OPTIONS Box 3
Currency futures are forward transactions with standard
contract sizes and maturity dates (e.g US dollars 125,000
for settlement in December) which are traded on a
formal exchange. Because futures contracts are
standardised, they are less flexible than forward
contracts. Dealing in futures also involves certain
transactions costs, such as the costs of being, or trading
through, a member of the exchange. But, futures do
provide the opportunity to deal in smaller amounts than
in the spot/forward markets and to obtain a considerable
exposure with a small capital outlay, since the initial
capital outlay is small relative to the contract size.
Currency options provide the buyer with the right, but
not the obligation, to sell or buy an amount of foreign
currency at an exchange rate and date specified in
advance. The buyer must pay a premium to the writer of
the option (which is often a bank). Currency options
allow the user to guarantee the buying price (call) or
selling price (put) of a currency without foregoing the
opportunity to benefit from favourable exchange rate
movements, as the user can buy or sell in the spot market
if the price is better. The writer of an option benefits
from the premiums received but, because it stands
committed to buy or sell currency at the pre-agreed
exchange, it faces the risk of losses arising from
exchange rate movements.
any estimation of what the future exchange rates in question
are likely to be. Thus, if a currency with a high interest rate
is sold forward in exchange for a currency with a lower
interest rate, then the seller continues to enjoy the benefit of
the higher interest rate for the period until the value date.
However, the buyer must wait to obtain the currency on
which it can earn the higher interest rate. This imbalance is
compensated by the purchaser receiving a discount on the
spot exchange rate in a deal undertaken for forward
settlement.
A forward transaction can be “closed out” at any time by
means of another forward transaction to sell or repurchase the
foreign currency for the original value date.
Forward transactions are a flexible and commonly used
method of protecting the value of future flows of foreign
currency in terms of the domestic currency of a firm or bank.
As the foreign exchange market has grown, so other
instruments such as futures and options (see Box 3) have
developed to facilitate the protection, or hedging, of foreign
exchange commitments.
THE DETERMINATION OF EXCHANGE RATES
In the long run, the demand for one country’s currency in
terms of another country’s currency is determined by real
economic factors. The exchange rate is influenced by relative
inflation, growth and interest rates and trade and investment
flows between countries. Foreign exchange dealers therefore
closely monitor announcements of new economic statistics on
the major world economies. When economic releases are out
of line with forecasts, dealers alter the rates they are quoting
to reflect the implied change in their assessment of the
currency’s value.
Since changes within and between different governments
often lead to changes in economic and financial policies,
political developments can also affect the foreign exchange
market. The market may therefore react to changes in public
opinion polls or other news items which have implications for
future political developments. But expected news, whether
economic or political, rarely moves exchange rates - the
effect will already have been anticipated or “discounted”.
Unexpected news, such as a country changing the regime it
favours for managing its currency, or unanticipated problems
in a nation’s economy, however, can lead to sudden and sharp
exchange rate movements.
Alongside these fundamental considerations, banks and
brokers undertake “technical analysis”, studying market
movements by means of charts showing the movement of
exchange rates over time. Charts can be used to extrapolate
from past movements. Technical analysis is based on the
underlying assumption that price movements follow broadly
predictable patterns which reflect market psychology, and
that past patterns can thus give an indication to possible
future trends.
THE MARKET IN LONDON Box 4
Participants
The vast majority of foreign exchange business in London
is accounted for by trading between banks: in April 1998,
domestic and international inter-bank transactions
accounted for 83 percent of trading, up from 75 percent in
1995. Of the remainder of banks’ trading activity, 9.5
percent was with other, non-bank financial institutions such
as pension funds and asset managers; non-financial
institutions, such as multinational corporations, account for
just over 7 percent.
The proportion of principals’ business handled by brokers
is now 27 percent, down from 35 percent in 1995.
However, electronic broking systems have continued to
take market share away from traditional, telephone-based,
voice brokers: the proportion of business conducted by
voice brokers has fallen to 16 percent, from 30 percent in
1995; the share of electronic brokers such as Reuters and
EBS has risen from 5 percent to 11 percent.
Spot transactions
Over the past 15 years, spot business has not grown as fast
as forward business: forward transactions now account for
65 percent of turnover, compared with 27 percent in 1986.
In the forward market, most of the transactions are swaps,
which are often used to hedge currency risk and manage
liquidity.
