forex manual

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ForexConfidential

SECTION ONE

(PAGE 2)

I. What is the FX Market? 2 (PAGE 3-4)

II. Why Trade FX? 3 Enormous Liquidity 3 No Slippage 3 Market Transparency 3 Trending Markets 3 24-hour Access 3 Low to Zero Transaction Cost 4 High Leverage 4 Low account Minimums 4 No Bear-Only Market 4 Above Average Profit Potential 4 (PAGE 4-6)

III. Brief History of the FX Market 4 Gold Exchange Standard 5 Bretton Woods Accord 5 Smithsonian Agreement 6 Free-Floating System 6 (PAGE 7-9)

IV. Market Structure 7 Overview 7 Interbank 7 Market Hours 7 Markets within the FX Market 8

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V. Key Players in FX Market 10 Commercial and Investment Banks 10 Central Banks 10 The Federal Reserve (Fed) 10 The European Central Bank (ECB) 11 Bank of England (BoE) 11 Swiss National Bank (SNB) 12 The Bank of Japan (BOJ) 12 Bank of Canada (BoC) 12 Corporations 12 Hedge Funds and International Funds 13 FX Funds 13 Individuals 13 (PAGE 14)

VI. International Overview 14 (PAGE 14)

VII. FX Regulations 14 CFTC 14 NFA 14 (PAGE 15)

VIII. Your Role in the FX Market 15 (PAGE 15)

IX. How Can Forex be Accessed? 15

THE FX MARKET


ForexConfidential

Part I. What is the FX Market?

The Foreign Exchange market, also referred to as the Forex or FX market, is the largest market in the world with over $1.5 trillion changing hands daily and soon expected to top $2 trillion. Compare that to the New York Stock Exchange at $28 billion, the equities market at $191 billion, and the daily value of the futures market at $437.4 billion, and you will clearly see that the FX market alone is approximately three times the total amount of the US Equity and Treasury markets combined.

Unlike other financial markets, the Forex market has no physical location and no central exchange. It operates through an electronic network of banks, corporations, institutional investors, and individuals trading one cur-rency for another. The lack of a physical exchange en-ables the Forex market to operate on a 24-hour basis, spanning from one time zone to another, across the major financial centers around the world. The FX market plays a key role in transferring financial payments across borders and moving funds and pur-chasing power from one currency to another. This inter-national market plays an extensive and direct role in national economies and has a major impact that

affects our lives and our prosperity. The movement of different currencies between countries determines a very important price the exchange rate. It is the exchange rate that allows the currencies to be traded for profit. There are two major reasons to buy and sell currencies: 1) About 5% of daily turnover is from companies and governments that buy or sell products and services in foreign countries, then profits made are converted back into their domestic currency. 2) The other 95% is trading for profit or speculation, which translates to the tremendous profit- potential in this highly lucrative market. Trading for speculation in the FX market has increased tremendously throughout the years as institutions and individuals recognize the high profit potential in this highly lucrative market. Although speculative trading is increasing, not everyone involved in Forex is a speculator. Therefore, there is far less risk of manipulation within the FX market. Even in the case of central bank intervention, the overall effect on the FX market is relatively insignificant. Forex is a genuine market in which the prices of currencies are solely determined by the forces of supply and demand. As a result, all market participants, including individual traders, are well-protected from artificial manipulation of prices. Unfortunately, this protection for traders does not extend to other markets. In the equity market, everyone is a speculator, including individuals and corporations. When everyone is speculating for profit, manipulation of prices is inevitable. Consequently, traders in the equity market suffer immensely when prices are manipulated by various institutions. Until recently, large international banks dominated the FX market, only allowing access via telephone trading to major corporations, large funds, and high net worth individuals. This little known, underexposed, foreign exchange currency market can now be traded online and is available to the general public with a minimal capital investment of $300. Individual investors now have the opportunity to trade in the largest and most liquid financial market in the world.

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Part II. Why Trade FX? Foreign exchange is by far the preferred market choice for aggressive traders. The FX market offers unparalleled liquidity, no slippage, market transparency, trending markets, 24-hour access, low to zero transaction cost, high leverage, low account minimums, no bear-only market, and most importantly, above average profit potential.

Enormous Liquidity

The FX market is the most liquid market in the world. It can absorb trading volumes and per-trade sizes that may overwhelm any other market. Trading essentially consists of two parts: opening a position and closing of that position. Liquidity, which is highly correlated with volume, qualitatively evaluates how easily traders can enter and exit positions. A liquid market enables participants to execute large volume transactions with little impact on market prices. On the simplest level, the enormous liquidity alone is powerful enough to attract any investor to the FX market, as it suggests the freedom to open or close a position at will. In addition, technical analysis, the study of price movements, operates better in liquid markets. Illiquid markets make it much more difficult to accurately determine entry and exit points.

No Slippage

Traders in illiquid markets may experience delays and subsequently, suffer from slippage. In these markets, there may be delays in the execution of traders orders and thus, market orders could potentially be filled at a different price from the market rate when the order was initially placed. Furthermore, traders may experience difficulty in exiting or selling positions, which greatly compromises the ability to clear profitable trades. In the FX market, there is absolutely no slippage traders will always get in and out at the price they placed their orders. This is due to the tremendous amount of volume that the FX market generates.

Market Transparency

Market transparency is highly desired in a trading environment. It is a condition in which market participants are able to observe the detailed information

in the trading process. Ultimately, the greater the market transparency, the more efficient the market becomes. The FX market offers the highest level of market transparency out of all financial markets. Informed traders are better off than uninformed traders because most financial markets could be exploited by those with private information. Traders in all financial markets rely on market transparency because it allows them to see a transparent spread, which enables them to employ their premeditated strategies while still flexible enough to accommodate an ever-changing marketplace. With the transparency of information, traders can exercise their risk management strategies in accordance to their fundamental and technical approaches. For example, in the case of Enron, inaccurate reporting by officers of the company resulted in the downfall of the company and losses of many shareholders. Markets where this could occur are considered a poor trading market. Furthermore, market transparency ensures the ability to trade from live, executable prices. Markets that do not offer executable prices and force traders to absorb slippage, obviously compromise traders profit potential.

Trending Markets

Although currency prices in the FX market may be volatile, they generally repeat themselves in cycles, creating trends. The trends can be analyzed by traders using technical tools. Since technical analysis statistically works better in markets characterized by cycles and trends, traders benefit from this attribute of Forex. The entire premise of technical analysis is based on the study of price movements. Through this analysis, traders can identify trends and capture key entry and exit points at which they should execute their trades and maximize their profit potential.

24-hour Access

Forex is a true 24-hour, 6 days a week, market. FX trading begins each day in Australia and moves around the globe as the business day begins in each financial center first to Tokyo, then London, and New York.

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Unlike any other financial market, investors can re-spond to currency fluctuations caused by economic, social, and political events at the time they occur re-gardless if it is daytime or nighttime. The only breaks in trading occur during a brief period over the weekend. A trader is able to put on a trade during the London ses-sion, follow it during the New York session, and close the trade in the middle of the following day during the Tokyo session. This type of market access is invaluable to a market participant who needs to react quickly to global events.

Low to Zero Transaction Cost

The amount of cost to execute trades has dropped considerably in recent years. Transaction costs include all the expenses to actually execute a trade. Because transaction costs reduce profits, the lower the transaction costs, the more beneficial it is for the trader. Markets that have centralized exchanges tend to have higher transaction costs due to exchange and clearing fees associated with trading. Active stock and futures traders often see substantial portions of their gross profits going to broker commissions, exchange fees, and data/chart feeds. Transaction costs can also be increased with faulty executions. As regards the FX market, there are minimal to no brokerage fees and zero exchange and clearing fees since it is an over-the- counter market.. What you see is what you get, allowing you to make quick decisions on your trades without having to account for fees that may affect your profit/loss or slippage.

High Leverage

The FX market provides traders with access to much higher leverage than other financial markets. FX traders can benefit from leverage in excess of 100 times their capital versus the 10 times capital that is typically offered to professional equity day traders. In the FX market, the margin deposit for leverage is not a down payment on a purchase of equity; instead, it is a performance bond, or good faith deposit, to ensure against trading losses. This is very useful to short-term day traders who need the enhancement in capital to generate quick returns.

