factors effecting currency trading

Although exchange rates are affected by many factors, in the end, currency prices are a result of supply and demand forces. The world's currency markets can be viewed as a huge melting pot: in a large and ever-changing mix of current events, supply and demand factors are constantly shifting, and the price of one currency in relation to another shifts accordingly. No other market encompasses (and distills) as much of what is going on in the world at any given time as foreign exchange.
Supply and demand for any given currency, and thus its value, are not influenced by any single element, but rather by several. These elements generally fall into three categories: economic factors, political conditions and market psychology Economic factors
These include economic policy, disseminated by government agencies and central banks, economic conditions, generally revealed through economic reports, and other economic indicators.
Economic policy comprises government fiscal policy (budget/spending practices) and monetary policy (the means by which a government's central bank influences the supply and "cost" of money, which is reflected by the level of interest rates).
Economic conditions include:
Government budget deficits or surpluses: The market usually reacts negatively to widening government budget deficits, and positively to narrowing budget deficits. The impact is reflected in the value of a country's currency.
Balance of trade levels and trends: The trade flow between countries illustrates the demand for goods and services, which in turn indicates demand for a country's currency to conduct trade. Surpluses and deficits in trade of goods and services reflect the competitiveness of a nation's economy. For example, trade deficits may have a negative impact on a nation's currency.
Inflation levels and trends: Typically, a currency will lose value if there is a high level of inflation in the country or if inflation levels are perceived to be rising. This is because inflation erodes purchasing power, thus demand, for that particular currency.
Economic growth and health: Reports such as gross domestic product (GDP, employment levels, retail sales, capacity utilization and others, detail the levels of a country's economic growth and health. Generally, the more healthy and robust a country's economy, the better its currency will perform, and the more demand for it there will be.
Political conditions
Internal, regional, and international political conditions and events can have a profound effect on currency markets.
For instance, political upheaval and instability can have a negative impact on a nation's economy. The rise of a political faction that is perceived to be fiscally responsible can have the opposite effect. Also, events in one country in a region may spur positive or negative interest in a neighboring country and, in the process, affect its currency.

Market psychology
Market psychology and trader perceptions influence the foreign exchange market in a variety of ways:
Flights to quality: Unsettling international events can lead to a "flight to quality," with investors seeking a "safe haven". There will be a greater demand, thus a higher price, for currencies perceived as stronger over their relatively weaker counterparts.
Long-term trends: Currency markets often move in visible long-term trends. Although currencies do not have an annual growing season like physical commodities, business cycles do make themselves felt. Cycle analysis looks at longer-term price trends that may rise from economic or political trends.
"Buy the rumor, sell the fact:" This market truism can apply to many currency situations. It is the tendency for the price of a currency to reflect the impact of a particular action before it occurs and, when the anticipated event comes to pass, react in exactly the opposite direction. This may also be referred to as a market being "oversold" or "overbought". To buy the rumor or sell the fact can also be an example of the cognitive bias known as anchoring, when investors focus too much on the relevance of outside events to currency prices.
Economic numbers: While economic numbers can certainly reflect economic policy, some reports and numbers take on a talisman-like effect: the number itself becomes important to market psychology and may have an immediate impact on short-term market moves. "What to watch" can change over time. In recent years, for example, money supply, employment, trade balance figures and inflation numbers have all taken turns in the spotlight.
Technical trading considerations: As in other markets, the accumulated price movements in a currency pair such as EUR/USD can form apparent patterns that traders may attempt to use. Many traders study price charts in order to identify such patter

financial instruments

Spot
A spot transaction is a two-day delivery transaction, as opposed to the futures contracts, which are usually three months. This trade represents a “direct exchange” between two currencies, has the shortest time frame, involves cash rather than a contract; and interest is not included in the agreed-upon transaction. The data for this study come from the spot market. Spot has the largest share by volume in FX transactions among all instruments.

Forward
One way to deal with the Forex risk is to engage in a forwardtransaction. In this transaction, money does not actually change hands until some agreed upon future date. A buyer and seller agree on an exchange rate for any date in the future, and the transaction occurs on that date, regardless of what the market rates are then. The duration of the trade can be a few days, months or years.