Currency composition
The most widely traded currency pairs are US$/€, US$/¥
and £/US$. A wide range of currencies are traded in
London; unlike other European financial centres, trading in
the domestic currency accounts for a small proportion of
turnover. Only 18 percent of turnover in the UK involves
sterling; this compares with domestic currency trading
accounting for 66 percent of turnover in Germany,
41 percent in France and 39 percent in Switzerland.
Market share of overseas banks
About 15 percent of the foreign exchange business in
London transacted by banks is done by UK institutions and
the remaining 85 percent by overseas banks. North
American principals are the most active, with a 49 percent
share, followed by UK principals (15 percent) and Japanese
(7 percent)
Source: Bank of England Survey, April 1998
Cross-border interbank 57.9%
(approx. $369.3 bn per day)
Domestic interbank 25.2%
(approx. $160.9 bn per day)
Other financial institutions 9.5%
(approx. $60.5 bn per day)
Non-financial institutions 7.3%
(approx. $46.6 bn per day)
Average daily turnover by counterparty
THE ROLE OF GOVERNMENT AND CENTRAL BANKS
Not only is the exchange rate influenced by real economic
variables, but its level and volatility also have an impact (both
direct and indirect) on these same economic factors. Even
modest changes in the value of a currency can have significant
effects on business and the national economy more generally.
If a currency were to weaken excessively, it would put
upward pressure on domestic inflation as imports and
internationally tradeable goods produced domestically rose in
price: the cost, in terms of the domestic currency, of buying
foreign currency is higher at a weaker exchange rate.
Conversely, a strengthening currency might lead to a fall in
import prices and lower domestic inflation: the cost of
buying foreign currency in terms of the domestic currency is
lower at a stronger exchange rate. Domestic producers
would need to contain their costs in order to remain
internationally competitive. Otherwise their profitability and
the level of growth and employemnt in the economy as a
whole might fall.
The pound (‘sterling’) is currently allowed to “float” freely
against all other currencies. This means that the authorities
are not committed to maintaining the market value of sterling
within a pre-announced range against any other currency.
Sterling was a member of the Exchange Rate Mechanism of
the European Monetary System from 8 October 1990 until
16 September 1992. During this period sterling’s ability to
fluctuate against the other participating currencies was
constrained by the central banks of participating countries,
who were committed to holding sterling within a margin of
6 percent on either side of its agreed central rates against each
of the other participating currencies.
The authorities have a number of means of influencing the
exchange rate. The Bank of England can intervene in the
foreign exchange market by buying or selling pounds which
would alter the supply of sterling relative to other currencies.
However, although intervention could be effective in
smoothing short-term fluctuations in the value of the pound,
it cannot resolve underlying economic problems, which have
to be addressed by more fundamental policy measures.
Although monetary policy can influence the level of the
exchange rate, the overall objective of monetary policy in the
UK is the achievement of domestic price stability, as defined
by the inflation target set by the Government.
The Government’s foreign exchange reserves are
approximately $35 billion; in addition, the Bank of England
has approximately $4 billion of holdings of foreign currency
and gold. A principal source of the reserves is borrowing by
the government in foreign currency. The other main source is
intervention. When the Bank of England intervenes to buy
foreign currencies (and sells sterling), the proceeds will be
added to the reserves. On the other hand, sales of foreign
currencies to protect the value of sterling will reduce the
reserves. However, this does not mean that the reserves have
been spent: the foreign exchange reserve “asset” has merely
been converted into a sterling one.
THE EFFECTIVE EXCHANGE RATE Box 5
An effective exchange rate is a measure of the value of a
currency against several other currencies (a “basket”) at
once. It is calculated as a weighted geometric average of
exchange rates and expressed as an index relative to a
base year. (In the chart below the base year is 1990,
when the sterling’s average level was 100). Because the
effective exchange rate is an average of a currency’s
exchange rates, it is often more useful when looking at
the value of a currency over a long period than a single
exchange rate (such as sterling-dollar). The higher the
index figure, the stronger the currency. In the chart
below the weight given to each currency in the basket is
derived from the trade flows in manufactured goods and
represents the relative importance of the country in
question as a competitor in export markets. The weights
are revised periodically to accommodate countries’
changing economic circumstances.
© Bank of England 1999 Reproduction in whole part is permitted for education purposes provided the source is acknowledged.
Sterling's effective exchange rate (January 1992-March 2000)
70
80
90
100
110
120
Jan-92 Jan-94 Jan-96 Jan-98 Jan-00
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