Low Account Minimums

Many individuals believe that entering the highly lucrative foreign exchange market requires large initial trading capital. This was indeed true prior to 1996, without the integration of online trading into the FX market. Today, individuals can get Started with a mini- account for as little as $300.

No Bear-Only Market

One of the biggest advantages of trading FX is that there is no fear of a bear-only market. In many markets, high-return investments can often be difficult to sell after they are bought. However, in Forex, the major currency pairs always have buyers and sellers; hence, the FX investor should never worry about being stuck in a trade due to lack of market interest.

Above Average Profit Potential

There is no question that speculative trading in Forex offers huge profit potential. It is an exciting way to earn exceptionally high returns on ones investment capital. Part III. Brief History of the FX Market

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The Foreign Exchange market, (FX or Forex) as we know it today, originated in 1973. However, money has been around in one form or another since the time of the Egyptian Pharaohs. While the Babylonians are credited with the first use of paper bills and receipts, Middle Eastern moneychangers were the first currency traders exchanging coins of one culture for another. During the middle ages, paper bills emerged as an alternative form of currency besides coins. These paper bills represented transferable third party payments of funds, which made foreign exchange much easier and less cumbersome for merchants and traders. From the infantile stages of Forex during the Middle Ages to World War I (WWI), the Forex market was relatively stable and without much speculative activity. After WWI, it became very volatile and speculative activity increased ten fold. Speculation in the Forex market was not looked on as favorable by most institutions and the public in general. The Great Depression and the removal of the gold standard in 1931 created a serious lull in Forex activity. From 1931 until 1973, the Forex market went through a series of changes. These changes greatly impacted the global economies at the time. There was little if any speculation in the Forex market during these times.

Gold Exchange Standard

The Gold Exchange Standard, which prevailed between 1876 and WWI, dominated the international economic system. Under the gold exchange standard, currencies gained a new phase of stability as they were supported by the price of gold. It abolished the age-old practice in which kings and rulers arbitrarily debased money and triggered inflation. However, the gold exchange standard had its weakness. As an economy strengthened, it would import heavily from abroad until it ran down its gold reserves required to back its money. As a result, money supply would shrink, interest rates would rise, and economic activity would slow down to the extent of recession. Ultimately, prices of goods would bottom out, appearing attractive to other nations. Consequently, this would cause a rush in buying sprees that would inject

the economy with enough gold to increase its money supply, drive down interest rates, and recreate wealth into the economy. Such patterns prevailed throughout the gold standard until the outbreak of WWI, which interrupted trade flows and the free movement of gold. Several other major transformations occurred after the Gold Exchange Standard, leading to the birth of the current FX market: the Bretton Woods Accord, Smithsonian Agreement, and the Free-Floating System.

Bretton Woods Accord

The first major transformation, the Bretton Woods Accord, occurred toward the end of World War II. A total of 44 countries, including the United States, Great Britain, and France met in New Hampshire in July 1944, to design a new economic order.

The design of the Bretton Woods framework was to have the United States become an anchor for all free world currencies. The accord aimed at installing international monetary stability by preventing money from fleeing across nations and restricting speculation in the world currencies. Major currencies were pegged to the dollar, which was in turn tied to gold at a value of $35 per ounce. The dollar was the primary reserve currency and member countries were able to sell currency to the Federal Reserve in exchange for gold at the present rate. In addition to these interventions, the International Monetary Fund (IMF) and the International Bank for Reconstruction and Development (World Bank) were established to ensure that the Bretton Woods system would operate effectively.

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Once the Bretton Woods Agreement was founded, the participating countries agreed to try and maintain the value of their currency with a narrow margin against the dollar and a corresponding rate of gold as needed. Countries were prohibited from devaluing their currencies to their trade advantage and were only allowed to do so for devaluations of less than 10%. Trading under the Bretton Woods system had unique characteristics. Since exchange rates were fixed, intense trading took place around devaluation or revaluation, known as creeping pegs. Speculation against the British pound in 1967 demonstrated creeping pegs patterns. Despite all the efforts by the Bank of England and other central banks to support the pound, the pound was devalued. This failure was monumental because it was the first time that the central bank intervention failed under the Bretton Woods system. The failure of the central bank intervention continued with the dollar in the following years. As the Bretton Woods system was highly dependant on a strong US dollar, the dollar began to experience pressure in 1968, causing extreme speculation on the future of this system. The Agreement was finally abandoned in 1971, and the US dollar would no longer be convertible into gold.

Smithsonian Agreement

After the Bretton Woods Accord came to an end, the Smithsonian Agreement was signed in December of 1971. This agreement was similar to the Bretton Woods Accord, but it allowed for a greater fluctuation band for foreign currencies. The Smithsonian Agreement strived to maintain fixed exchange rates, but to do so without the backing of gold. Its key difference from the Bretton Woods system was that the value of the dollar could float in a range of 2.25%, as opposed to just 1% under Bretton Woods. Ultimately, the Smithsonian Agreement proved to be unfeasible as well. Without exchange rates fixed to gold, the free market gold price shot up to $215 per ounce. Moreover, the U.S. trade deficit continued to grow, and from a fundamental standpoint, the US dollar

needed to be devalued beyond the 2.25% parameters established by the Smithsonian Agreement. In light of these problems, the foreign exchange market was forced to close in February of 1972. In 1972, the European community tried to move away from their dependency on the dollar. The European Joint Float was established by West Germany, France, Italy, the Netherlands, Belgium, and Luxemburg. Both agreements made mistakes similar to the Bretton Woods Accord and by 1973, collapsed.

Free-Floating System

The collapse of the Smithsonian agreement and the European Joint Float in 1973 signified the official switch to the free-floating system. This occurred by default as there were no new agreements to take their place. Governments were now free to peg their currencies, semi-peg, or allow them to freely float. In 1978, the free- floating, system was officially mandated. The value of the US dollar was to be determined entirely by the market, as its value was not fixed to any commodity, nor was the fluctuation of its exchange rate confined to certain parameters. While this did provide the US dollar, and other currencies by default, the agil-ity required to adapt to a new and rapidly evolving international trading environment, it also set the stage for unprecedented inflation. Europe tried to gain independence from the dollar by creating the European Monetary System in July of 1978. This, like all of the earlier agreements, failed in 1993. The major currencies today move independently of other currencies. The currencies are traded by anyone who wishes to trade. This has caused a recent influx of speculation by banks, hedge funds, brokerage houses, and individuals. Central banks intervene on occasion to move or attempt to move currencies to their desired levels. The underlying factor that drives todays Forex market, however, is supply and demand. The free- floating system is ideal for todays markets.

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Part IV. Market Structure

Overview

Unlike other financial markets, the Forex market has no physical location and no central exchange; hence, it is considered an over-the-counter (OTC) market. The FX market operates through an electronic network of banks, corporations, institutional investors, and individuals trading one currency for another. Forex traders and market makers are all linked to one another round the clock via computers, telephones, and faxes where currency denominations, amounts, settlement dates, and prices are negotiable. The lack of a physical exchange enables the Forex market to operate on a 24- hour basis, spanning from one time zone to another, across the major financial centers around the world. The FX market is organized into a hierarchy, which consists of participants with different ranking. The standards that determine the participants positions are credit access, volume of transactions, and level of sophistication; those with superiority in these measures receive priority in the FX market. At the top of the hierarchy is the interbank market, which generates the highest volume in trades.

Interbank

Interbank is a credit-approved system where banks trade on the sole basis of their credit relationships with one another. In the interbank market, the largest banks are able to trade with each other directly, via interbank brokers or through electronic brokering systems such as Reuters and EBS. While all the banks can see the rate that everyone is dealing at, each bank has a spe-cific credit relationship with the other bank and trade at the rates being offered.

Other institutions in the market, such as corporations, online FX market makers, and hedge funds trade FX through commercial banks. However, many banks

(community banks and banks in emerging markets), corporations, and institutional investors do not have access to these rates because they do not have established credit relationships with large commercial banks. Subsequently, these smaller participants are obligated to trade FX through a large bank, and often, this equates to much less competitive rates. The rates become less and less competitive as it trickles down the hierarchy of participants. Eventually, the customers of banks and foreign exchange agencies receive the least competitive rates. However, in the late 1990s, technological advances have eliminated the barriers that existed between the interbank and end-users of FX. Since 1996, retail clientele can connect directly to market makers via online trading. Average traders can enjoy the competitive rates and trade alongside the worlds largest banks.

