Main Players In Forex

Central Banks And Governments

Policies that are implemented by governments and central banks can play a major roll in the FX market. Central banks can play an important part in controlling the country's money supply to insure financial stability.

Banks

A large part of FX turnover is from banks. Large banks can literally trade billions of dollars daily. This can take the form of a service to their customers or they themselves speculate on the FX market.

Hedge Funds

As we know the FX market can be extremely liquid which is why it can be desirable to trade. Hedge Funds have increasingly allocated portions of their portfolios to speculate on the FX market. Another advantage Hedge Funds can utilize is a much higher degree of leverage than would typically be found in the equity markets.

Corporate Businesses

The FX market mainstay is that of international trade. Many companies have to import or exports goods to different countries all around the world. Payment for these goods and services may be made and received in different currencies. Many billions of dollars are exchanges daily to facilitate trade. The timing of those transactions can dramatically affect a company's balance sheet.

The Man In The Street

Although you may not think it, the man in the street also plays a part in toady's FX world. Every time he goes on holiday overseas he normally need to purchase that country's currency and again change it back into his own currency once he returns. Unwittingly he is in fact trading currencies.

He may also purchase goods and services whilst overseas and his credit card company has to convert those sales back into his base currency in order to charge him.

Speculators And Investors

We shall differentiate speculator from investors here with the definition that an investor has a much longer time horizon in which he expects his investment to yield a profit. Regardless of the difference both speculators and investors will approach the FX market to exploit the movement in currency pairs.

They both will have their reason for believing a particular currency will perform better or worse as the case may be and will buy or sell accordingly. They may decide that the Euro will appreciate against the US Dollar and take what is called a long position in Euro. If the Euro does in fact gain ground against the US Dollar they will have made a profit.

Forex Statements

Before we move on to account statements I just want to touch on segregation of funds. In times past there was a danger that traders who deposited money with their broker who did not segregate their clients money from their own companies money were at some risk.

The problem arose if the broker misused the deposited funds to either reinvest or otherwise manipulated these deposits to enhance their own standing. There were also instances were the broker became insolvent and many complications ensued as to what was the clients money and what was the broker's money.

With the advent of regulation most broker now segregate their clients funds from the brokerage funds. Deposits are normally held with banks or other large financial institution that are also regulated and bonded or insured. This protects you money should anything happen to your broker.

The deposit taking institution is normally aware that these deposits are client's funds. Depending on regulation in the particular country you live, each client may have their own segregated account or for smaller depositors they may be pooled. The point is that segregation of funds is a safeguard. Ask your broker if your funds are segregated and who actually has your money.

Just as with a bank you are entitled to interest on the money you have on deposit. Some broker may stipulate that interest is only payable on accounts over a certain amount but the trend today is that you will earn interest on any amount you have that is not being used to cover your margin.
Your broker is probably not the most competitive place to earn interest but that should not be the point of having your money with him in the first place. Payment on your account that is not being used and segregation of funds all go to show the reputability of the company you are dealing with.

In this section I will discuss briefly the basic account statement. I have to keep this basic, as there are as many flavors of account statements as you can imagine.

Just about every broker has their own way of presenting this. The most important thing is to know where you stand at the end of each day or week. Just because your broker is Internet based and has all the bells and whistles does not mean they are infallible.

Many of the actions taken before information is imputed are still done by hand and if humans are involved there will be a mistake at some point. The responsibility lies with you. It is your money so make sure that all the transactions are correct.

FX Some Company

New York

Statement for: Mr. Joe BloggsStatement Date: 16th July 2002

Account No: 123456

Summary Of All Trades From: 15/07/02-17/07/02

Ticket No	Time	Trade Date	Value Date	B/S	Symbol	Quantity	Rate	Debit	Credit	Balance
123458	09:05	15/07/2002	17/07/02	B	EUR/USD	100,000	0.9850			$10,000
123459	13:01	15/07/2002	17/07/02	S	EUR/USD	100,000	0.9870		$200.00	$10,200
123460	14:05	16/07/2002	18/07/02	S	USD/JPY	100,000	116.85			$10,200

Total Equity	$10,200
Margin Available	$9,200
Margin Requirements	$1,000
Current Position	Short USD/JPY

Normally there is a ticket or docket number to help identify the trade. You will nearly always find the time and date of the trade. The value date if the currency were to be delivered. You should always see the direction of the trade, buy or sell (Long or Short). The amount and rate you bought or sold. Balance to let you know if you made a profit or a loss.

You should also see any open positions you may have and the margin requirements for that position. A lot of the more modern systems will show your open position as though it has been closed just to give you an up to the minute balance.

Accounts In Forex

Although the movement today is towards all transaction eventually finishing in a profit and loss in US Dollars it is important to realize that your profit or loss may not actually be in US Dollars.

