FOREIGN

EXCHANGE MARKET

FOREIGN EXCHANGE MARKET.

Foreign exchange market is a market where foreign currencies are bought & sold.
Foreign exchange market is a system facilitating mechanism through which one
countrys currency can be exchanged for the currencies of another country.
The purpose of foreign exchange market is to permit transfers of purchasing power
denominated in one currency to another i.e. to trade one currency for another.

Introduction
The project covers various trading areas of forex market such as, spot market, forward
market, derivatives, currency futures, currency swaps etc. It helps in understanding
various trend patterns and trend lines. What considerations are kept in mind while
trading in forex market and why one should enter such market is studied under this
project.
Another part of this project covers Risk Management in general as well as in
forex market. Risk Management is the process of measuring, or assessing risk and
then developing strategies to manage the risk. In general, the strategies employed
include transferring the risk to another party, avoiding the risk, reducing the negative
effect of the risk, and accepting some or all of the consequences of a particular risk.
A person has to face risk whether hes in business or is entering the forex market.So,
he uses various strategies and methods to overcome that risk.
The data used in this project has been collected from websites based on related topics
and various books of forex market and risk management. The information displayed
may be limited,as each and every aspect related with the project that is provided by the
avilable sources might not be complete in all respects.

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HISTORY
Initially, the value of goods was expressed in terms of other goods, i.e. an economy
based on barter between individual market participants. The obvious limitations of
such a system encouraged establishing more generally accepted means of exchange at
a fairly early stage in history, to set a common benchmark of value. In different
economies, everything from teeth to feathers to pretty stones has served this purpose,
but soon metals, in particular gold and silver, established themselves as an accepted
means of payment as well as a reliable storage of value.
Originally, coins were simply minted from the preferred metal, but in stable political
regimes the introduction of a paper form of governmental IOUs gained acceptance
during the Middle Ages. Such IOUs, often introduced more successfully through force
than persuasion were the basis of modern currencies.
Before the First World War, most central banks supported their currencies with
convertibility to gold. Although paper money could always be exchanged for gold, in
reality this did not occur often, fostering the sometimes disastrous notion that there
was not necessarily a need for full cover in the central reserves of the government.
At times, the ballooning supply of paper money without gold cover led to devastating
inflation and resulting political instability. To protect local national interests, foreign
exchange controls were increasingly introduced to prevent market forces from
punishing monetary irresponsibility.
In the latter stages of the Second World War, the Bretton Woods agreement was
reached on the initiative of the USA in July 1944. The Bretton Woods Conference
rejected John Maynard Keynes suggestion for a new world reserve currency in favour
of a system built on the US dollar. Other international institutions such as the IMF, the
World Bank and GATT were created in the same period as the emerging victors of
WW2 searched for a way to avoid the destabilising monetary crises which led to the
war.

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The Bretton Woods agreement resulted in a system of fixed exchange rates that partly
reinstated the gold standard, fixing the US dollar at USD35/oz and fixing the other
main currencies to the dollar - and was intended to be permanent.
The Bretton Woods system came under increasing pressure as national economies
moved in different directions during the sixties. A number of realignments kept the
system alive for a long time, but eventually Bretton Woods collapsed in the early
seventies following president Nixon's suspension of the gold convertibility in August
1971. The dollar was no longer suitable as the sole international currency at a time
when it was under severe pressure from increasing US budget and trade deficits.
But the idea of fixed exchange rates has by no means died. The EEC introduced a new
system of fixed exchange rates in 1979, the European Monetary System. This attempt
to fix exchange rates met with near extinction in 1992-93, when pent-up economic
pressures forced devaluations of a number of weak European currencies. Nevertheless,
the quest for currency stability has continued in Europe with the renewed attempt to
not only fix currencies but actually replace many of them with the Euro back in 2001.
This project is fairly advanced now and the final structure and fixed levels were
decided in May 1998. After this a dangerous three-year period loomed, where
devaluation candidates could be attacked nearly without risk until the final
introduction of the Euro in this Millennium.
The lack of sustainability in fixed foreign exchange rates gained new relevance with
the events in South East Asia in the latter part of 1997, where currency after currency
was devalued against the US dollar, leaving other fixed exchange rates, in particular in
South America, looking very vulnerable.
But while commercial companies have had to face a much more volatile currency
environment in recent years, investors and financial institutions have found a new
playground. The size of foreign exchange markets now dwarfs any other investment
market by a large factor. It is estimated that more than USD1, 200 billion is traded
every day, far more than the world's stock and bond markets combined.

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INTRODUCTION TO TRADING FOREIGN EXCHANGE

This short introduction explains the basics of trading Forex online, a brief explanation
of the markets and the major benefits of trading Forex online. There are also two
scenarios describing the implications of trading in a bear as well as bull market to
better acquaint you with some of the risks and opportunities in the largest and most
liquid market in the world.
OVERVIEW
Foreign exchange , forex or just Forex are all terms used to describe the trading of the
world's many currencies. The forex market is the largest market in the world, with
trades amounting to more than $1.5 trillion every day. This is more than one hundred
times the daily trading on the NYSE (New York Stock Exchange) . Most forex trading
is speculative , with only a few percent of market activity representing governments'
and companies' fundamental currency conversion needs.

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Unlike trading on the stock market, the forex market is not carried out by a central
exchange, but on the interbank market , which is thought of as an OTC (over the
counter ) market. Trading takes place directly between the two counterparts necessary
to make a trade, whether over the telephone or on electronic networks all over the
world. The main centres for trading are Sydney, Tokyo, London, Frankfurt and New
York. This worldwide distribution of trading centres means that the forex market is a
24-hour market.
TRADING FOREX
A currency trade is the simultaneous buying of one currency and selling of another
one. The currency combination used in the trade is called a cross (for example, the
Euro/US Dollar, or the GB Pound/Japanese Yen.). The most commonly traded
currencies are the so-called majors EURUSD, USDJPY, USDCHF and GBPUSD.
The most important forex market is the spot market as it has the largest volume. The
market is called the spot market because trades are settled immediately or on the
spot. In practice this means within two banking days.
FORWARD OUTRIGHTS
For forward outrights, settlement on the value date selected in the trade means that
even though the trade itself is carried out immediately, there is a small interest rate
calculation left. This is because if you trade e.g. NOKJPY, you get almost 7% (annual)
interest in Norway and close to 0% in Japan. So, if you borrow money in Japan, to
finance the trade as you must have one currency with which to buy or another, and
place it in Norway you have a positive interest rate differential.
This differential has to be calculated and added to your account. You can have both a
positive and a negative interest rate differential, so it may work for or against you
when you make a trade. The interest rate differential doesn't usually affect trade
considerations unless you plan on holding a position with a large differential for a long
period of time. The interest rate differential varies according to the cross you are
trading.
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TRADING ON MARGIN
Trading on margin means that you can buy and sell assets that represent more value
than the capital in your account. Forex trading is usually done with relatively little
margin since currency exchange rate fluctuations tend to be less than one or two
percent on any given day. To take an example, a margin of 2.0% means you can trade
up to $500,000 even though you only have $10,000 in your account. In terms of
leverage this corresponds to 50:1, because 50 times $10,000 is $500,000, or put
another way, $10,000 is 2.0% of $500.000. Using this much leverage gives you the
possibility to make profits very quickly, but there is also a greater risk of incurring
large losses and even being completely wiped out.
Therefore, it is inadvisable to maximize your leveraging as the risks can be very high.