The FX market is no longer reserved for big corporations; it is now made available to all types of consumers. Furthermore, the boundless opportunity to trade foreign exchange awaits all aspiring corporations and individual traders.

Market Hours

The spot FX market is unique to any other market in the world since trading is available. 24 hours a day. Somewhere around the world, a financial center is open for business, and banks and other institutions exchange currencies every minute of the day with only minor gaps on the weekend. The FX market opens at 5 pm (EST) on Sunday and close at 1 pm (EST) on Friday. The major financial centers around the world overlap due to their time zones. The International Date Line is located in the Western Pacific. Each business day begins in Wellington, New Zealand, then Sydney, Australia, followed by the Asian financial markets starting with Tokyo, Japan, Hong Kong, China, and finally Singapore. Only a few hours later, markets will open in the Middle East. When the markets in Tokyo are starting to wind down, Europe opens for business.

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Markets within the FX Market

Although spot trading accounts for 48% of all FX transactions worldwide, the three main markets, Tokyo, London, and New York, represent almost 70% of the worlds FX volume. Foreign exchange activity does not flow evenly, and throughout the course of the international trading day, there are certain markets characterized by very heavy trading activity in some (or all) currency pairs. At other times, the same markets are characterized by light activity in some (or all) cur-rency pairs. Foreign exchange activity tends to be the most active when markets overlap, particularly the U.S. markets and the major European markets; i.e., when it is morning in New York and afternoon in London.

As Japans economy has dwindled over the past decade, Japanese banks have been unable to commit to FX, the large amounts of capital they once did in the 1980s. Despite this, Tokyo is the first major market to open, and many large participants use it to get a read on dynamics or to begin scaling into positions. Approximately 10% of all FX trading volume takes place during the Tokyo session. Trading can be relatively thin.

Finally, New York and other major U.S. centers start their day. Towards the late afternoon in the United States, the next day arrives in the Western Pacific areas and the process begins again. Hence, the FX market is opened 6 days a week, 24 hours a day.

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Hedge funds and banks have been known to use the Tokyo lunch hour to run important stop and option barrier levels. Japanese yen, New Zealand dollar, and Australian dollar pairs tend to be the biggest movers during Tokyo hours as other currencies are quite thin and usually remain constant.

London is by far the most important and influential FX market, with approximately 30% of all worldwide transactions. Most big banks dealing desks stem from London and the market is responsible for roughly 28% of the total world spot volume. London tends to be the most orderly market due to the large liquidity and ease of completing transactions. Most large market participants use London hours to complete serious foreign exchange deals.

New York is the second most important market that represents approximately 16% of total worldwide mar-ket volume. In the United States spot market, the major-ity of deals are executed between 8am and 12pm, when European traders are still active. Trading often be-comes slower in the afternoon as liquidity dries up. In fact, there is a drop of over 50% in trading activity since California never served to bridge the gap between the U.S. and Asia. As a result, traders tend to pay less attention to market development in the afternoon. New York is greatly affected by the U.S. equity and bond markets, thus the pairs will often move closely in tandem with the capital markets.

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Part V. Key Players in the FX Market With the advances of technology and especially the opening on the Internet, the foreign exchange market has expanded from simple foreign exchange and bank transactions to a more speculative nature. Today, an increasing number of FX transactions are trading for profit or speculation, which translates to the tremendous profit-potential in this highly lucrative market. There are five major players in the FX market; Commercial/Investment Banks, Central Banks, Corporations, Hedge/International Funds, and individuals.

Commercial and Investment Banks

Commercial and investment banks account for the largest portion of FX trading volume. The lnterbank market caters to both the majority of commercial turnovers as well as enormous amounts of speculative trading everyday. Their primary role in the FX market is essentially selling currencies, as other participants execute trades through them. Banks trade currencies because it is highly lucrative and it limits their credit exposure on Letters of Credit. Banks gain profits by acting on their clients behalf and making trades. About three quarters of all foreign exchange trading is between banks. They generate billions of dollars worth of currency in a days volume. Below is a list of the top financial institutions in the world as rated by Euromoney Magazine in their May, 2001 edition.

Central Banks

Central banks play a significant role in the FX market as they can influence spot price fluctuations. Central banks generally do not speculate in currencies, but they use currencies to promote acceptable trading conditions to their banking industries by affecting money supply and interest rates through open market operations or the active trading of government securities. Central banks also often attempt to restore order to volatile markets through interventions. The reasons for central bank interventions may be a result of a variety of factors: to restore stability, protect a certain price level, slow down currency movements, or to reverse a trend. An example would be the recent intervention by the Bank of Japan to push down the value of the yen. On the surface, this may disturb many traders to make their investment decisions. However, it has been proven time and again that central banks can only influence currency values for short periods. Over time, the markets adjust to the changes, creating trend formations that may be very beneficial to traders. Trend strategies may guide FX traders to take advantage of these trends in the market. Central banks normally keep sizeable amounts of foreign currencies on hand; hence, their influence is so great that the mere mention of central banks interventions would violently move the market. As their investments are generally more long-term, central banks trades are quite profitable. The major central banks include: The Federal Reserve, European Central Bank, Bank of England, Swiss National Bank, Bank of Japan, and Bank of Canada.

The Federal Reserve (Fed):

The Federal Reserve Board (Fed) is the central bank of the United States. They are responsible for setting and implementing monetary policy. The board consists of a 12-member committee, which comprise the Federal. Open Market Committee (FOMC). The voting members of the FOMC are the seven Governors of the Federal Reserve Board, plus five Presidents of the twelve district reserve banks. The FOMC holds 8 meetings per year, which are widely watched for interest rate announcements or changes in

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growth expectations. The Fed has a high degree of independence to set monetary authority. They are less subject to political influences, as most members are assigned long term positions that allow them to remain in office through periods of alternate party dominance in both the Presidency and Congress. The U.S. Treasury is responsible for issuing government debt and for making fiscal policy decisions. Fiscal policy decisions include determining the appropriate level of taxes and government spending. The U.S. Treasury is the actual government body that determines dollar policy. That is, if. they feel that the USD rate in the foreign exchange market is under- or overvalued, they are in the position of giving the NY Federal Reserve Board the instructions to intervene in the FX market by physically selling or buying USD. Therefore, the Treasurys view on dollar policy, and changes to that view, is very important to the currency market.

The European Central Bank (ECB):

The European Central Bank (ECB) is the governing body responsible for determining the monetary policy of the countries participating in the European Member Union

(EMU). The Executive Board of the EMU consists of the President and Vice President of the ECB and four other members. These individuals along with the governors of the national central banks comprise the Governing Council. The ECB is set up so that the Executive Board implements the policies dictated by the Governing Council. New monetary policy decisions are typically made by a majority vote in biweekly meetings, with the President having the casting vote in the event of a tie. The primary objective of the European Central Bank is to maintain price stability. ECB is considered inflation paranoid as it has strong German influence. ECB aand the ESCB are independent institutions from both na-tional governments and other EU institutions, giving them total control over monetary and currency policy. The European central bank is a strict monetarist and much more likely to keep interest rates high. Two edicts of monetary policy are: to keep a harmonized Con-sumer Price Index (CPI) below 2% and an M3 annual growth (Money supply) around 4.5%. Refinance rate is the main weapon used by the

ECB to implement EU monetary policy. ECB watches the fiscal discipline of its members closely. ECB is considered an untested central bank and doubts linger as to how they will react to any future crisis. The ECB keeps close tabs on budget deficits of the individual countries as the Stability and Growth Pact states that they must be kept below 3% of Gross Domestic Production (GDP). The ECB does intervene in the FX markets, especially when inflation is a concern. Comments by members of the Governing Council frequently move the EUR and are widely watched by FX market participants.

