Trading
Foreign Exchange ...
by: (Wayne Fowler)
Foreign Exchange
trading is essentially about exchanging one currency for another at
an agreed time and agreed rate of exchange. Varied participants for
many different reasons trade billions of dollars globally each day
around the world. It trades 24 hours a day and is by far the most
liquid and volatile market to trade.
There are broking houses
today that allow the small investor to trade the foreign exchange
market on a margin basis to maximize profitability. This is becoming
very popular but lack of education and understanding has limited
investors from getting involved in this exciting and rewarding market.
Before trading, an understanding
of the basics of the wholesale foreign exchange market is essential.
Firstly foreign exchange is a self-governing market with little
regulation. Central banks offer some control as far as licenses
and bank exposures are concerned but no one body governs the market.
All trades transacted
initially settle two business days forward, this is known as the
spot date. Whenever you see prices quoted it is naturally assumed
it will settle on the spot date. This is not to say it that it cannot
be changed as most transactions settle on future dates, which are
known as forward deals. We can do this by making adjustments to
the initial agreed exchange rate where consideration to time and
the interest rate differentials of the two currencies involved.
An example of a spot trade
rolled out to a forward date would be a car importer who has a contract
to buy YEN 90,000,000 worth of cars settling in six months time.
The risk is that the yen gets stronger over that time resulting
in them paying more for the cars. What they can do to limit the
risk is to lock in today's price on the exchange rate and roll the
spot deal out six months time when the commercial deal is set to
take place. There will be an adjustment on the exchange rate made
to factor in the borrowing costs for the six monthly period but
at least the exchange rate is set and the importer knows exactly
how much the deal will cost in six months time.
The main participants
trading foreign exchange consists of importers, exporters, fund
managers, Investment banks, central banks, and other government
agencies.
Exporters
- this group usually has a positive affect on their home currency
as they are selling goods overseas receiving foreign currency. They
then sell that foreign currency converting it to their home currency
to bring the money back on shore.
Importers
- this group usually has a negative affect on their home currency
as they sell their home currency to purchase goods overseas.
Local Fund Managers
- they invest people's retirement funds investing all round the
world. Their affect on their home currency depends on their investment
decisions but generally speaking are negative to the home currency.
Global Fund Managers
- their impact changes depending upon their investing decisions.
During periods where a country's stocks and bond markets look attractive
they have a positive impact but as things change, they may become
sellers and have a substantial negative impact.
Central Banks
- smooth over large fluctuations that are deemed to be negative
to the economy. They are also involved in some government commercial
transactions.
Other Government
Agencies - many government agencies can be involved in
large commercial transactions affecting the exchange rate.
The core of the foreign
exchange market and where most liquidity is provided is called the
interbank market. It is an arrangement between banks who agree to
always make each other a dealing spread on set amounts, usually
5 or 10 mio and usually receive a 5 point spread in normal market
conditions.
This allows banks to clear
large amounts of money quickly and easily. For example a bank has
AUD100 mio to sell so they call up 10 banks asking for prices in
lots of 10 mio each. This can be very exciting to watch and not
for the faint hearted.
Margin foreign exchange
works by placing an initial deposit, usually $10,000 and then maintaining
at least 5% deposit of the position you wish to take. For example,
a $200,000 aud position will require a deposit of $10,000. A small
brokerage fee or points taken at the time of dealing will be your
only costs.
An indication of the trading
potential in foreign exchange would be a Euro 200,000 position would
gain you Aud 3,150 every time the eurusd moved 100 pts. Not bad
for an investment of $10,000 as the euro moves at least 100 pts
on average 3 out of 5 trading days and has a strong correlation
with the Dow Jones Index.
Trading foreign exchange
on margin can be very exciting and rewarding provided you stick
to usual trading disciplines by "planning your trade" and then "trading
your plan." Stop loss orders placed on every position are essential
as currency markets can be very volatile, and like profits, the
losses can also be large.
When searching for a margin
foreign exchange broker always ensure they are well experienced
and have traded the markets for themselves, preferably with a large
bank as correctly deciphering market information, discipline and
guidance are all essential.
Written by Wayne Fowler,
Margin FX dealer at Tricom Securities.
