Some of the notable quotes:
Major currencies, economies and central banks 19
The movement of money between countries and currencies to take advantage of these interest-rate differentials is a major contributor to both the volume and volatility of currency trades. The process of buying a high-yield currency (one with a high interest rate) and selling a currency with a low yield (one with a low interest rate) is referred to as a carry trade. (p.g. 14)
As a result of its imposed status as the default reserve currency under Bretton Woods, many smaller nations still use the US dollar as their official currency. This process is referred to as official dollarisation. Some countries that use the US dollar include Panama, Bermuda and the Bahamas, where the US dollar is accepted as legal tender along with the local currency at a 1:1 exchange rate. (p.g. 20)
Other countries link their currency to the US dollar at a fixed exchange rate, known as a linked exchange rate system. Some examples include Barbados where the local Barbados dollar is convertible to US dollars at a 2:1 ratio... (p.g. 20)
Movements in the Canadian dollar exchange rate tend to be correlated to the price of crude oil and energy prices, rising and falling in line with movements in the price of these energy commodities. It is often referred to as a petro-currency because of this close correlation. (p.g. 36)
Monetary policy is referred to as being either expansionary or contractionary. Expansionary monetary policy rapidly increases the supply of money in the economy and is used to encourage employment and economic growth by lowering interest rates. Contractionary policy is used to control rising inflation or combat inflationary pressures by decreasing, or slowly increasing, the money supply by raising interest rates. (p.g. 39)
Monetary policies exist and can be implemented by central banks because all the reserve currencies are fiat money. Fiat money has no intrinsic value, as it is not legally convertible to anything, nor is it fixed to any standard value. It can be created from nothing at any time by the simple act of printing more money. (p.g. 39)
Repurchase agreements (p.g. 42)
Repurchase agreements (also known as repos or sale and purchase agreements) are transactions in government securities. The purchase of a security comes with an agreement by the seller to buy it back at a specified future date and at a price greater than the sale price. The difference is effectively an interest payment, and it is referred to as the repo rate. As the seller of the repo is effectively a borrower, and the buyer is a lender, a repo is a cash transaction combined with a forward contract.
When transacted by a central bank, the purchase of repos adds temporary or short-term reserves to the banking system; and then the reserves are withdrawn when the repo is recalled.
The purchase of repos by the country's central bank generally results in a reduction in the value of the currency on foreign exchange markets.
The foreign exchange markets and major participants 53
The forward outright rate is determined by adjusting the current spot rate by the discount or premium points. (p.g. 59)
When trading the AUD/USD as a forward outright, for example, the four variables that can determine if the trader makes a profit or a loss are changes in Australian interest rates, changes in US interest rates, movements in the AUD/USD spot rate, and changes in the AUD/USD forward rate. (p.g. 59)
Non-deliverable forwards (p.g. 60-1)
A non-deliverable forward (NDF) is a short-term, cash-settled currency transaction between two counter-parties.
NDF is similar to a forward outright, except that no physical delivery of the principal or notional amount takes place. On the contract settlement date only the difference between the forward agreed rate and the prevailing spot rate is exchanged as either a profit or a loss in cash. Because NDFs are non-cash, off-balance sheet transactions where the principal sums do not actually change hands, they offer much lower counterparty risk than forward outrights.
The following formula is used to set the price for a contract for a given currency pair: (p.g. 66)
F = S (1 + RQ x t) / (1 + RB x T)
Where:
F = the price for the currency futures contract
S = the spot rate for the currency pair
RQ = the interest rate of the quote currency
RB = the interest rate of the base currency
T = the tenor, or time to maturity (in days)
How the decentralised spot forex market work (p.g. 69)
Retail forex dealers and market makers 75
Market maker (p.g. 77)
A market maker is an organisation that continuously quotes buy and sell prices in the market and is always willing and able to deal at these quoted prices.
This market-making role ensures there is always a price to trade at, and it provides continuous liquidity for the market.
Market making also effectively creates the market, as the inter-bank dealers buy and sell among themselves in order to profit from these slight variations in price.
Banks will also be holding varying amounts, or inventory positions, of different currencies depending on their own needs and the requirements of their clients.
Typically, market makers do not charge commissions or add an advertised mark-up to the prices quoted on their platforms because they are profiting from their client's activities in other ways: (p.g. 81)
Match buyers and sellers internally. The market maker may simply match a buy order for a currency from one client with a sell order for the same currency from another client.
The mechanics of trading forex 95
Currency pairs (p.g. 98-9)
The most actively traded currency pairs are referred to as the majors and generally involve the US dollar on one side of the deal.
Any currency pair that does not involve the US dollar is referred to as a cross currency pair, cross rate or cross.
Cross rates are derived from the respective uS dollar-related pairs but are quoted independently. The EUR/JPY cross rate, for example, is derived from the EUR/USD exchange rate and the USD/JPY exchange rate.
Long or short? (p.g. 100)
If you buy the currency pair - that is, buy the base currency and sell the quote currency - you want the base currency to rise in value so you can then sell it at a higher price and make a profit.
If you short sell the currency pair - that is, sell the base currency and buy the quote currency - you want the base currency to fall in value so you can then buy it back at a lower price and make a profit.