Bank of England (BoE):

The Bank of England (BoE) is the central bank of the United King-dom. The bank was founded in 1694, nationalized in 1946, and gained operational independence

in 1997. The BoE is committed to promoting and main-taining a stable and efficient monetary and financial framework as its contribution to a healthy economy. In 1997, parliament passed the Bank of England Act, giv-ing the BoE total independence in setting monetary policy. Prior to 1997, the BoE was essentially a govern-mental organization with very little freedom. Treasurys role in setting monetary policy diminished markedly since 1997. However, the Treasury still sets inflation targets for the B0E, currently defined as 2.5% annual growth in Retail Prices Index (RPI), excluding mort-gages (RPIX). The treasury is also responsible for mak-ing key appointments at the Central Bank. The BoEs nine member Monetary Policy Committee (MPC) is responsible for making decisions on interest rates. Although the MPG has independence in setting interest rates, the legislation provides that in extreme circumstances the government may intervene. The Bank of Englands main policy tool is the minimum lending rate or base rate. Changes to the base rate are usually seen as a clear change in monetary policy. The BoE most frequently affects monetary policy through daily market operations (the buying/selling of government bonds). The BoE is infamous for attempting to influence exchange rates through impure market interventions.

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Swiss National Bank (SNB):

The Swiss National Bank is the central Bank of Switzerland. The Swiss National Bank enjoys 100% autonomy in determining the nations

monetary and exchange rate policies. In December 1999, the SNB shifted from a monetarist approach to an inflation-targeting one (2% annual inflation target). Dis-count rate is the official tool used to announce changes in monetary policy; however, it is rarely used as the bank relies more on the 3-month London Interbank Of-fer Rate (LIBOR) to manipulate monetary policy. The LIBOR is the rate at which major international banks lend to one another; it primarily serves as a benchmark for short-term interest rates. SNB officials often affect the Franc spot movements by making remarks on li-quidity, money supply, and the currency itself. Interven-tion is frequent; however, most often intervention is used to enforce economic policy. It is also used in open market operations, such as raising or lowering interest rates, to affect the value of its currency. As a country where international trade has been the primary source of the countrys economic development, its preference is for a weaker franc, in order for its exports to remain competitive. SNB is highly regarded and the franc is considered by most market participants to be the worlds best managed currency.

The Bank of Japan (BOJ):

The Bank of Japan (BoJ) is the key monetary policymaking body in Japan In 1998 the Japanese government passed laws giving the

BoJ operational independence from the Ministry of Finance (MoF). It was given the complete control over monetary policy. However, despite the governments attempts to decentralize decision-making, the MoF still remains in charge of foreign exchange policy. The MoF is considered the single most important political and monetary institution in Japan. MoF officials frequently make statements regarding the economy, which have notable impacts on the yen. The BoJ is responsible for executing all official Japanese FX transactions at the direction of the MoF. However, it is important to note that the Bank of Japan does possess total autonomy

over monetary policy and can have significant indirect impacts on foreign exchange rates. The BoJs main economic tool is the overnight call rate. The call rate is controlled by the open market operations and any changes to it often signify major changes in monetary policy. Since the introduction of a floating exchange rate system in February 1973, the Japanese economy has experienced large fluctuations in Forex rates, with the yen on a long rising trend. The reason for the yens strength, despite the excessive problems that have plagued the Japanese economy, is the fact that Japan has a trade surplus accounting for 3% of GDP. This is the highest of the G-7 countries and therefore creates a strong inherent demand for the currency for trade purposes, regardless of their economic conditions. The Japanese government is notorious for directly intervening on behalf of the yen through market interventions. BoJ interventions are frequent and violent. As an export-driven country, there are strong political interests in Japan for maintaining a weak yen in order to keep exports competitive. Accordingly, the BoJ has been known to go into the market and sell off the yen when its rate is perceived to be too strong.

Bank of Canada (BoC):

The Bank of Canada (BoC) is the central bank of Canada. The Governing Council of the Bank of Canada is the board that is

responsible for setting monetary policy and is an independent Central bank that has a tight reign on its currency. This council consists of seven members: the Governor and six Deputy Governors. The BoC does not have regular periodic policy setting meetings. Instead, the council meets on a daily basis and may make changes in policy at any time. Due to its tight economic relations with the United States, the Cana-dian dollar has a strong connection to the US dollar.

Corporations

Corporations which comprise a diverse group of small and large corporations, importers/exporters, financial service firms, and consumer service firms, were the major traders in currencies for many years.

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Corporations main interests in foreign exchange are to perform transactions related to cross border payments. Multinational corporations may need to make payments to foreign entities for materials, labor, marketing/advertising costs, and/or distributions, which would require the exchange of currencies. The primary focus of multinational corporations in the marketplace is to offset risk by hedging against currency depreciation, which would affect future payments. Now, however, a minority has begun to use the marketplace as a speculative tool; meaning, they enter the FX market purely to take advantage of expected currency fluctuation. This group of corporations using the FX market for speculative purposes is growing, and as very active participants, they have a great impact on spot market prices. Corporations approach to trading tends to be longer-term since they use the market for covering commercial needs, hedging, and speculations.

Hedge Funds and International

Funds

Global fund managers, hedge, large mutual, pension, and arbitrage funds that invest in foreign securities and other foreign financial instruments are relatively small. Although they may be small when compared to other market participants, they are the most aggressive. These groups can have substantial impacts on spot price movements as they are constantly re-balancing and adjusting their international equity and fixed income portfolios. These portfolio decisions can be influential because they often involve sizable capital transactions. A majority of the hedge funds are highly leveraged and actively seeking to profit in whichever way possible. Despite the highly criticized, sometimes devious nature of hedge funds, they are valued by traders because they often push the markets to retract from extreme levels. Hedge funds are used by high net worth individuals investing a minimum of $1 million. One of the best known Hedge Funds is the George Soros Quantum Group of Funds that made a billion dollar profit by shorting the British pound in 1992. International Funds are non-currency funds consisting of large capital, which exert substantial influence on the FX market. With more and more funds delegated to hedging activities, international funds are becoming a

main driver of international capital and equities trends, which in turn, greatly affects the Forex market.

FX Funds

Funds that invest in the FX are commonly called Global Macro funds. These funds depending on size tend to take different positions in the FX market. Many large funds tend to carry large trade positions, exploiting global interest rate differentials. Others tend to seek out opportunities to take advantage of misguided economic policies or currencies that overshoot their real value; by entering large positions, they are bethng on a return to equilibrium. Others simply gauge global events and take a longer-term view on which currencies will strengthen or weaken in the next six to eight months. Fund participation in the FX market has risen sharply in recent years and its total trading share is now around 20%. There is no doubt that with the increasing amount of money some of these investment vehicles have under management, the size and liquidity of the foreign exchange market is very appealing. While relatively small compared to other market participants, when acting together, they can have a profound effect on the currency spot movements.

Individuals

Retail spot currency trading is the new frontier of the trading world. Up until 1996, foreign exchange trading was only available to large banks, institutions, and extremely high net worth individuals. Prior to online retail FX dealers, individuals could not realistically participate in the FX market from a speculative standpoint. The interbank market operated as a tight circle; it acted somewhat like a specialist, as it manipulated the fates of tiers 2 and 3 to accommodate its own needs. Accordingly, individual traders looking to trade FX could not find a market maker capable of providing competitive spreads, fair quotes, and equitable customer service. With the advancement of technology, the internet, and online trading platforms, retail clients are provided with access to trading that is highly comparable to the offerings of the interbank market. Spreads are slightly wider at 5 pips on most currency pairs, as opposed to

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the interbank standard of 3 pips, but execution is unsurpassed. Now retail clients and multinational institutions can participate in the FX market on a highly equitable playing field. Part VII. International Overview The International Monetary Fund (IMF) is a cooperative organization that 182 countries have voluntarily joined. It exerts an international influence over world monetary issues, including the foreign exchange market. However, it has no effective authority, either by law or implied, over the domestic policies of its members.

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Part VII. FX Regulations

For many years, the retail online foreign exchange industry languished due to the lack of a regulatory environment to uphold investor protection. In December of 2000, however, Congress passed and the President signed the Commodities Modernization Act. The Act finally regulated the foreign exchange industry and placed its oversight under the auspices of the Commodities Futures Trading Commission (www.cftc.gov).