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WHY TRADE FOREX

24 hour trading
One of the major advantages of trading forex is the opportunity to trade 24
hours a day from Sunday evening (20:00 GMT) to Friday evening (22:00
GMT). This gives you a unique opportunity to react instantly to breaking news
that is affecting the markets.

Superior liquidity
The forex market is so liquid that there are always buyers and sellers to trade
with. The liquidity of this market, especially that of the major currencies, helps
ensure price stability and low spreads . The liquidity comes mainly from large
and smaller banks that provide liquidity to investors, companies, institutions
and other currency market players.

No commissions
The fact that forex is often traded without commissions makes it very attractive
as an investment opportunity for investors who want to deal on a frequent
basis.
Trading the majors is also cheaper than trading other cross because of the
high level of liquidity. For more information on the trading conditions at Saxo
Bank, go to the Account Summary on your Client Station and open the section
entitled "Trading Conditions" found in the top right-hand corner of the Account
Summary.
.Leverage
With a minimum account of USD 10,000, for example, you can trade up to
USD 500,000. The USD 10,000 is posted on margin as a guarantee for the
future performance of your position.
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Profit potential in falling markets

Since the market is constantly moving, there are always trading opportunities,
whether a currency is strengthening or weakening in relation to another
currency. When you trade currencies, they literally work against each other. If
the EURUSD declines, for example, it is because the U.S. dollar gets stronger
against the Euro and vice versa. So, if you think the EURUSD will decline (that
is, that the Euro will weaken versus the dollar), you would sell EUR now and
then later you buy Euro back at a lower price and take your profits. The
opposite trading scenario would occur if the EURUSD appreciates .
TWO WAYS TO TRADE
There are two basic approaches to analyzing currency markets, fundamental analysis
and technical analysis. The fundamental analyst concentrates on the underlying causes
of price movements, while the technical analyst studies the price movements
themselves.

TECHNICAL ANALYSIS
Technical analysis focuses on the study of price movements. Historical currency data is
used to forecast the direction of future prices. The premise of technical analysis is that
all current market information is already reflected in the price of that currency;
therefore, studying price action is all that is required to make informed trading
decisions. The primary tools of the technical analyst are charts. Charts are used to
identify trends and patterns in order to find profit opportunities. The most basic
concept of technical analysis is that markets have a tendency to trend. Being able to
identify trends in their earliest stage of development is the key to technical analysis.

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FUNDAMENTAL ANALYSIS
Fundamental analysis focuses on the economic, social and political forces that drive
supply and demand. Fundamental analysts look at various macroeconomic indicators
such as economic growth rates, interest rates, inflation, and unemployment. However,
there is no single set of beliefs that guide fundamental analysis. There are several
theories as to how currencies should be valued.
PSYCHOLOGY OF TRADING
Four Principles for Becoming a Better Trader
(A). Trade with a DISCIPLINED Plan:
The problem with many traders is that they take shopping more seriously than trading.
The average shopper would not spend $400 without serious research and
examination of the product he is about to purchase, yet the average trader would
make a trade that could easily cost him $400 based on little more than a feeling
or hunch. Be sure that you have a plan in place BEFORE you start to trade.
The plan must include stop and limit levels for the trade, as your analysis should
encompass the expected downside as well as the expected upside.
(B). Cut your losses early and Let your Profits Run:
This simple concept is one of the most difficult to implement and is the cause of most
traders demise. Most traders violate their predetermined plan and take their profits
before reaching their profit target because they feel uncomfortable sitting on a
profitable position. These same people will easily sit on losing positions, allowing the
market to move against them for hundreds of points in hopes that the market will come
back. In addition, traders who have had their stops hit a few times only to see the
market go back in their favor once they are out, are quick to remove stops from their
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trading on the belief that this will always be the case. Stops are there to be hit, and to
stop you from losing more then a predetermined amount!

The mistaken belief is that every trade should be profitable. If you can get 3 out of 6
trades to be profitable then you are doing well. How then do you make money with
only half of your trades being winners? You simply allow your profits on the winners
to run and make sure that your losses are minimal.
(C).Do not marry your trades:
The reason trading with a plan is the #1 tip is because most objective analysis is done
before the trade is executed. Once a trader is in a position he/she tends to analyze the
market differently in the hopes that the market will move in a favorable direction
rather than objectively looking at the changing factors that may have turned against
your original analysis. This is especially true of losses. Traders with a losing position
tend to marry their position, which causes them to disregard the fact that all signs point
towards continued losses.
(D).Do not bet the farm:
Do not over trade. One of the most common mistakes that traders make is leveraging
their account too high by trading much larger sizes than their account should prudently
trade. Leverage is a double-edged sword. Just because one lot (100,000 units) of
currency only requires $1000 as a minimum margin deposit, it does not mean that a
trader with $5000 in his account should be able to trade 5 lots. One lot is $100,000 and
should be treated as a $100,000 investment and not the $1000 put up as margin. Most
traders analyze the charts correctly and place sensible trades, yet they tend to over
leverage themselves. As a consequence of this, they are often forced to exit a position
at the wrong time. A good rule of thumb is to trade with 1-10 leverage or never use
more than 10% of your account at any given time. Trading currencies is not easy (if it
was, everyone would be a millionaire!).