Future
Main article: Currency future
Foreign currency futures are forward transactions with standard contract sizes and maturity dates — for example, 500,000 British pounds for next November at an agreed rate. Futures are standardized and are usually traded on an exchange created for this purpose. The average contract length is roughly 3 months. Futures contracts are usually inclusive of any interest amounts.

Swap
Main article: Forex swap
The most common type of forward transaction is the currency swap. In a swap, two parties exchange currencies for a certain length of time and agree to reverse the transaction at a later date. These are not standardized contracts and are not traded through an exchange.

Option
Main article: Foreign exchange option
A foreign exchange option(commonly shortened to just FX option) is a derivative where the owner has the right but not the obligation to exchange money denominated in one currency into another currency at a pre-agreed exchange rate on a specified date. The FX options market is the deepest, largest and most liquid market for options of any kind in the world.

Exchange Traded Fund
Main article: Exchange-traded fund
Exchange-traded funds (or ETFs) are Open Ended investment companies that can be traded at any time throughout the course of the day. Typically, ETFs try to replicate a stock market indexsuch as the S&P 500 (e.g. SPY), but recently they are now replicating investments in the currency markets with the ETF increasing in value when the US Dollar weakness versus a specific currency, such as the Euro. Certain of these funds track the price movements of world currencies versus the US Dollar, and increase in value directly counter to the US Dollar, allowing for speculation in the US Dollar for US and US Dollar denominated investors and speculators.

Speculation
Controversy about currency speculators and their effect on currency devaluations and national economies recurs regularly. Nevertheless, many economists (e.g. Milton Friedman) have argued 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 fundsand 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. 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 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. Given that Malaysia recovered quickly after imposing currency controls directly against IMF advice, this view is open to doubt

market size

The foreign exchange market is unique because ofits trading volumes,the extreme liquidity of the market,the large number of, and variety of, traders in the market,its geographical dispersion,its long trading hours: 24 hours a day (except on weekends),the variety of factors that affect exchange rates.the low margins of profit compared with other markets of fixed income (but profits can be high due to very large trading volumes)According to the BIS,[1] average daily turnover in traditional foreign exchange markets is estimated at $3,210 billion. Daily averages in April for different years, in billions of US dollars, are presented on the chart below:This $3.21 trillion in global foreign exchange market "traditional" turnover was broken down as follows:$1,005 billion in spot transactions$362 billion in outright forwards$1,714 billion in forex swaps$129 billion estimated gaps in reportingIn addition to "traditional" turnover, $2.1 trillion was traded in derivatives.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, and accounts for about 7% of the total foreign exchange market volume, according to The Wall Street Journal Europe (5/5/06, p. 20).Average daily global turnover in traditional foreign exchange market transactions totaled $2.7 trillion in April 2006 according to IFSL estimates based on semi-annual London, New York, Tokyo and Singapore Foreign Exchange Committee data. Overall turnover, including non-traditional foreign exchange derivatives and products traded on exchanges, averaged around $2.9 trillion a day. This was more than ten times the size of the combined daily turnover on all the world’s equity markets. Foreign exchange trading increased by 38% between April 2005 and April 2006 and has more than doubled since 2001. This is largely due to the growing importance of foreign exchange as an asset class and an increase in fund management assets, particularly of hedge funds and pension funds. The diverse selection of execution venues such as internet trading platforms has also made it easier for retail traders to trade in the foreign exchange market. [4]Because foreign exchange is an OTC market where brokers/dealers negotiate directly with one another, there is no central exchange or clearing house. The biggest geographic trading centre is the UK, primarily London, which according to IFSL estimates has increased its share of global turnover in traditional transactions from 31.3% in April 2004 to 32.4% in April 2006. RPPThe ten most active traders account for almost 73% of trading volume, according to The Wall Street Journal Europe, (2/9/06 p. 20). These large international banks continually provide the market with both bid (buy) and ask (sell) prices. The bid/ask spread is the difference between the price at which a bank or market maker will sell ("ask", or "offer") and the price at which a market-maker will buy ("bid") from a wholesale customer. This spread is minimal for actively traded pairs of currencies, usually 0–3 pips. For example, the bid/ask quote of EUR/USD might be 1.2200/1.2203. Minimum trading size for most deals is usually $100,000.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' checks. Spot prices at market makers vary, but on EUR/USD are usually no more than 3 pips wide (i.e. 0.0003). Competition has greatly increased with pip spreads shrinking