CFTC

The Commodity Futures Trading Commission (CFTC) was created by Congress in 1974 as an independent agency with the mandate to regulate commodity futures and option markets in the United States. The agency protects market participants against manipulation, abusive trade practices, and fraud. Through effective oversight and regulation, the CFTC enables the mar-kets to better serve their important functions in the na-tions economy, providing a mechanism for price recov-ery and a means of offsetting price risk. The CFTC sets forth many of the guidelines that the National Futures Association is required to follow.

NFA

The National Futures Association (NFA) officially began its operations on October 1, 1982, with the goal of maintaining the integrity of the futures marketplace. All companies trading in futures must become NFA members. Those companies that are not registered with the NFA are subject to closure by the CFTC. The passage of the Commodities Modernization Act re-quires that any company trading online forex be regis-tered with the NFA. The NFA has many capital require-ments and makes sure companies maintain high book-keeping and ethical standards in order to be registered. With the passage of the Modernization Act, the NFA required forex market makers to register as Futures Commission Merchants (FCMs).

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Part VIII. Your Role in the FX Market You may not realize it, but you already play a role in the foreign exchange market. Do you have some currency in your pocket or wallet? Do you have a checking or savings account? Do you have a mortgage? Do you run a business? Do you hold stocks, bonds, or other investments with a value expressed in a specific currency? A yes response to any of the above questions already makes you an investor in the currency markets. When you decide to hold assets in the currency of one country, you are investing in that countrys currency and economy. At the same time, you are also electing not to hold the currencies of other nations. For example, when you hold most of your portfolio (stocks, bonds, bank accounts, etc.) in US dollars, you are relying heavily on the integrity and value of the US dollar and economy, including the government that governs it. Concurrently, you are choosing not to hold the Japanese yen, British pound, or the euro. Almost all businessmen, businesswomen, and travelers actively trade currency. If you travel overseas, you would generally exchange your own currency for the currency of the country you are visiting. In view of this, it is not surprising that more and more prudent investors are deciding to diversify their portfolios by holding assets in multiple denominations within the FX market.

Part IX. How Can Forex be Accessed? At the most basic retail level, one can access Forex at any airport currency booth. For a service fee and a mark-up of 5-10%, one can buy or sell currencies. In fact, for many individuals, a trip to the currency exchange booth overseas is their first introduction to Forex. Investors wishing to speculate in the FX market can now access Forex through dealers offering margin accounts as small as $300, with a price spread that is as little as 4-5 pips. High net worth individuals, corporations, or fund managers with private banking relationship should be able to trade through their banks, while corporate clients requiring the actual delivery of currencies would create a credit relationship with a Forex dealer.

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(PAGE 17)

I. What is Trading? 17 (PAGE 17-24)

II. How a Forex Trade Works? 17 What are ISO Codes 17 Currency Pairs 17 How to Calculate which Currency is 18 Increasing or Decreasing in Value EUR/USD 18 USD/JPY 18 Hard and Soft Currencies 20 Chart Reading Basics 20 Trends 20 Lot Sizes and Margin 20 Lot Sizes 20 Margin 20 Risk Management 20 Determining Position Size 21 What is PIP? 21 Calculating Profit/Loss 21 Calculating pip values when the dollar 22 is the counter currency Calculating pip values when the dollar 22 is the base currency Bid/Ask Spread 22 Position Trading 23 100 K Account vs. Mini-Account

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III. Types of Transactions 24 Spot Transactions 24 Outright Forward Transactions 24 Futures Transactions 25 Swap Transactions 25 Option Transactions 25 Settlement and Delivery 26 Volumes & Open Interest 26 Interest Rollover 26 Trader A buying GBP/USD at 1.5755 27 How to Estimate Interest Rollover 27 GBP/USD 27 USD/JPY 27 Triple Rollover on Wednesday 27 (PAGE 28-29)

IV. Types of Orders 28 Market Order 28 Limit Order (Take Profit Order) Stop-Loss Order 28 Entry Order 28 Limit Entry Order 28 Stop Entry Order 29 (PAGE 29)

V. Proper Phone Etiquette 29 (PAGE 30)

VI. Fundamental Analysis 30 Vs. Technical Analysis

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Part I. What is trading? Trading is a unique form of speculation in order to generate profit. It can be a part-time or full time business, a profession or just a lifetime passion. You can trade almost anything from various commodities, stocks, bonds and of course, currencies. Currency trading is not gambling; rather it is a game in which a trader, applying different fundamental or technical analysis, makes a risk-calculated and educated trading decision. Making logical trading decisions and developing a sound and effective trading strategy is an important foundation of trading. Successful trading is often described as optimizing your risk with respect to your reward or upside. Any trading strategy should have a disciplined method of limiting risk while making the most out of favorable market moves. Part II. How a Forex Trade Works? To begin trading in the FX market, you must familiarize yourself with how currencies are handled and traded. Hard and soft currencies are traded in pairs and through ISO codes. There are five different types of transactions and six different ways to execute a trade. Additionally, it is very important to understand some common terms surrounding a trade which include: lot sizes and margin, PIP, bid-ask spread, position trading, settlement-delivery, volume, and open interest.

ISO Codes

Currencies in the FX market are not referred to by their full names; instead, they are identified by standardized codes or ISO Codes, developed by the International Organization for Standardization. ISO abbreviations are used widely on charts and trading platforms, but they are rarely used in conversations among traders. Traders or the media may refer to the currencies by their nicknames during everyday conversations. Throughout our training materials, we interchangeably use the full names, ISO codes, and nicknames of

currencies to help you get accustomed to the trading language. The table below lists the ISO codes and nicknames for the most commonly traded currencies:

Currency Pairs

In the Forex market, currency trading is always done in currency pairs, such as USD/CAD or USD/JPY, reflecting the exchange rate between the two currencies. An exchange rate is merely the ratio of one currency valued against another currency. For instance, the USD/JPY exchange rate specifies how many US dollars are required to buy a Japanese yen, or conversely, how many Japanese yen are needed to purchase a US dollar. In a pair of currencies, the first currency is known as the base (dominant) currency, and the second one is referred to as the counter or quoted (subordinate) currency. In the USD/JPY example, the US dollar is the base currency that we wish to trade, while the Japane-seyen is the counter currency that the exchange rate is quoted in. In simple and practical terms, the currency pair is a structure that can be bought or sold. The base currency acts as the basis for all transactions, regardless if it is buying or selling. When you buy a currency pair, it is implied that you are buying the first (base) currency and selling the second (counter or quoted) currency. Alternatively, a trader sells the currency pair when he/she anticipates that the base currency will depreciate relative to the quoted currency.

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How to Calculate which Currency is

Increasing or Decreasing in Value

Always remember that the simplest way to remember which currency is increasing or decreasing in value is to view rate changes from the perspective of the base currency. If we look at a chart and see an exchange rate increasing, it means that the value of the base currency is appreciating (getting stronger). Conversely, if we look at a chart and see an exchange rate decreasing, it represents that the value of the base currency is depreciating (getting weaker). The diagram below may help you to have a more lucid understanding of this relationship.

The following is a couple of examples to help you grasp these key concepts:

EUR/USD:

In the EUR/USD pair, the euro acts as the base currency while the US dollar acts as the quoted currency. Therefore, the euro (base currency) is the basis for buying and selling in trading. If you anticipate that the stock market will fall and cause the USD to depreciate, you will buy the currency pair. By buying the EUR/USD pair, you are buying euros in anticipation that the euro will appreciate against the USD. If you choose to sell the pair, you are then buying the US dollars, expecting it to climb against the euro.

USD/JPY:

In the USD/JPY pair, the US dollar acts as the base currency while the Japanese yen acts as the quoted currency. Therefore, the dollar (base currency) is the basis for buying and selling in trading. If you think that the Japanese government is going to weaken the yen in order to strengthen their export industry, you would buy the currency pair. By buying the pair, you are buying dollars in anticipation that they will increase in value against the yen. On the other hand, if you believe that Japanese investors are pulling money out of US financial markets and repatriating funds back to Japan, you would sell the pair. By selling the pair, you expect the yen to strengthen against the dollar.