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Fundamentals Every Trader Should Know

Currency prices reflect the balance of supply and demand for currencies. Two primary
factors affecting supply and demand are interest rates and the overall strength of the
economy. Economic indicators such as GDP, foreign investment and the trade balance
reflect the general health of an economy and are therefore responsible for the
underlying shifts in supply and demand for that currency. There is a tremendous
amount of data released at regular intervals, some of which is more important than
others. Data related to interest rates and international trade is looked at the closest.
(1).Interest Rates
If the market has uncertainty regarding interest rates, then any bit of news regarding
interest rates can directly affect the currency markets. Traditionally, if a country raises
its interest rates, the currency of that country will strengthen in relation to other
countries as investors shift assets to that country to gain a higher return. Hikes in
interest rates, however, are generally bad news for stock markets. Some investors will
transfer money out of a country's stock market when interest rates are hiked, causing
the country's currency to weaken. Which effect dominates can be tricky, but generally
there is a consensus beforehand as to what the interest rate move will do. Indicators
that have the biggest impact on interest rates are PPI, CPI, and GDP. Generally the
timing of interest rate moves are known in advance. They take place after regularly
scheduled meetings by the BOE, FED, ECB, BOJ, and other central banks.
(2).International Trade
The trade balance shows the net difference over a period of time between a nations
exports and imports. When a country imports more than it exports the trade balance
will show a deficit, which is generally considered unfavorable.
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For example, if U.S dollars are sold for other domestic national currencies (to pay for
imports), the flow of dollars outside the country will depreciate the value of the
currency. Similarly if trade figures show an increase in exports, dollars will flow into
the United States and appreciate the value of the currency. From the standpoint of a
national economy, a deficit in and of itself is not necessarily a bad thing.
However, if the deficit is greater than market expectations then it will trigger a
negative price movement.
The base currency-the first currency listed in the currency pair-is the basis for the buy
or the sell. As an example, the US Dollar is the base currency for USD/JPY (US
Dollar/Japanese Yen). The current bid/ask price for USD/JPY could be 107.20/107.23,
which means you could buy $1 US for 107.23 Japanese Yen, or sell $1 US for 107.20
Japanese Yen.

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RISK MANAGEMENT
Generally, Risk Management is the process of measuring, or assessing risk and then
developing strategies to manage the risk. In general, the strategies employed include
transferring the risk to another party, avoiding the risk, reducing the negative effect of
the risk, and accepting some or all of the consequences of a particular risk. Traditional
risk management focuses on risks stemming from physical or legal causes (e.g. natural
disasters or fires, accidents, death, and lawsuits). Financial risk management, on the
other hand, focuses on risks that can be managed using traded financial instruments.
Intangible risk management focuses on the risks associated with human capital, such
as knowledge risk, relationship risk, and engagement-process risk. Regardless of the
type of risk management, all large corporations have risk management teams and small
groups and corporations practice informal, if not formal, risk management.
In ideal risk management, a prioritization process is followed whereby the risks with
the greatest loss and the greatest probability of occurring are handled first, and risks
with lower probability of occurrence and lower loss are handled later. In practice the
process can be very difficult, and balancing between risks with a high probability of
occurrence but lower loss vs. a risk with high loss but lower probability of occurrence
can often be mishandled.

Intangible risk management identifies a new type of risk - a risk that has a 100%
probability of occurring but is ignored by the organization due to a lack of
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identification ability. For example, knowledge risk occurs when deficient knowledge is
applied. Relationship risk occurs when collaboration ineffectiveness occurs. Processengagement risk occurs when operational ineffectiveness occurs. These risks directly
reduce the productivity of knowledge workers, decrease cost effectiveness,
profitability, service, quality, reputation, brand value, and earnings quality.
Intangible risk management allows risk management to create immediate value from
the identification and reduction of risks that reduce productivity.
Risk management also faces a difficulty in allocating resources properly. This is the
idea of opportunity cost. Resources spent on risk management could be instead spent
on more profitable activities.

The Forex Market is the largest and most liquid financial market in the world. Since
macroeconomic forces are one of the main drivers of the value of currencies in the
global economy, currencies tend to have the most identifiable trend patterns. Therefore,
the Forex market is a very attractive market for active traders, and presumably where
they should be the most successful. However, success has been limited mainly for the
following reasons:
Many traders come with false expectations of the profit potential, and lack the
discipline required for trading. Short term trading is not an amateur's game and is not
the way most people will achieve quick riches. Simply because Forex trading may
seem exotic or less familiar then traditional markets (i.e. equities, futures, etc.), it does
not mean that the rules of finance and simple logic are suspended. One cannot hope to
make extraordinary gains without taking extraordinary risks, and that means suffering
inconsistent trading performance that often leads to large losses. Trading currencies is
not easy, and many traders with years of experience still incur periodic losses. One
must realize that trading takes time to master and there are absolutely no short cuts to
this process.
The most enticing aspect of trading Forex is the high degree of leverage used.
Leverage seems very attractive to those who are expecting to turn small amounts of
money into large amounts in a short period of time.

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However, leverage is a double-edged sword. Just because one lot ($10,000) of
currency only requires $100 as a minimum margin deposit, it does not mean that a
trader with $1,000 in his account should be easily able to trade 10 lots. One lot is
$10,000 and should be treated as a $100,000 investment and not the $1000 put up as
margin. Most traders analyze the charts correctly and place sensible trades, yet they
tend to over leverage themselves (get in with a position that is too big for their
portfolio), and as a consequence, often end up forced to exit a position at the wrong
time.
For example, if your account value is $10,000 and you place a trade for 1 lot, you are
in effect, leveraging yourself 10 to 1, which is a very significant level of leverage.
Most professional money managers will leverage no more then 3 or 4 times.
UTILIZING STOP LOSS ORDER.
A stop-loss is an order linked to a specific position for the purpose of closing that
position and preventing the position from accruing additional losses. A stop-loss order
placed on a Buy (or Long) position is a stop-loss order to Sell and close that position.
A stop-loss order placed on a Sell (or Short) position is a stop-loss order to Buy and
close that position. A stop-loss order remains in effect until the position is liquidated or
the client cancels the stop-loss order. As an example, if an investor is Long (Buy) USD
at 120.27, they might wish to put in a stop-loss order to Sell at 119.49, which would
limit the loss on the position to the difference between the two rates (120.27-119.49)
should the dollar depreciate below 119.49. A stop-loss would not be executed and the
position would remain open until the market trades at the stop-loss level. Stop-loss
orders are an essential tool for controlling your risk in currency trading.
RISK WARNING
Trading foreign currencies is a challenging and potentially profitable opportunity for
educated and experienced investors. However, before deciding to participate in the
Forex market, you should carefully consider your investment objectives, level of
experience and risk appetite. Most importantly, do not invest money you cannot afford
to lose.