Market participants

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

trading characteristics

There is no unified or centrally cleared market for the majority of FX trades, and there is very little cross-border regulation. 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 not 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 instantaneously. A joint venture of the Chicago Mercantile Exchange and Reuters, called FXMarketSpace opened in 2007 and aspires to the role of a central market clearing mechanism.The main trading centers are in London, New York, Tokyo, and Singapore, but banks throughout the world participate. Currency trading happens continuously throughout the day; as the Asian trading session ends, the European session begins, followed by the North American session and then back to the Asian session, excluding weekends.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, large cross-border M&A deals 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.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 is expressed. For instance, EUR/USD is the price of the euro expressed in US dollars, as in 1 euro = 1.3045 dollar. Out of convention, the first currency in the pair, the base currency, was the stronger currency at the creation of the pair. The second currency, counter currency, was the weaker currency at the creation of the pair.The factors affecting XXX will affect both XXX/YYY and XXX/ZZZ. This causes positive currency correlation between XXX/YYY and XXX/ZZZ.On the spot market, according to the BIS study, the most heavily traded products were:EUR/USD: 28 %USD/JPY: 18 %GBP/USD (also called sterling or cable): 14 %and the US currency was involved in 88.7% of transactions, followed by the euro (37.2%), the yen (20.3%), and the sterling (16.9%) (see table). 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 far 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 exception to this is EUR/JPY, which is an established traded currency pair in the interbank spot market.

forex trade

Why trade Forex?24 hour trading One of the major advantages of trading forex is the opportunity to trade 24 hours a day from Sunday evening (20:00 GMT) to Friday evening (22:00 GMT). This gives you a unique opportunity to react instantly to breaking news that is affecting the markets.Superior liquidityThe forex market is so liquid that there are always buyers and sellers to trade with. The liquidity of this market, especially that of the major currencies, helps ensure price stability and narrow spreads. The liquidity comes mainly from banks that provide liquidity to investors, companies, institutions and other currency market players.No commissionsThe fact that forex is often traded without commissions makes it very attractive as an investment opportunity for investors who want to deal on a frequent basis.Trading the “majors” is also cheaper than trading other cross because of the high level of liquidity. For more information on the trading conditions of Saxo Bank, go to the Account Summary on your SaxoTrader and open the section entitled "Trading Conditions" found in the top right-hand corner of the Account Summary.100:1 LeverageLeverage (gearing) enables you to hold a position worth up to 100 times more than your margin deposit. For example, a USD 10,000 deposit can command positions of up to USD 1,000,000 through leverage. You can leverage the first USD 25,000 of your investment up to 100 times and additional collateral up to 50 times.Profit potential in falling marketsSince the market is constantly moving, there are always trading opportunities, whether a currency is strengthening or weakening in relation to another currency. When you trade currencies, they literally work against each other. If the EURUSD declines, for example, it is because the U.S. dollar gets stronger against the Euro and vice versa. So, if you think the EURUSD will decline (that is, that the Euro will weaken versus the dollar), you would sell EUR now and then later you buy Euro back at a lower price and take your profits. The opposite trading scenario would occur if the EURUSD appreciates.Brief history of Forex tradingInitially, the value of goods was expressed in terms of other goods, i.e. an economy based on barter between individual market participants. The obvious limitations of such a system encouraged establishing more generally accepted means of exchange at a fairly early stage in history, to set a common benchmark of value. In different economies, everything from teeth to feathers to pretty stones has served this purpose, but soon metals, in particular gold and silver, established themselves as an accepted means of payment as well as a reliable storage of value.Originally, coins were simply minted from the preferred metal, but in stable political regimes the introduction of a paper form of governmental IOUs (I owe you) gained acceptance during the Middle Ages. Such IOUs, often introduced more successfully through force than persuasion were the basis of modern currencies.Before the First World War, most central banks supported their currencies with convertibility to gold. Although paper money could always be exchanged for gold, in reality this did not occur often, fostering the sometimes disastrous notion that there was not necessarily a need for full cover in the central reserves of the government.At times, the ballooning supply of paper money without gold cover led to devastating inflation and resulting political instability. To protect local national interests, foreign exchange controls were increasingly introduced to prevent market forces from punishing monetary irresponsibility.In the latter stages of the Second World War, the Bretton Woods agreement was reached on the initiative of the USA in July 1944. The Bretton Woods Conference rejected John Maynard Keynes suggestion for a new world reserve currency in favour of a system built on the US dollar. Other international institutions such as the IMF, the World Bank and GATT (General Agreement on Tariffs and Trade) were created in the same period as the emerging victors of WW2 searched for a way to avoid the destabilising monetary crises which led to the war. The Bretton Woods agreement resulted in a system of fixed exchange rates that partly reinstated the gold standard, fixing the US dollar at USD35/oz and fixing the other main currencies to the dollar - and was intended to be permanent.The Bretton Woods system came under increasing pressure as national economies moved in different directions during the sixties. A number of realignments kept the system alive for a long time, but eventually Bretton Woods collapsed in the early seventies following president Nixon's suspension of the gold convertibility in August 1971. The dollar was no longer suitable as the sole international currency at a time when it was under severe pressure from increasing US budget and trade deficits.The following decades have seen foreign exchange trading develop into the largest global market by far. Restrictions on capital flows have been removed in most countries, leaving the market forces free to adjust foreign exchange rates according to their perceived values.But the idea of fixed exchange rates has by no means died. The EEC (European Economic Community) introduced a new system of fixed exchange rates in 1979, the European Monetary System. This attempt to fix exchange rates met with near extinction in 1992-93, when pent-up economic pressures forced devaluations of a number of weak European currencies. Nevertheless, the quest for currency stability has continued in Europe with the renewed attempt to not only fix currencies but actually replace many of them with the Euro in 2001. This project is fairly advanced now and the final structure and fixed levels were decided in May 1998. After this a dangerous three-year period loomed, where devaluation candidates could be attacked nearly without risk until the final introduction of the Euro in this Millennium. -->The lack of sustainability in fixed foreign exchange rates gained new relevance with the events in South East Asia in the latter part of 1997, where currency after currency was devalued against the US dollar, leaving other fixed exchange rates, in particular in South America, looking very vulnerable.But while commercial companies have had to face a much more volatile currency environment in recent years, investors and financial institutions have found a new playground. The size of foreign exchange markets now dwarfs any other investment market by a large factor. It is estimated that more than USD1,200 billion is traded every day, far more than the world's stock and bond markets combined.