From my observation the trend is more pronounced in the US as you would expect. Most US based traders assume they will see their balance at the end of each day in US Dollars. I have even spoken with some traders who are oblivious to the fact the their profit might have actually been in Japanese Yen.

Let me explain a little more. You sell (go short) USD/JPY and as such are short USD and Long (bought) JPY. You enter the trade at 116.10 and exit 116.90. You in fact made 80,000 Japanese Yen (1 lot traded) not US Dollars.

If you traded all four major currencies against the US Dollar you would in fact have made or lose in EUR, GPY, JPY and CHF. This might give you a ledger balance at the end of the day or month with four different currencies.

This is common in London. They will stay in that currency until you instruct the broker to exchange the currencies into your own base currency.

This actually happened to me. After dealing with mainly US based brokers it had never occurred to me that my statement would be in anything other than US Dollars.

This can work for you or against you depending on the rate of exchange when you change back into your home currency. Once I knew the convention I simply instructed the broker to change my profit or loss into US Dollars when I closed my position. It is worth checking how your broker approaches this and simply ask them how they handle it. A small point, but worth noting.

Nowadays most countries have regulated forex, but it is still worth checking that the broker who you are dealing with is regulated in the country that it operates, insured or bonded and has some kind of track recorded.

I cannot advise you on which broker you should use as there are just to many variables to each person, but as a rule of thumb, nearly all countries have some kind of regulatory authority who will be able to advise you. Most of the regulatory authorities will have a list of brokers that fall within their jurisdiction and will give you that list. They probably wont tell whom to use but at least if the list came from them you can have some confidence in those companies.

Once you have a list, give a few of them a call, see who you feel comfortable with, ask for them to send you their polices and procedures. If you live near where your broker is based, go spend the day with him. I have been to many brokerages just to check them out. It will give you a chance to see their operation and meet their team.

This brings up another interesting point. When you open an account with a broker you will have to fill in some forms basically stating your acceptance of their polices. This can range from a 1 page document to something resembling a book. Take the time to read through these documents and make a list of things you don't understand or want explained.

Most reputable companies will be happy to spend some time with you on this. Your involvement with your broker is largely up to you. As a forex trader you will probably spend long hours staring at the screen without talking to anyone. You may be the sort of person who likes this or you may be the sort of person who likes to chat with the dealer in the trading room. You will normally get a call once a week or once a month from someone in the brokerage asking if everything is OK.

A brief tutorial in Forex

Tutorial by Trendways

Foreign exchange rates

A foreign exchange rate is the parity between two currencies i.e. the amount of one currency needed to sell (or buy) in order to buy (or sell) one unit of the other currency. There are two ways to express such a rate. The most common (or international way) quotes the amount of any currency that corresponds to one U.S.Dollar. So when we see USD/DEM at 1.5000 this means that one dollar can be exchanged for 1.5 Dmarks. Among the major currencies it is only British sterling which is quoted the other way i.e. GBP/USD at 1.5500 means that one pound is exchanged for 1.55 dollars. The American way of quoting rates uses the opposite direction, that is it expresses the dollar amount that can be exchanged for one unit of foreign currency. So when we see for example the Dmark at 0.6625 this means that one mark can be exchanged for 0.6625 dollars (or the same at 66 1/4 cents). The term «cross rate» is usually used to express the parity between two nondollar currencies like DEM/SFR.

Bid and offer

Exchange rates in practice are quoted as two-way rates. Thus a dollar/mark quotation will read something like 1.5000/10. The bank or company which quotes this rate understands that it buys marks (selling dollars) at 1.5010 and sells marks (buying dollars at 1.5000). In other words it buys cheaper and sells dearer a given currency in exchange for the other one. Of course, the opposite is true for the person that asks for a quotation. The difference between the purchase and the sale rates is called «spread». Such spreads vary in size according to market volatility.

Rate direction and currency direction

One needs to keep very clear in mind the idea of market direction. First of all, in the foreign extern market it is a mistake to say that the market is going up or down. In the stock market one can use this expression as stocks either go up or go down. However, in the FX market a rate as we said defines the parity of two currencies, hence at any time one goes up , so the other goes down. Therefore we can talk about the dollar going up or down but not about the market doing so. Another issue that often confuses people (even traders and bankers) is the difference between a currency moving up and its rate going up. We have to explain this in more detail as any misunderstanding can lead to painful surprises when trading in the real market. For simplicity reasons let us forget for the time being the bid/offer spread. So let us suppose that dollar/mark moves from 1.5000 to 1.5010. In this case the rate goes up whereas the value of the mark goes down (simply because the value of the dollar goes up). In other words one needs more marks at 1.5010 to exchange for one dollar.