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There is considerable exposure to risk in any foreign exchange transaction. Any
transaction involving currencies involves risks including, but not limited to, the
potential for changing political and/or economic conditions that may substantially
affect the price or liquidity of a currency. Moreover, the leveraged nature of FX trading
means that any market movement will have an effect on your deposited funds
proportionally equal to the leverage factor. This may work against you as well as for
you. The possibility exists that you could sustain a total loss of initial margin funds and
be required to deposit additional funds to maintain your position. If you fail to meet
any margin call within the time prescribed, your position will be liquidated and you
will be responsible for any resulting losses. Investors may lower their exposure to risk
by employing risk-reducing strategies such as 'stop-loss' or 'limit' orders.
There are also risks associated with utilizing an internet-based deal execution software
application including, but not limited, to the failure of hardware and software and
communications difficulties.
OBJECTIVES OF RISK MANAGEMENT
Mere survival;
Peace of mind;
Lower risk management costs and thus higher profits;
Fairly stable earnings;
Little or no interruption of operations;
Continued growth;
Satisfaction of the firms sense of social responsibility desire for a good image;
Satisfaction of externally imposed obligations.

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STEPS IN THE RISK MANAGEMENT PROCESS
The core of the process is a series of five steps:

Establish the context

Identify risks

Analyse risks

Evaluate risks

Treat risks

In parallel with the core process, communication & consultation is required to ensure
adequate information is provided and conclusions are disseminated. Monitoring and
review is an intrinsic part of the process required to ensure that the process is executed
in a timely fashion and the identification, analysis, evaluation and treatment are kept
up to date.
1. Establish the context
Establishing the context includes planning the remainder of the process and mapping
out the scope of the exercise, the identity and objectives of stakeholders, the basis upon
which risks will be evaluated and defining a framework for the process, and agenda for
identification and analysis.
2.Identification
After establishing the context, the next step in the process of managing risk is to
identify potential risks. Risks are about events that, when triggered, will cause
problems. Hence, risk identification can start with the source of problems, or with the
problem itself.

Source analysis Risk sources may be internal or external to the system that is
the target of risk management. Examples of risk sources are: stakeholders of a
project, employees of a company or the weather over an airport.

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Problem analysis:- Risks are related to identified threats. For example: the
threat of losing money, the threat of abuse of privacy information or the threat
of accidents and casualties. The threats may exist with various entities, most
important with shareholder, customers and legislative bodies such as the
government.

When either source or problem is known, the events that a source may trigger or the
events that can lead to a problem can be investigated. For example: stakeholders
withdrawing during a project may endanger funding of the project; privacy
information may be stolen by employees even within a closed network; lightning
striking a Boeing 747 during takeoff may make all people onboard immediate
casualties.
The chosen method of identifying risks may depend on culture, industry practice and
compliance. The identification methods are formed by templates or the development of
templates for identifying source, problem or event. Common risk identification
methods are:

Objectives-based Risk Identification Organizations and project teams have

objectives. Any event that may endanger achieving an objective partly or
completely is identified as risk.

Objective-based risk identification is at the basis of COSO's Enterprise Risk

Management - Integrated Framework

Scenario-based Risk Identification In scenario analysis different scenarios

are created. The scenarios may be the alternative ways to achieve an objective,
or an analysis of the interaction of forces in, for example, a market or battle.
Any event that triggers an undesired scenario alternative is identified as risk.

Taxonomy-based Risk Identification The taxonomy in taxonomy-based risk

identification is a breakdown of possible risk sources. Based on the taxonomy
and knowledge of best practices, a questionnaire is compiled. The answers to
the questions reveal risks.

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Common-risk Checking In several industries lists with known risks are

available. Each risk in the list can be checked for application to a particular
situation.

3.Assessment
Once risks have been identified, they must then be assessed as to their potential
severity of loss and to the probability of occurrence. These quantities can be either
simple to measure, in the case of the value of a lost building, or impossible to know for
sure in the case of the probability of an unlikely event occurring. Therefore, in the
assessment process it is critical to make the best educated guesses possible in order to
properly prioritize the implementation of the risk management plan.
The fundamental difficulty in risk assessment is determining the rate of occurrence
since statistical information is not available on all kinds of past incidents. Furthermore,
evaluating the severity of the consequences (impact) is often quite difficult for
immaterial assets. Asset valuation is another question that needs to be addressed. Thus,
best educated opinions and available statistics are the primary sources of information.
Nevertheless, risk assessment should produce such information for the management of
the organisation that the primary risks are easy to understand and that the risk
management decisions may be prioritized. Thus, there have been several theories and
attempts to quantify risks. Numerous different risk formulae exist, but perhaps the
most widely accepted formula for risk quantification is:
Rate of occurrence multiplied by the impact of the event equals risk
Later research has shown that the financial benefits of risk management are not so
much dependent on the formulae used. The most significant factor in risk management
seems to be that
1.) Risk assessment is performed frequently and
2.) It is done using as simple methods as possible.
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In business it is imperative to be able to present the findings of risk assessments in

financial terms. Robert Courtney Jr. (IBM, 1970) proposed a formulae for presenting
risks in financial terms. The Courtney formulae was accepted as the official risk
analysis method for the US governmental agencies. The formulae proposes calculation
of ALE (Annualised Loss Expectancy) and compares the expected loss value to the
security control implementation costs (cost-benefit analysis).
Potential Risk Treatments
Once risks have been identified and assessed, all techniques to manage the risk fall into
one or more of these four major categories:

Transfer

Avoidance

Reduction (aka Mitigation)

Acceptance (aka Retention)

Ideal use of these strategies may not be possible. Some of them may involve trade offs
that are not acceptable to the organization or person making the risk management
decisions.
Risk

avoidance

Includes not performing

an activity that could carry risk. An example would be not buying a property or
business in order to not take on the liability that comes with it. Another would be not
flying in order to not take the risk that the airplane were to be hijacked. Avoidance may
seem the answer to all risks, but avoiding risks also means losing out on the potential
gain that accepting (retaining) the risk may have allowed. Not entering a business to
avoid the risk of loss also avoids the possibility of earning the profits.