why choose life forex

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chinese milestone

The Chinese Yuan has crossed the psychological barrier of 7.5 RMB/USD, a level last seen nearly a decade ago. The currency’s appreciation has been gradual but visible, not withstanding the cries of western bureaucrats. By all accounts, the Yuan will continue rising, though not at the same pace as its trade surplus, which is projected to jump from $177 Billion in 2006 to $300 Billion in 2007. Predictions regarding the extent of the appreciation range from 20% to 400%, the implication being that it depends who you ask. But the general consensus is clear: the Yuan is pointing upwards. Bloomberg News reports: Non-deliverable forward contracts show traders are betting the yuan will reach 7.0070 in 12 months, a gain of 6.9 percent from the spot rate, and 6.95 by the end of 2008

Brazil intervenes

Continuing our coverage of BRIC countries (see previous post), the Brazilian Real has climbed 20% in value this year alone, on top of gains recorded in previous years. Fearing that an expensive currency will adversely affect its economy, Brazil's Central Bank announced its plans to intervene in forex markets on behalf of the Real. The Central Bank will buy Dollars at the spot rate, which should bring down the Real slightly. However, the Central Bank also intervened about two months ago, with limited effect on the Real. And it doesn't hold that this time around will be any different. Ultimately, there are economic forces beyond the control of the Central Bank which are propelling the Real upward. Reuters reports:"But I don't think the bank is going to be able to prevent the real from strengthening further," said one analyst. "The dollar inflows into the country are too strong

bank of japan

As expected, the Bank of Japan left its benchmark interest rate unchanged at its latest meeting. The current rate of .5% remains the lowest in the industrialized world and thus will continue to fuel the Japanese carry trade. The Bank fended off the criticism of several European Ministers, wary of the Yen’s continued appreciation against the Euro, including a 5% increase in the last month alone. The EU has insisted that Japan should hike rates immediately both to avoid global economic imbalances and to prevent its own economy from overheating. Japan defended its decision by pointing to certain small business indicators, which suggest the sector is still underperforming. Carry traders, rest easy. Bloomberg News reports: “The Bank of Japan will probably need to put off a hike at least until December to nail down its assessment of global growth as well as the performance of small companies