Pip (p.g. 103)
A standard lot is 100,000 units of the base currency
A mini lot is 10,000 units of the base currency
A micro lot is 1,000 units of the base currency
How to place a forex trade 121
Rollover (p.g. 128-9)
Rollover is a way of extending the settlement date of an open spot forex position.
If you hold a spot forex position overnight - that is, the position is rolled over - then you may pay or receive what is called the rollover fee.
Every currency trade involves borrowing one currency to buy another, so when you roll over an open position, rollover charges come into play.
For example, if you buy the AUD/USD, and the inter-bank interest rates are higher in Australia than in the US, then you may receive a rollover fee (interest may be credited to your account). On the other hand, if the interest rates are higher in the US, then you may have to pay a rollover fee.
Currency futures 133
Price quotes (p.g. 134)
European-style quotes express the amount of currency that can be exchanged for US$1. The US dollar is quoted first and is the base currency. European-style quotes for forex pairs are only used in spot forex.
American-style quotes express the amount of US dollars needed for one unit of the foreign currency. The US dollar is quoted second and is the quote or counter currency. American-style quotes are always quoted in US dollars and cents.
Just as with spot forex, the exchange rate in currency futures is the price of the base currency in terms of, or relative to the quote currency. If, for example, the EUR/USD pair is quoted at 1.3695, this means that 1 euro can buy 1.3695 US dollars, or that it takes 1.3695 US dollars to buy 1 euro.
This clearing operation assumes the role of a third party to every transaction in a matching process called novation. (p.g. 139)
Bid/ask spread (p.g. 146)
The bid or buy price is always displayed on the left-hand side, and the ask or sell price is always displayed on the right-hand side. The ask price is also called the offer price.
The bid price is the price that the buyer is willing to pay to buy the base currency, and represents the price at which you can sell.
The ask or offer price is the price that the seller is willing to sell the base currency, and represents the price at which you can buy.
The difference between the bid and the ask prices is referred to as the spread.
This initial margin is also referred to as a security deposit or performance bond. It is essentially a good faith deposit that indicates you are willing and able to meet your obligations under the terms of the contract. (p.g. 148)
In addition to the initial margin required at the outset of a trade, a second margin called variation or maintenance margin is also required. Maintenance margin is part of the initial margin that must be maintained in cash in the traders account while a trade remains open. it is generally a smaller amount that the initial margin. (p.g. 150)
As the price of the contract rises and falls, all open positions are re-valued at the end of each trading day in a process known as mark-to-market. If you have an open position that is in profit, the clearing house will credit your account. If you have an open position that is in loss, your trading account will be debited to maintain the margin requirement. (p.g. 150)
Macro economics and how it affects forex 159
Purchasing power parity theory (p.g. 161)
PPP theory is based on the notion that the price of a product in one country should be equal to the price of the same product in another country when converted to a common currency.
PPP is calculated using this formula:
S = P1 / P2
Where
S is the exchange rate of currency 1 to currency 2
P1 is the cost of the product in currency 1
P2 is the cost of the same product in currency 2
Balance of payment theory (p.g. 162)
BOP is a measure of the payment that flow in and out of a country.
The current account measures trade in goods and services, such as raw material exports and manufactured goods imports. The difference between imports and exports is referred to as the trade balance or the balance of trade.
The capital account measures flows of money for financial transactions and investment
Economic releases can provide information on an event that has already happened based on past data (called a lagging indicator), an anticipated event in the future based on past data (called a leading indicator); or an event that is curretly occurring based on current data and information (called a coincident indicator). (p.g. 165)
Economic indicators (p.g 165-6)
Nine of the most widely watched and monitored economic indicators that have ramifications for forex traders are discussed here: gross domestic product (GDP), balance of trade, industrial production, durable goods orders, construction indicators, retail sales, the consumer confidence index, the Institute for Supply Management index and the Conference Board Leading Economic Index.
Institute for Supply Management Index (p.g. 172)
The ISM Index is a monthly index that measures the activity of 300 nationwide purchasing managers in the manufacturing and industrial sectors.
Index values above 50 indicate expansion within the sector and the overall economy over the previous month, while values under 50 indicate a contracting economy.
Consumer price index (p.g. 174)
A CPI is a measure of the average price of consumer goods and services purchased by households within an economy. It measures the average change in prices paid for a constant basket of goods and services from one period to the next within the same area.
Economists and other market analysts tend to focus on the CPI-U figures in the united States. The CI-U figure, or the core inflation rise, excludes food and energy components form the measurement as these ted to be the most volatile and seasonal prices.
Employment Cost Index
The ECI is a quarterly report that details changes in the cost of labour in the US. It is both an inflation and an employment indicator as it measures whether the cost of employment is rising or falling, thus measuring wage inflation. (p.g. 178)
Money management for forex 193
If you start out with $10,000 and lose $6,000 through poor or no money management, you have lost 60 per cent of your account. In order for you to return your account to the $10,000 you started out with you need to make a 150 per cent return on the $4,000 left in your account. Put another way, you will have to be two and a half times more successful in you r attempts to make back your losses than you were when you made the losses initially. (p.g. 197)
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