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Risk reduction
Involves methods that reduce the severity of the loss. Examples include sprinklers
designed to put out a fire to reduce the risk of loss by fire. This method may cause a
greater loss by water damage and therefore may not be suitable. Halon fire suppression
systems may mitigate that risk, but the cost may be prohibitive as a strategy.
Modern software development methodologies reduce risk by developing and
delivering software incrementally. Early methodologies suffered from the fact that they
only delivered software in the final phase of development; any problems encountered
in earlier phases meant costly rework and often jeopardized the whole project. By
developing in increments, software projects can limit effort wasted to a single
increment. A current trend in software development, spearheaded by the Extreme
Programming community, is to reduce the size of increments to the smallest size
possible, sometimes as little as one week is allocated to an increment.
Risk retention
Involves accepting the loss when it occurs. True self insurance falls in this category.
Risk retention is a viable strategy for small risks where the cost of insuring against the
risk would be greater over time than the total losses sustained. All risks that are not
avoided or transferred are retained by default. This includes risks that are so large or
catastrophic that they either cannot be insured against or the premiums would be
infeasible. War is an example since most property and risks are not insured against
war, so the loss attributed by war is retained by the insured. Also any amounts of
potential loss (risk) over the amount insured is retained risk. This may also be
acceptable if the chance of a very large loss is small or if the cost to insure for greater
coverage amounts is so great it would hinder the goals of the organization too much.
Risk transfer
Means causing another party to accept the risk, typically by contract or by hedging.
Insurance is one type of risk transfer that uses contracts. Other times it may involve
contract language that transfers a risk to another party without the payment of an
insurance premium. Liability among construction or other contractors is very often
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transferred this way. On the other hand, taking offsetting positions in derivatives is
typically how firms use hedging to financially manage risk.
Some ways of managing risk fall into multiple categories. Risk retention pools are
technically retaining the risk for the group, but spreading it over the whole group
involves transfer among individual members of the group. This is different from
traditional insurance, in that no premium is exchanged between members of the group
up front, but instead losses are assessed to all members of the group.
Create the plan
Decide on the combination of methods to be used for each risk. Each risk management
decision should be recorded and approved by the appropriate level of management. For
example, a risk concerning the image of the organization should have top management
decision behind it whereas IT management would have the authority to decide on
computer virus risks.
The risk management plan should propose applicable and effective security controls
for managing the risks. For example, an observed high risk of computer viruses could
be mitigated by acquiring and implementing anti virus software. A good risk
management plan should contain a schedule for control implementation and
responsibile persons for those actions. The risk management concept is old but is still
not very effectively measured
4.Implementation
Follow all of the planned methods for mitigating the effect of the risks. Purchase
insurance policies for the risks that have been decided to be transferred to an insurer,
avoid all risks that can be avoided without sacrificing the entity's goals, reduce others,
and retain the rest.
5.Review and evaluation of the plan
Initial risk management plans will never be perfect. Practice, experience, and actual
loss results, will necessitate changes in the plan and contribute information to allow
possible different decisions to be made in dealing with the risks being faced.
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Risk analysis results and management plans should be updated periodically. There are
two primary reasons for this:
1. to evaluate whether the previously selected security controls are still applicable
and effective, and
2. to evaluate the possible risk level changes in the business environment. For
example, information risks are a good example of rapidly changing business
environment.

Foreign Exchange Risk Management Guidelines

Your business is open to risks from movements in competitors' prices, raw material
prices, competitors' cost of capital, foreign exchange rates and interest rates, all of
which need to be (ideally) managed.
This section addresses the task of managing exposure to Foreign Exchange
movements.
These Risk Management Guidelines are primarily an enunciation of some good and
prudent practices in exposure management. They have to be understood, and slowly
internalized and customized so that they yield positive benefits to the company over
time.
It is imperative and advisable for the Apex Management to both be aware of these
practices and approve them as a policy. Once that is done, it becomes easier for the
Exposure Managers to get along efficiently with their task.
(1).Exposure Analysis

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An Exposure can be defined as a Contracted, Projected or Contingent Cash Flow
whose magnitude is not certain at the moment. The magnitude depends on the value of
variables such as Foreign Exchange rates and Interest rates.
The company will determine and analyze its Foreign Exchange exposures.

Determination:
The following cash flows/ transactions will be considered for the purpose of exposure
management.
Variable / Cash Flows

Transaction Type

Contracted Foreign Currency Cash Flows

Foreign Interest Rates, whether Floating

Both Capital and Revenue in

nature

or Fixed

All

Interest

Payments/

Receipts

Cash Flows from Hedge Transactions

All Open hedge transactions

Projected/ Contingent Cash Flows

Both Capital and Revenue in

nature
Cash Flows above $100,000/- in value will be brought to the notice of the
Exposure Manager, as soon as they are projected.

It is the responsibility of the Exposure Manager to ensure that he receives the

requisite information on exposures from various sections of the company in
time.
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Analysis
These exposures will be analyzed and the following aspects will be studied:

Foreign Currency Cash Flows/ Schedules

Variability of Cash flows - how certain are the amounts and/ or value dates?

Inflow-Outflow Mismatches / Gaps

Time Mismatches / Gaps

Currency Portfolio Mix

Floating / Fixed Interest Rate ratio

(2). MARKET FORECASTS

After determining its Exposures, the company has to form an idea of where the market
is headed. The company will focus on forecasts for the next 6 months, as forecasts for
periods beyond 6 months can be unreliable.
The focus of the Apex Management is to be aware of :

The Direction or the Big Trend in rates.

The underlying assumptions behind the forecasts

The Probability that can be assigned to the forecast coming true

The possible extent of the move

The Risk Appraisal exercise and Benchmarking decisions will be based on such
forecasts.
(3).RISK

APPRAISAL

This exercise is aimed at determining where the company's exposures stand vis--vis
market forecasts.
The following Risks will be considered.
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1.Risk to the Exposure or Value at Risk (VAR)
Given a particular view or forecast, VAR tries to determine by how much the
companys underlying cash flows are affected.
2. FORECAST RISK
What is the likelihood of the rate actually moving to xx.xxxx and what is the
likelihood of a forecast going wrong. It is imperative to know this before deciding on a
Benchmark and devising a hedging strategy.
3.Market and Transaction Risk
This will take into consideration the risks attached with each particular market and the
likelihood of a transaction not going through smoothly. For instance:

The Rupee is given to sudden swings in sentiment, whereas the Deutschemark

is generally more predictable.

The monetary and time costs of hedging with a nationalized bank are generally
higher than with a private/ foreign bank.