Hard & Soft Currencies

Alongside the US dollar, four major currencies dominate trading in the Forex market by nature of their popularity and activity. According to a recent survey on 300 major traders by Greenwich Associates, the trading volume on the euro, Japanese yen, British pound, and Swiss franc accounts for over 70% of North American activity. According to currency market expert, Cornelius Luca, in his book Trading in the Global Currency Markets, second edition, market share for the five major currencies after the introduction of the euro is estimated at:

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Other tradable currencies include the Canadian, Australian, and New Zealand dollars. Each of these accounts for 3-7% of the total market volume and they are often referred to as minor currencies. Together, the majors and minors constitute all hard currencies that are currently traded in Forex. Soft currencies are currencies such as the Argentine peso, the Russian ruble, the Hong Kong dollar, and the Polish zloty. These are not tradable or recognized outside their country of origin. In the spot FX market, currency pairs can be divided into two categories: dollar-based currency pairs and cross-currency pairs. Dollar-based currency pairs are those that consist of the US dollar and another currency, while cross-currency pairs are those with neither of its currencies being the US dollar. The most actively traded dollar-based currency pairs are the EUR/USD, USD/JPY, GBP/USD, and the USD/CHF. The most actively traded cross-currency pair is the EUR/JPY. Normal daily movement on just these five pairs can be anywhere from 50 pips on a slow day to over 100, 200, even 300 pips on a very active day. (See definition of pips below.)

As mentioned before, currencies are often referred to by their nicknames. Similar to currencies, it is important to familiarize yourself with the common names of the currency pairs. There is a specific trading terminology that is used frequently to describe each currency pair.

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Chart Reading Basics

Charts are used to show the correlation between the value of the base and quoted currencies. The following charts are in the format in which you would see them on an actual computer screen. In these charts, the changing currency is the quoted currency.

Trends

Trend is a term used to describe the persistence of price movements in one direction over a period of time. Trends move in three directions: up, down and sideways. An uptrend signifies the strengthening of the base currency, while a downtrend represents the weakening of the base currency. A sideways trend occurs when markets bounce back and forth between support and resistance levels, the lowest and highest points within a given period, resulting in less significant price movements. It is estimated that 70% of the time, markets will fluctuate randomly or move between support and resistance levels. The rest of the time, market behavior is characterized by persistent price movements trends that break through support and resistance levels. It is highly possible to increase your ability to capitalize on trends by locating trend signals, identifying specific entry points within the trend, and using risk management techniques to limit losses. More information on trends and strategies is discussed in section 4: technical analysis.

Lot Sizes and Margin

The FX market attracts many new traders because currency trading can be conducted on a highly leveraged basis. Every trader should have a thorough

understanding of lot sizes and margin requirements before trading in order to employ proper risk management.

Lot Sizes

In Forex, one million dollars worth of a currency is generally accepted as a minimum round lot and is often referred to as one dollar or one buck. Single orders, in excess of a million dollars, are regularly traded by large institutions and corporations. However, smaller size orders are available to individual FX traders. For example, some dealers offer sizes in half-dollar (.5) and quarter-dollar increments (.25), while others offer sizes of approximately $200,000 USD (.2), $100,000 USD (.1), $50,000 USD (.05), and even $10,000 USD (.01). An advantage of currency trading is that most brokers will allow you to trade 100 times the value of your deposit. Therefore, if you deposit $2,000 into your account, you would be able to trade $200,000 worth of currency units. This is referred to as trading on margin, which is also common with stockbrokers; however, stockbrokers leverage is typically 50% greater than your investment. Hence, if you invest $2,000 with a stockbroker, you would be able to trade with a market value of only $3,000.

Margin

Margin is a monetary deposit that you provide as collateral to cover any losses. All dealers establish their own margin policy based on a percentage of the lot size. Normal margins range from 1% to 5%. For example, if the margin for day trading is 1% (100:1) with a dealer that offers lot sizes of $200,000, you may open a one-lot position with $2,000 in your account. The requirements for margin vary with account size, and may be changed from time to time at the sole discretion of the dealing desk, based on volume traded and market conditions. As the account size and the ability to trade more lots increase, the margin percentage may also increase.

Risk Management

For the purpose of risk management, traders must have position limits. This number is set relative to the money

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in a traders account. Risk is minimized in the spot FX market because the online capabilities of the trading platform will automatically generate a margin call if the required margin amount exceeds the dollar value of the account as a result of trading losses. All open positions will be closed immediately regardless of the size or the nature of positions held within the account. This advanced feature is very beneficial for traders. In the futures market, on the other hand, if the price moves against your position, it may be liquidated at a large loss, making you liable for any resulting deficit in the account.

Determining Position Size

Prior to starting up your trade station, an assessment should be made of the maximum account loss that is likely to occur overtime, per lot. For example, assume you have determined that the worst case scenario is to lose 20 pips on any trade. This translates into approximately $200 per $100,000 position size. Further assume that the $100,000 position size is equal to one lot. Six consecutive losing trades would result in a loss of $1,200 (6 x $200); a difficult period but not an unrealistic one over the long run. This scenario would translate to a 12% loss for an account that has a trading capital of $10,000. Therefore, even though it may be possible to trade 5 lots or more with a $10,000 account, this analysis suggests that the resulting drawdown would be too great - 60% or more of the capital would be wiped out. Traders should have a sense of this maximum loss per lot and determine the amount he/she wishes to trade for a given account size that will yield tolerable drawdown.

What is a PIP?

A pip (price interest percentage) is the smallest increment a price moves and it determines the profit or loss of a trade. It is simply a base point value to the right of the decimal point of the quoted currency that is used to measure changes in exchange rates (the difference between the rates of the currency). A few examples of where the pip is located within the exchange rate are listed below. The one-digit for pip

values is underlined and highlighted in red for each example.

For instance, the US dollar moves from 1.6000 to 1.6004 in the cable/dollar pair, it has moved 4 pips. When you have an open position, each upward or downward pip movement in the market price can be either a profit or a loss, depending on which currency (base or quoted) you bought and which one you sold.

Calculating Profit/Loss

Many Forex retail brokers assign a fixed dollar value per pip that varies according to the lot size and the makeup of each currency pair. For example, the pip value may be $10 per pip on each $100,000 lot of ca-ble/dollar, while only $6.50 per pip on each $100,000 lot of dollar/franc. Other dealers offer a floating pip value that is calculated according to the lot size of each cur-rency pair and the fluctuating exchange rate. For exam-ple, notice how the pip value on a 15,000,000 lot of dollar/yen is calculated based on a one-pip movement from 120.00 to 120.01: The value of a pip is determined by the currency pair and the rate at which the pair is trading. For currency pairs where the dollar is not the base currency (EUR/USD, AUD/USD, NZD/USD, GBP/USD), each pip has a fixed value of $10. For example, if you are trading EUR/USD and the market moves 10 pips in your favor,

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then your profit would be exactly $100. On the other hand, when a currency other the dollar is the counter currency (USD/JPY, USD/CHF USD/CAD) the pip value in dollar terms fluctuates based on prevailing market rates. Although most online trading platforms with reputable brokers offer live Profit/Loss tracking whereby profits and losses are calculated and re-calculated every time the exchange rate changes, it is fundamental for a trader to have an understanding of the value of a pip. The table below gives you an idea of the dollar value attached to each pip:

Calculating pip values when the

dollar is the counter currency

If the current exchange rate for EUR/USD is 1.1460, then one euro is worth 1.1460 US dollars. Consequently, 100,000 euros are worth 114,600 US dollars. If the market price moves one pip to 1.1470, then one euro is now worth 1.1470 US dollars. This is a pretty small change in the value of the euro (one thousandth of a dollar to be exact) but this can be substantial when we are talking about a lot of euros, 100,000 Euros are now worth 114,700 dollars. If a trader had bought 100,000 euros by selling 114,600 dollars when the market price was 1.1460,

then those 100,000 Euros would be worth 114,700 dollars (10 US dollars more) when the market price moves to 1.1470. The trader could choose to close the position out and take this $100 profit. Conversely, lets say the trader initially sold 100,000 euros by buying 114,600 dollars when EUR/USD was trading at 1.1460. If the market price moves to 1.1470 and the traders chooses to close the position, he/she would have to buy back the 100,000 Euros with 114,700 dollars. The loss on the trade would be $100.