Basis points or pips

A foreign exchange rate usually consists of an integer part and 4 decimal points (or 2 decimal points when expressed per 100 units like e.g. dollar/yen). Thus the decimals are expressed either at 10th thousands or hundreds. Each such 0.0001 or 0.01 is called basis point or pip. E.g. a 50 pips change of 1.5000 is either 1.5050 or 1.4950.

Spot and forward rates

To some people these concepts are more easily understood as cash rates and futures. As a matter of fact we would not like to use the term «futures» here as this may lead to confusion with the typical futures contracts. Instead, let us use a more descriptive approach. A spot rate is the exchange rate which is valid for a transaction (purchase of currency A and sale of currency B) that must be concluded within the next two working days. Thus the value date (i.e. the day of actual delivery of currencies) of a transaction performed on a Monday is Wednesday. For Thursday it is Monday (weekend days are not counted). On the other hand, a forward transaction regards a deal which is concluded today and actual effect will take place on a fixed future date In the next paragraph we describe the relationship between a spot and a forward rate.

Interest rates, swap rates and forward rates

Many people, even in the financial sector think that a forward rate is an expectation or forecast of a future foreign exchange movement. This is a big mistake. Actually, a forward rate is nothing else but a mirror of the currently prevailing spot rate, allowing for the interest rate differential between the two currencies and the time period at the expiration of which the actual transaction will be concluded. So the spot rate is adjusted by the so called swap rate to give the forward rate. For the unsophisticated investor it is enough to say that the swap rate is there to compensate the low interest currency holder for the time period involved in a forward transaction. The best way to explain these strange sounding terms is an example. We shall keep the simplistic approach and will not get involved here with FX rate spreads and interes rate spreads. Suppose person X buys $ 100,000 against Dmarks from bank B at spot rate 1.5000 for value 30 days forward. Furthermore let us assume that the dollar interest rate for this period is 5% and for the mark 3%. This means that during these 30 days A will earn interest on the marks he keeps until delivery and B will earn interest on the dollars for the same reason. The forward rate must allow for the compensation of A so that on balance no party is better or worse off. Investor A will receive interest in marks= (150,000x3x30)/36,000 = 375. On the other hand bank B will receive interest in dollars = (100,000x5x30)/36,000 = 416.67. This dollar amount calculated by prevailing spot rate 1.5000 is equivalent to 625 marks. It is evident that bank B has to compensate investor A through the forward rate, i.e. A will pay a lower price for the dollars he is buying forward to equalise the difference of 250 marks. Through a formula we can reach the swap rate 0.0025 This is subtracted from 1.5000 and the forward rate 1.4975 prevails. Indeed, the investor will finally deliver 149,750 marks to receive 100,000 dollars.

The need for a forward market

The actual need for the existence of a foreign market is not speculation, although as we explain in another article (see Why get involved in the foreign exchange market) today there is no clear-cut line between hedging and speculating. However, there are a couple of characteristic categories of people who use the forward market in order to cover for time lags. The first group includes exporters and importers. As receipts and payments do not usually coincide timewise, these people buy forward the currency that they will have to pay and sell forward the currency that they will receive. In this way they overcome undesirable market fluctuations and take care of future cash flows. The second group consists of people who use the forward market to preserve the value and nature of their assets without speculating against future trends. These operators use both the spot and forward market through swaps, which are explained below.

Swaps

A swap transaction (not to be confused with the swap rate) is a double-leg deal, in which one buys spot currency X selling currency Y and simultaneously sells forward currency X buying currency Y. Let us give an example to show the rational of such a transaction. Assume that an American investor has a future receipt in Dmarks. In addition, assume that he thinks that German bonds are presently a good investment. So he has dollar assets but does not hold cash in marks. In plain words he needs marks right now and cannot wait for the future receipt marks to come. One solution would be to sell dollars and buy marks in the spot market. However, suppose he does not wish in a foreign exchange adventure for he cannot forecast the exchange value of the future receipt. In this case he sells dollars against marks spot getting his marks and buying his bonds. Simultaneously he buys dollars forward against marks matching the value date of the receipt. Upon expiration of the forward period, the investor cashes the receipt, pays back the marks that he owes and gets his original dollars. Hence he has been able to overcome the time lag problem.

FX market and Money market

The last issue to be discussed in this brief walk is the non-difference between two markets that are the flip side of each other. We have already mentioned earlier that a swap rate is basically based on interest rate differentials. We have also explained in the previous paragraph the nature of a swap transaction. The investor who uses marks bought in the forward market to buy German bonds has another option. He can place his dollars on deposit and borrow from the bank the marks he needs.Hence, he will have a dollar deposit and a mark loan. Indeed, the interest between what he gets and what he pays is also expressed through the swap rate Therefore, both ways lead to the same result. The only advantage going though the foreign exchange market rather than through the money market is simplicity i.e. usually it is faster and easier to obtain an FX facility rather than obtaining a loan, even one based on a collaterilised deposit.