4. Systems Risk
The risks that arise through gaps or weaknesses in the Exposure Management
system. For example:
(4). BENCHMARKING :This exercise aims to state where the company would like its exposures to reach.
1. The company will set a Benchmark for its Exposure Management practices.
2.

The

Benchmarks

will

be

set

for

months

periods.

3. The Benchmark will reflect and incorporate the following:

i.

The Objective of Exposure Management, or in other words, "Should Exposure

Management be conducted on a Profit Centre or Cost Centre basis?"
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ii.

The Forecasts discussed and agreed upon earlier. Mathematically, the

Benchmark should be the Probabilistic Expectation of the rate in question.

iii.

The Forecast risk, Market and Transaction risk, and Systems risk as determined
earlier.

iv.

Room for error in keeping with the Stop Loss Policy to be decided

4. The Benchmark will be realistic and achievable.

A small note on the Profit/ Cost centre concept:

Profit Centre under this concept, the Exposure Manager is required to generate a NET
profit on the exposure over time. This is an aggressive stance implying a
high degree of risk appetite on the part of Apex Management. A company
with a strong position in its daily bread and butter business can afford to
take some financial risks and can opt for this concept.
The Benchmarks under a Profit-Centre concept would take the form of
The total cost of a foreign currency loan should be reduced by at least 25
Cost Centre

bp over a one year period, from the forecasted rate of ex. % p.a..
under this concept, the Exposure Manager would be required to ensure
that the cashflows of the company are not adversely affected beyond a
certain point. This is a defensive strategy, implying a lower risk appetite.
A company whose cash-flows are volatile, or whose underlying business
is not on a very sound footing would be advised to adopt this concept.
The Benchmarks under a Cost-Centre concept would take the form of
Foreign Exchange fluctuations should add no more than x% to the cost
of Imported Raw Material over and above the budgeted cost.

(5). HEDGING
This is the most visible and glamorized part of the Exposure Management function.
However, the Trader is like the Driver in a car rally, who needs to follow the general
directions of the Navigator.

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1. The company will use all hedging techniques available to it, as per need and
requirement. In this regard, it will pass a Board Resolution authorizing the use of the
following:

Rupee-Foreign Currency Forward Contracts

Cross Currency Forward Contracts

Forward-to-Forward Contracts

FRAs

Currency Swaps

Interest Rate Swaps

Currency Options

Interest Rate Options

Others, as may be required.

(6). STOPLOSS
Exposure Management should not be undertaken without having a Stop-Loss policy in
place. A Stop-Loss policy is based on the following two fundamental principles:
It is appropriate to recount here some words from a speech Dr Alan Greenspan,
Chairman of the US Federal Reserve, delivered in December 1997, on the Asian
financial crisis. He says,
Whether an Exposure is hedged or not, it is assumed that the decision to hedge/ not to
hedge is backed by a View or Forecast, whether implicit or explicit. As such, Stop Loss
is nothing but a commitment to reverse a decision when the view is proven to be
wrong.
While Benchmarks will be based upon the Big Trend and will incorporate a certain
amount of room for error, the Exposure Manager should be careful to not violate the
Benchmark on the wrong side.
(7). REPORTING AND REVIEW
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There needs to be continuous monitoring whether the Exposures are headed where
they are intended to reach. As such, the Exposure Management activities need to be
reported and reviewed.

Review
A monthly Review meeting will consider the following:

Issue

On the basis of

Exposure

Exposure NAV Report

Points to be reviewed
Is the Benchmark being met/

Performance

bettered?
What are the chances of the
Benchmark being violated on
the wrong side?
Reasons for the Benchmark
being violated on the wrong
side

Market
Situation

Reviews of market developments Is the Big Trend still in place? Or

Forecasts of market movements
has it changed?
Does the Benchmark need to be

Benchmarking The above two

Hedging

changed?

MTM and Exposure NAV Reports

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Is the strategy working well? Or

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does it need to be fine-tuned/

Strategy
Operational
issues

overhauled?
Exposure Manager's experiences

Operational problems to be solved

(8). CONCLUSION
Exposure Management is an essential part of business and should be viewed with
Objectivity. It is neither a license to print money nor is it a cause for getting trapped in
a Fear Psychosis, and should be viewed with the same clarity of vision as, say,
Production or Marketing is viewed.
Having said that, it should be remembered that

All that has been stated above cannot start happening straightaway

Installing Hedging, Reporting and Review systems that work takes time and
effort

There will be a Learning Curve to be overcome when setting Benchmarks

There will be initial losses, which should be viewed as what they are - initial
losses.

There has to be a long-term commitment to Exposure Management, because it is today

an activity, which no company can afford to ignore.
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WHY HEDGE FOREIGN CURRENCY RISK

International commerce has rapidly increased as the internet has provided a new and
more transparent marketplace for individuals and entities alike to conduct international
business and trading activities. Significant changes in the international economic and
political landscape have led to uncertainty regarding the direction of foreign exchange
rates. This uncertainty leads to volatility and the need for an effective vehicle to hedge
foreign exchange rate risk and/or interest rate changes while, at the same time,
effectively ensuring a future financial position.
Each entity and/or individual that has exposure to foreign exchange rate risk will have
specific foreign exchange hedging needs and this website can not possibly cover every
existing foreign exchange hedging situation. Therefore, we will cover the more
common reasons that a foreign exchange hedge is placed and show you how to
properly hedge foreign exchange rate risk.
Foreign Exchange Rate Risk Exposure - Foreign exchange rate risk exposure is
common to virtually all who conduct international business and/or trading. Buying
and/or selling of goods or services denominated in foreign currencies can immediately
expose you to foreign exchange rate risk. If a firm price is quoted ahead of time for a
contract using a foreign exchange rate that is deemed appropriate at the time the quote
is given, the foreign exchange rate quote may not necessarily be appropriate at the time
of the actual agreement or performance of the contract. Placing a foreign exchange
hedge can help to manage this foreign exchange rate risk.
Interest Rate Risk Exposure - Interest rate exposure refers to the interest rate
differential between the two countries' currencies in a foreign exchange contract. The
interest rate differential is also roughly equal to the "carry" cost paid to hedge a
forward or futures contract. As a side note, arbitragers are investors that take advantage
when interest rate differentials between the foreign exchange spot rate and either the
forward or futures contract are either to high or too low. In simplest terms, an
arbitrager may sell when the carry cost he or she can collect is at a premium to the
actual carry cost of the contract sold. Conversely, an arbitrager may buy when the
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carry cost he or she may pay is less than the actual carry cost of the contract bought.
Either way, the arbitrager is looking to profit from a small price discrepancy due to
interest rate differentials.
Foreign Investment / Stock Exposure - Foreign investing is considered by many
investors as a way to either diversify an investment portfolio or seek a larger return on
investment(s) in an economy believed to be growing at a faster pace than investment(s)
in the respective domestic economy. Investing in foreign stocks automatically exposes
the investor to foreign exchange rate risk and speculative risk. For example, an
investor buys a particular amount of foreign currency (in exchange for domestic
currency) in order to purchase shares of a foreign stock. The investor is now
automatically exposed to two separate risks. First, the stock price may go either up or
down and the investor is exposed to the speculative stock price risk. Second, the
investor is exposed to foreign exchange rate risk because the foreign exchange rate
may either appreciate or depreciate from the time the investor first purchased the
foreign stock and the time the investor decides to exit the position and repatriates the
currency (exchanges the foreign currency back to domestic currency).
Therefore, even if a speculative profit is achieved because the foreign stock price rose,
the investor could actually net lose money if devaluation of the foreign currency
occurred while the investor was holding the foreign stock (and the devaluation amount
was greater than the speculative profit). Placing a foreign exchange hedge can help to
manage this foreign exchange rate risk.
Hedging Speculative Positions - Foreign currency traders utilize foreign exchange
hedging to protect open positions against adverse moves in foreign exchange rates, and
placing a foreign exchange hedge can help to manage foreign exchange rate risk.
Speculative positions can be hedged via a number of foreign exchange hedging
vehicles that can be used either alone or in combination to create entirely new foreign
exchange hedging strategies.