Calculating pip values when the

dollar is the base currency

When the USD is the base currency, the value of a pip will fluctuate according to the exchange rate of the currency pair. For example, if the current exchange rate for USD/CAD is 1.3300, then one dollar is worth 1.33 Canadian Dollar; hence, 100,000 dollars are worth 133,000 CAD. If the market price of USD/CAD moves up by one pip to 1.3301, then I dollar will be worth 1.3301 CAD; hence, one lot of 100,000 dollars equal 133,010 CAD. In this particular case, a one pip fluctuation is valued at $10 Canadian Dollar or $7.52 USD when the USD/CAD price is 1.3301. The calculation is simple, since at this time I USD=1.3301, then 10 CAD= 7.52 USD. Simply divide 10 by 1.3301. If a trader closes out a position at a one pip profit when the USD/CAD market price is 1.3301, he/she automatically locks in a 10 CAD profit which is equivalent to $7.52 at that time. At a different market price, however, such as 1.3200, those 10 CAD will have a value of $7.58.

Bid/Ask Spread

All FX quotes include a two-way price, the bid and ask. The bid price is always lower than the ask price. The bid is the price at which a market maker is willing to buy (and traders can sell) the base currency in exchange for

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the counter currency. The ask is the price at which a market maker will sell (and a trader can buy) the base currency in exchange for the counter currency. The difference between the bid and the ask price is referred to as the spread, which can be recovered with a favorable currency movement.

In the above example, the bid price for EUR/USD is 1.1797, which indicates the price at which a trader can sell the currency pair. The ask price is 1.1801, indicating the price at which a trader can buy the currency pair. The difference between the bid and the ask price gives us a 4-pip spread in this example. The 4-pip spread represents the cost of the transaction. It is important to note that since the FX market is a decentralized market, the spreads that a trader receives for a given currency pair will vary according to the market maker one trades with. Generally, there is an average of 4-5 pips on the major currency pairs and 5- 20 pips on the cross currency pairs.

Position Trading

The objective of currency trading is to exchange one currency for another in the anticipation that the market rate or price will change, thus, increasing the value of the currency bought relative to the one sold. In trading language, a long position is one in which a trader buys a new currency at one price and aims to sell it later at a higher price. When a trader buys a currency and the price appreciates in value, the trader must sell the currency back in order to secure the profit. A short position is one in which the trader sells a currency in anticipation that it will depreciate. If a trader sells a currency and the price depreciates in value, the trader must buy the currency back in order to secure the profit. While a long position is to buy and a short position is to sell, an open trade or position is one in which a trader has either bought or sold a currency pair and has not sold or bought back the equivalent amount to effectively close the position.

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Part III. Types of Transactions There are several types of transactions that take place in the FX market. These transactions are Spot, Outright Forward, Futures, Swap, and Option. According to the Bank for International Settlements, market share for these five transactions are estimated at: Spot = 48%, Swap = 39%, Forwards = 7%, Options = 5%, Futures = 1% Spot Transactions This type of transaction accounts for almost half of all FX market transactions. The exchange of two curren-cies at a rate agreed on the date of the contract for de-livery in two business days (except for USD/CAD, which is the next business day).

Outright Forward Transactions One way to deal with the foreign exchange risk is to engage in forward transaction. In this transaction, money does not actually change hands until an agreed upon future date. A buyer and seller agree on an exchange rate for any date in the future and the

l00K Account vs. Mini-Account

You may choose to open a regular (l00K) account or a mini account. As a novice trader, we recommend that you begin trading with a mini-account once you are ready to trade live. As you have developed a disciplined trading system, you may choose to proceed to a regular account. Below is a chart that illustrates the differences between the two accounts.

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transaction occurs on that date, regardless of what the market rates are then. The date can be a few days, months, or years in the future.

Futures Transactions

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. These contracts are traded on a separate exchange set up for that purpose.

Swap Transactions

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. The purpose of a swap transaction is to manage liquidity and currency risk, by executing foreign exchange transactions at the most appropriate moment. For example: selling US dollars for euros value spot and agreeing to reverse the deal at a later date com-monly I day, 1 week, I month, or 3 months. Effectively, the underlying amount in each currency is simultane-ously borrowed or lent the long lent and the short borrowed.

Since currency risk is replaced by interest rate risk, such transactions are conceptually different from spot transactions. They are, however, closely linked because foreign exchange swaps are often initiated to move the delivery date of a foreign currency originating from spot, or outright forward transactions to a more optimal moment in time. It is by using swaps that traders can hold a position without ever being delivered. This

enables customers to trade on a margin basis, and pay margin on a daily basis when the position is marked to the market.

Option Transaction

To address the lack of flexibility in forward transactions, the foreign currency option was developed. An option is similar to a forward transaction. It gives its owner the right to buy or sell a specified amount of foreign currency at a specified price at any time up to a specified expiration date. For a price, a market participant can buy the right, but not the obligation, to buy or sell a currency at a fixed price on or before an agreed upon future date. The agreed upon price is called the strike price. Depending on whichthe option rate or the current market rateis more favorable, the owner may exer-cise the option or let the option lapse, choosing instead to buy/sell currency in the market. This type of transac-tion allows the owner more flexibility than a swap or futures contract. In all of these transactions, market rates might change. However, the buyer and seller are locked into a contract at a fixed price that cannot be affected by any changes in the market rates. These tools allow the market participants to plan more safely, since they know in advance what their FX will cost. It also allows them to avoid an immediate outlay of cash.

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Settlement and Delivery

The Spot market is traded on a two-business day value date. It requires a two-day settlement between the banks as they may be in different time zones (the only exception is the Canadian dollar, where 24 hours is the requirement). For instance, for trades executed on Monday, the value day (day of delivery) is Wednesday.

Volume & Open Interest

Volume consists of the total amount of currency traded within a specific period, usually one day. Of course, traders are more interested in the volume for a specific currency. A high trading volume suggests that there is high interest and liquidity in a market. Also, some chart patterns require heavy volume for successful development. A low trading volume is a warning sign to traders to be extra careful. In a low-volume market, rates can be all over the map and make it harder to get the price one wants. Open interest is the net outstanding position in a specific instrument. It normally represents the difference between the outstanding long (buy) positions and the outstanding short (sell) positions. Volume and open interest are difficult to quantify in most of the foreign exchange markets because about 97% of the markets are decentralized. Volume figures can be calculated in the foreign exchange futures markets because these transactions take place on centralized trading floors, and all trades go through clearinghouses. However, futures transactions (pure futures and options on futures) only account for about 3% of the worlds foreign exchange activity. The other 97% of currency trading takes place in the spot, swap, forwards, and cash options markets, where trading is completely decentralized. Hence, volume is impossible to measure with any precision and can only be roughly extrapolated from futures market data.

Interest Rollover

Interest rollover fees are a function of the interest rates established by the various central banks and federal authorities used to regulate the official policy of the currency. Economies that are growing rapidly may

encounter inflation, in which prices of goods and services are rising rapidly. Along with rapid economic growth and inflation, interest rates may often rise as a result. In turn, raised interest rates increase the cost of the currency and thus, decrease the overall demand for goods and services. The decreased demand will inhibit prices from continuing to rise at an excessive, rapid pace. Conversely, economies facing recessionary periods may require economic stimuli to encourage consumer spending, which in turn expedites economic growth. A cut in interest rates may make money more accessible and cheaper to borrow. The decreased interest rate would enable entrepreneurs to borrow capital with less financial stress. Therefore, a cut in interest rates would ideally revitalize the economy and cease the economic recession or, to a greater extent, depression. Rollover charges are determined by the difference between the interest rates of the two corresponding countries. The greater the interest rate differential between the currency pair, the greater the rollover charge will be. It takes place when the settlement of a trade is rolled forward to the next value date. As mentioned above, trades must be settled in two business days in the FX market. If a trader sells 100,000 euros on Tuesday, the trader must deliver 100,000 euros on Thursday, unless the position is rolled over. Traders that hold a position overnight pay interest on the currency they borrow, and earn interest on the currency they purchase. Typically, interest rollover charges are applied at 5pm (17:00) New York time (9pm GMT; 10pm GMT when New York is operating on daylight savings time from late March to late October) in coordination with the international trading day. For the FX trader, interest rollover charges can have a small impact on their overall profit and loss from exchange rate speculation. To illustrate how interest rollover charges work, consider the following example:

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Trader A buying GBP/USD at 1.5755.