Australian dollar approches parity

Over the last few months, the Australian Dollar has risen over 15% against the USD, bringing the currency to a 23-year high. With parity (1:1 exchange rate) in sight, some analysts are beginning to draw parallels between the Australian Dollar and the Canadian Dollar, which skyrocketed to parity against the USD just last month. Both economies are rich in natural resources, relying heavily on them to drive exports. In fact, more than half of Australia's exports are comprised of natural resources. It is no surprise that as oil, gold, and a host of other raw materials have surged to record highs, the Australian economy has outperformed even the rosiest of expectations. With China's economic boom promising to keep raw material prices high for the near future, the prospects for Australia's economy, and hence its currency, are brighter than ever. What’s more, the basic divergence in growth is clearly tipping towards the momentum underlying the Aussie economy with consumer spending, business investment and export income promising strength for the economy and currency in the months to come.

commentary

At last week’s G8 meeting in Washington, it was expected that currencies would be a hot topic of discussion. With the Dollar retreating to record lows on a daily basis, the failure of China to allow the Yuan to appreciate, the Japanese Yen’s continued weakness despite its strong economy, and the recent parity of the Canadian Dollar and USD, there are certainly plenty of forex phenomena that deserve attention. However, it is the Euro/USD relationship that probably received the most scrutiny, as the biggest contingent of the G8 uses the Euro. European politicians and bureaucrats have spent the last few months arguing with America-as well as amongst themselves-over the declining Dollar. The consensus is certainly that the Dollar is harming the European economies; as one German Minister phrased it, the “pain threshold” has been crossed. At the same time, it is clear that a relatively weak Dollar is probably in the best interest of global economic stability, since the US current account and financial account imbalances can only be solved by changes in exchange rates. Thus, there is a growing divide between European politicians, who tend to think in provincial terms, and the European Central Bank, which is more focused on the Big Picture. The new President of France, for example, has been quite vocal in lamenting the appreciation of the Euro, even going so far as to demand the ECB step in. Jean Claude Trichet, president of the ECB, responded by calling on European politicians to be circumspect in their comments on the Euro. However, since Central Banks do not participate in G8 conferences, you can bet that politicians hounded Hank Paulson, US Secretary of the Treasury, on the declining Dollar. Some analysts have even speculated that ‘intervention’ would enter into the discussions. In fact, the US has not intervened in forex markets since 1994, when Europe and American worked in tandem to prop up a then-ailing Dollar. After a couple months, however, the plan was abandoned due to mixed results. Is it possible that the US, confronted with the same situation, will once again attempt intervention? The answer is “not likely.” First, the Europeans are not even united in their position on the USD/Euro exchange rate. Secretly, they would probably all prefer a stronger Dollar, but in public, only a handful have called for intervention. Second, short of fixing the exchange rate (which would require the US to borrow money), it is very difficult for a government/central bank to control its currency. Recent intervention by South Korea and Japan, as well as America’s efforts in 1994, ended in failure. Finally, there is the issue of China, which does control its currency. The US would surely appear hypocritical if it intervened on behalf of the Dollar while simultaneously encouraging China to float the Yuan. Thus, while certain US economic concessions may result of the G8 conference, a controlled appreciation of the Dollar will not likely be one of them

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In an official G7 press release, US Treasury Secretary Henry Paulson proclaimed that the USwould continue to pursue a “Strong Dollar” policy. While this remark was certainly anticipated and probably even appreciated, by representatives from the EU, analysts have been quick to mock. Their point, which is well-taken, is that it seems ridiculous for the US to insist that it supports a strong Dollar when economic fundamentals support a continued decline. The current account deficit is not retreating, interest rates are being lowered, and the credit crunch threatens to collapse the US housing and stock markets. Meanwhile, the USD has declined in five of the last six years, and the Bush administration has not made any serious efforts (beyond rhetoric) to intervene on its behalf, leaving market participants chuckling and scratching their heads when they hear “Strong Dollar.” Reuters reports: Paulson even before he became Treasury secretary said publicly that the dollar would have to weaken to ameliorate the U.S. trade shortfall. So his maintaining a strong-dollar policy may reflect a more global perspective.