How To Trade Forex Successfully: Forex Trading Risk Management

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Trading the Markets
Trading the markets for speculation purposes is a challenging task that numerous
amounts of people have embarked on. Do you know anyone who successfully makes
money trading? The answer is most likely no. If you do I recommend you become as
friendly as possible with the person and learn everything you can from him, unless he
is charging for his services. That usually means he is not a successful trader.
With the type of leverage that is offered in the futures, options and forex markets, I
personally find it hard to believe that anyone who has a successful system that is right
for them will be too eager to teach it. Why should they teach if they can be trading the
daylights out of it and be making millions with the 400:1 leverage that some forex
platforms offer.
On the other hand numerous people have made millions trading. Look at the list of
CTAs on IASG.com, look at John W. Henry, Max Ansbacher, Warren Buffet, Peter
Lynch and all the Market Wizards. I recommend reading the market wizards book for
some inspiration.
The problem is that most traders go into trading with the wrong attitude. Have you
ever heard this phrase I am tired of working I need to trade to get rich. It takes 7
years to complete medical school and there is no green arrow red arrow system for
performing heart surgery.
Trading will pay you much more than doctors make so you should expect to have to do
more work than doctors do for a longer period of time to get wealthy and become a
market wizard. While you start and practice it is imperative that you do so at a low
cost, meaning you dont blow out your account on bad trades due to poor risk
management.
It has been hypothesized that, with proper risk management, a simple system like
flipping a coin to buy or sell could be successful. However having the slightest edge
should enhance the traders chances a great deal. By edge, I mean something that will
make the trader make more money than he looses. An edge can be discretional or
algorithmic as long as the trader makes money in the long run.
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A perfect example of this is the game of blackjack. The house has a very slight edge
less than not more than 2%. But by repetitive play they consistently end up profitable.
This is because they have a set approach, and edge, and they dont get emotional when
a player goes on a winning streak. Good traders put themselves in the position of a
casino.
Traders can make money discretionally by following support and resistance levels,
watching the volume, size and market action. Or, traders can create a trading system by
back-testing a certain edge. Calculate the systems expectancy, develop trading and risk
management rules, and follow those rules religiously to generate profits. Numerous
people will try to sell systems.
It is very important that with any system traders create a reevaluation point. By
reevaluation point I mean a point where the trader starts to question the systems
effectiveness and begins to look for other systems that he expects to fair profitable
over time. The reevaluation point should be decided upon before trading begins. It
should be based on the back tested data, and you must take into account concepts that
we will discuss such as a drawdown, consecutive loosing sessions, reward risk ratio.
TOOLS FOR MANAGING RISK IN FOREX MARKET
THE SPOT MARKET
1. Introduction
The spot market accounts for nearly a third of global foreign exchange turnover. It can
be broadly divided into two tiers:
The interbank market where currency is bought and sold for delivery and settlement
within two days, with the banks acting as wholesalers or market makers.
The retail market made up of private traders, who deal over the telephone or the
internet through intermediaries (brokers).
The forex market has no centralized exchanges. All trades are over-the-counter deals,
agreed and settled by individual counterparties known to one another. The forex
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market is truly global and operates 24 hours a day, Monday to Friday. Daily trading
commences in Wellington, New Zealand and follows the sun to (inter alia) Sydney,
Tokyo, Hong Kong, Singapore, Bahrain, Frankfurt, Geneva, Zurich, Paris, London,
New York, Chicago and Los Angeles before starting again.
2. Currency pairs and the rate of exchange
Every foreign exchange transaction is an exchange between a pair of currencies. Each
currency is denoted by a unique three-character International Standardization
Organization (ISO) code (e.g. GBP represents sterling and USD the US dollar).
Currency pairings are expressed as two ISO codes separated by a division symbol (e.g.
GBP/USD), the first representing the base currency and the other the secondary
currency.
The rate of exchange is simply the price of one currency in terms of another. For
example GBP/USD = 1.5545 denotes that one unit of sterling (the base currency) can
be exchanged for 1.5545 US dollars (the secondary currency). The base currency is the
one that you are buying or selling. This elementary point is often lost on beginners.

Exchange rates are usually written to four decimal places, with the exception of
Japanese yen which is written to two decimal places. The rate to two (out of four)
decimal places is known as the big figure while the third and fourth decimal places
together measure the points or pips. For instance, in GBP/USD = 1.5545 the big
figure is 1.55 while the 45 (i.e. the third and fourth decimal places) represents the
points.
6. Screen-based spot trading
The technology for trading forex has evolved from the telephone and telex (not
forgetting voice dealing) through to the modern Electronic Broking System (EBS) that
enables straight through processing (STP) with integrated quotation, transactional
and administrative

functionality.

EBS-type technology is now available to individual, private investors who can receive
live, streaming data from and transact directly through their chosen brokers. The
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private dealer, however, does not deal on the highly competitive inter-bank market
with its tight spreads. In practice, brokers add points to the price spread in lieu of
dealing

commission.