In this case, Trader A is borrowing US dollars, and hence will pay interest on the borrowed funds. Trader A is, however, earning interest on the British pounds that have been purchased. If the Bank of England which regulates the pound offers a higher interest rate than the Federal Reserve which regulates the US dollar the client has an opportunity to earn interest. Alternatively, if the Federal Reserve issues a higher interest rate on the US dollar than the Bank of England offers on the British pound, then the client will experience a net interest payment. Because banks can lend to each other at rates different from what the central bank lends to them, the rollover calculations can never be reduced to an exact science. Like the currency exchange rate, the rollover interest rates are subject to market conditions, and hence can fluctuate as well.

How to Estimate Interest Rollover

Since interest rates raise the cost of the currency it is more expensive to borrow currencies with a high interest rate a central banks interest rate policy can be used to adjust the economy to its respective needs. However, since the interest rollover charge is generally quite small, it should not serve as the core of a trading strategy. The following is a sample calculation of interest rollover: Suppose the Bank of England has an official interest rate of 3.5%, while the Federal Reserve has an official interest rate of 1%. Consequently, a client who is buy-ing GBP/USD will earn interest, since he/she is only paying 1% while earning 3.5%. Because interest rates are quoted on a yearly basis, it is divided down to a daily basis that can be applied for daily interest rollover charges. Although there are 365 days in a year, financial transactions in a year are rounded off to 360 days. For instance, in the United States, 1% of the principal balance for the whole year is divided by 360. The following is the equation to calculate the amount for interest rollover:

(No. of Lots) x (No. of Units per Lot) x (Annual Interest Rate Differential / 360) x (No. of Days)

GBP/USD

Trader A buys 2 contracts of GBP/USD on Thursday and closes them on the next day Contract Value: GBP 100,000 Opening Price: 1.6770 Yearly Interest Rate Differential: GBP 3.5% - USD 1% = 2.5% Calculation: GBP 100,000 x 2 x (2.5%/360) x 1 = 13.88

USD/JPY

Trader A sells 3 lots of USD/JPY on Monday and closes them on the next day Lot Value: USD 100,000 or JPY 12,200,000 Opening Price: 110.00 Yearly Interest Rate Differential: USD 1% - JPY 0% = 1% Calculation: USD 100,000 x 3 (-1%/360) x I = -8.31

Triple Rollover on Wednesday

Since there is a two-day settlement period in foreign exchange, the transactions that are opened on Wednesday at 5 pm which is the Thursday trading day should not get settled until Saturday. Of course, banks are closed during the weekend, so the transaction cannot effectively be settled until Monday (which begins on Sunday at 5 pm New York time). Therefore, for positions opened and held overnight on Wednesday, rollover fee is charged for the following Monday as well, meaning an extra two days of fees for the weekend. As a result, rollover fees are tripled in the FX market on Wednesday. It is important to understand that every transaction has a value day. If the deal is not

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closed on the same day, the trade is subject to rollover charges. Part IV. Types of Orders When placing an order in the FX market, you can choose from the 4 different options available. This includes: market, limit, stop-loss, and entry orders.

Market Order

A market order is an order to buy or sell a currency pair at the current market price. One of the key advantages of trading in a spot market is that market orders are guaranteed when dealing with a reputable broker, as the vast liquidity of the market ensures that there are always buyers and sellers.

Limit Order (Take Profit Order)

A limit order allows a client to specify the rate at which he will take profits and exit the market. Essentially, it defines the amount of profit that the trader is looking to capture on this particular trade. Lets assume a trader has an open position where he is long (meaning he has bought) GBP/USD, he would place a limit order at 1.5900; if the market reached that rate, he would be taken out of the market, and his profit from the trade would immediately be reflected in his balance. Alternatively, a trader could place a limit order to an existing sell position.

Stop-Loss Order

A stop-loss order works like a limit order, but in an opposite fashion: it specifies the maximum loss that a trader is willing to accept on a given position. For example, if a trader is long USD/JPY at 121.50 with a limit at 121.70, he may wish to maximize the loss he is willing to accept by placing a stop-loss order at 121.30. In such a case, if the market reached 121.30, he would be stopped out of the position and would have suffered a loss no greater than 20 pips.

Entry Order

All entry orders are essentially contingent orders: they will only be filled if the market reaches that rate. For example, suppose you are trading USD/JPY, and the

current quote is 120.50 120.55. You can place an entry order to buy at 120.15 so that your order will only be filled if the market reaches 120.15. Ultimately, there are two types of entry orders: limit entry orders and stop orders.

Limit Entry Order

Limit entry orders are classified as entry orders whereby the rate specified is either below the current market rate if it is a buy order, or alternatively, above the market rate if it is a sell order. Limit entry orders are often conducive to strategies pertaining to range-bound markets, whereby clients can place orders to buy at the bottom of the range and sell at the top. Suppose the current market rate to sell EUR/USD is at 1.0800, and to buy is at 1.0804. There are two types of limit entry orders that a trader could place in such a situation: 1. A trader could place an order to sell at a price above the current market rate, for instance, sell at 1.0820. If the sell rate in the spot market reaches 1.0820, the sell order would be activated. In this case, the trader expects that the market will reach 1.0820 and then reverse its direction. 2. A trader can place a limit entry order to buy at a price that is below the current market rate. For instance, a trader could place a limit entry order to buy at 1.0790. His order would only be activated meaning it would only begin to affect his P/L if the buy rate reached 1.0790. The trader is expecting a reversal of the trend after the market reaches the rate he/she specified. In other words, the trader will profit if the market bounces off the 1.0790 level. Since both buy and sell limit entry orders assume the reversal of a trend, they are most commonly used by traders who believe the market is trading within an upper and lower range, and that it will not break out of this range.

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Stop Entry Order

Stop entry orders rely on rationale that is the opposite of limit entry orders. If a trader wishes to buy at a price above the current market rate, or, alternatively, sell at a price below current market price, then he is placing a stop entry order. Stop entry orders are conducive to breakout strategies, whereby the trader believes that if the specified rate is reached, the trends movement is confirmed and thus will continue in that direction. Suppose the current market rate for the USD/JPY is at 117.04; in other words, traders can enter the market to sell at 117.04, and can buy at 117.09. There are two types of stop entry orders that a trader could place in such a situation: 1. The trader could place an order to sell at a price below the current market rate. So, for instance, he could place an order to sell at 116.75; if the sell rate in the spot market reaches 116.75, the sell order would be activated. In this case, the trader expects that the market will reach this level; it will break out and con-tinue in this direction. 2. The trader can place a stop entry order to buy at a price that is above the current market rate. For in-stance, if the trader placed an order to buy at 117.85, his order would only be activated meaning it would only begin to affect his PIL if the buy rate reached 117.85. In this example, the trader is expecting a break-out if the market reaches the rate he/she specified. In other words, the trade will break through the 117.09 level. Since both buy and sell stop entry orders assume a breakout, they are most commonly used by traders who believe the market will make a big move.

Part V. Proper Phone Etiquette Although most trades are placed online, traders always have the option of calling the dealing desk to place an order. It is important for spot traders to get their point across quickly and accurately, leaving no room for interpretation or error. Lets take a look at a typical spot trade: Please give me a price on USD/JPY (or USD/CHF, or EUR/USD, or GBP/USD) for (the number of lots you want to trade) lot(s). Example: Trader says, Please give me a price on USD/JPY for 3 lots. The dealer will respond with a 2-way price quote. For example, he may quote USD/JPY at: 125.10-125.15 (but he will probably just say 125.10-1 5). Dealer replies, 125.10-15. So you can either buy USD/JPY at 125.15, or you may sell USD/JPY at 125.10. To buy USD/JPY you can say any of the following: 15, I buy, I buy at 15, mine, or mine at 15. To sell USD/JPY, you can say any of the following: 10, I sell, I sell at 10, yours, or yours at 10. Trader states, I buy at 15. You would normally have 3-5 seconds to respond (sometimes more, sometimes less) prior to a price change, depending on market volatility. If no response is given and the price changes, the dealer will say change, price

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