A private trader requires:

A margin account broker with internet access and a fast connection
A computer terminal capable of running several programmes simultaneously
Proprietary software to open and manage positions and to display technical analysis
tools.
Sufficient monitors to handle market data, submit dealing instructions, display
technical analysis; and for keeping tabs on open positions, managing orders (e.g. stop
loss, TPO, limit etc.) and viewing the state of the margin account. For demonstrations
of

the

kind

of

proprietary

(www.pronetanalytics.com)

software

and

available,

Nostradamus

visit

Pronet

Analytics

(www.nostradamus.co.uk)

Pronet Analytics provides the only chart-based software package approved by

Association of Cambistes Internationale, the governing body of professional forex
trading.
From early 2003, a new spot trading software package from US provider Gain Capital
will

be

available

through

the

UK

online

margin

broker

Easy2Trade

(www.easy2trade.com), better known for its futures online global trading platform.
We will build our required margin into the bid-offer spread, says Easy2Trade chief
executive

David

Wenman.

It

will

be

free

to

use

after

that.

Before you splash out on the full kit, why not does a test drive by renting a dealing
desk at an organization like TraderHouse (www.traderhouse.net).
7. Fundamental and technical analysis
Without the apparatus for making sense of the currency market, any trade represents a
pure gamble. There are two broad schools of analysis, which are not mutually
exclusive.
7.1Fundamentalanalysis
Fundamental analysis is the application of micro and macroeconomic theory to
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markets, with the aim of predicting future trends. So what fundamental forces drive
currency markets?
(a). The balance of trade: Currencies that are associated with long term trade
surpluses will tend to strengthen against those associated with persistent deficits simply because there is net buying of surplus currencies corresponding to the excess of
exports

over

imports.

Trends are important too. An improving balance of trade should cause the relevant
currency to appreciate relative to those associated with a deteriorating or stable balance
of

trade.

(b). Relative inflation rates: If country A is suffering a higher rate of price inflation
than country B, then As currency ought to weaken relative to Bs in order to restore
purchasing

power parity.

(c). Interest rates: International capital flows seek the highest inflation-adjusted
returns, creating additional demand for high real interest-rate currencies and pushing
up their rates of

exchange.

(d). Expectations and speculation: Markets anticipate events. Speculation on, say, the
future rate of inflation may be enough to move the exchange rate - long before the
actual trend

becomes

apparent.

It should be understood that these economic forces act in concert. It is a supremely

difficult task, however, to establish where the sum of interacting economic forces will
take the market. The solution, some argue, lies in technical analysis.
7.2Technical analysis
Technical analysis is concerned with predicting future price trends from historical price
and volume data. The underlying axiom of technical analysis is that all fundamentals
(including expectations) are factored into the market and are reflected in exchange
rates.
The tools of technical analysis are now freely available to private investors in support
of their trading decisions. It cannot be stressed too heavily, however, that such tools are
only estimators

and

are

not

infallible.

The following is the briefest of introductions to the technical analytical tools used to
identify trends and recurring patterns in a volatile marketplace. Aspiring forex dealers
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are advised to undergo proper training in technical analysis, although true proficiency
comes with practice, endurance and experience.

TREND CLASSIFICATIONS

DRAWING TRENDLINES
The basic trendline is one of the simplest technical tools employed by the trader, and is
also

one

of

the

most

valuable

in

any

type

of

technical

trading.

For an up trendline to be drawn, there must be at least two low points in the graph
where

the

2nd

low

point

is

higher

than

A price low is the lowest price reached during a counter trend move.
BULLISH TREND LINES

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the

first.

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TREND, ANALYSIS AND TIMING

Markets don't move straight up and down. The direction of any market at any time is
either Bullish (Up), Bearish (Down), or Neutral (Sideways). Within those trends,
markets have countertrend (backing & filling) movements. In a general sense
"Markets move in waves", and in order to make money a trader must catch the wave at
the right time.
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DRAWING VARIOUS TRENDLINES

DRAWING TRENDLINES

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TRENDLINES
Drawing Trendlines will help to determine when a trend is changing.

TREND

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The direction of trend is absolutely essential to trading and analyzing the market.

In the Foreign Exchange (FX) Market it is possible to profit from UP and Down
movements, because of the buying of one currency and selling against the other
currency e.g. Buy US Dollar Sell German Mark. ex. Up Trend chart.

8. Tips for aspiring spot traders

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Andy Shearman, a director of forex day-trading service Trader House Network (UK)
has
Seven Pillars of Wisdom for aspiring forex traders:

(1) Dont be under-capitalized or you will lose trading opportunities.

(2) Dont suspend your daily (successful) economic activity while you are learning to
trade

currencies.

(3) Get an education. Make time to practice and to check markets every day.
(4) Decide what your monetary goals are and devise a trading plan to realize them.
Remember that you have overheads and that risk is involved. Your target remuneration
must

not

only

be

realistic

but

must

include

risk

premium.

(5) Choose a good broker preferably one that feeds live, streaming prices to your
screen.
(6) Be decisive. Over-caution will cost you money. You cant make any profits if you
dont trade. Dont agonize too long over a deal and trust your instincts.
(7) Watch your back. Never leave your trading screen even momentarily without
putting stop losses in place. A pee is a long time in the forex market.
Trading forex is a bit like life in a combat zone, says Shearman. There are bouts of
frenetic, exhilarating and even panic-stricken activity interspersed with periods of
uneventful ness. No one can physically trade 24 hours a day. You need your rest and
recreation.
Trader House has come up with a novel solution. It has set up a tutorial centre (with a
night school for those with a day job) and a dealing room at the Cottesmore Country
Club in West Sussex. You can play hard in the forex markets and chill out later in the
bar, the gym, the pool or on the golf course - all for the rental of a dealing desk. Who
needs the Lottery!

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CURRENCY FUTURES
A transferable futures contract that specifies the price at which a specified currency can
be bought or sold at a future date. Currency future contracts allow investors to hedge
against foreign exchange risk. Since these contracts are marked-to-market daily,
investors can--by closing out their position--exit from their obligation to buy or sell the
currency prior to the contract's delivery date.
A currency future, also FX future or foreign exchange future, is a futures contract
to exchange one currency for another at a specified date in the future at a price
(exchange rate) that is fixed on the last trading date. Typically, one of the currencies is
the US dollar. The price of a future is then in terms of US dollars per unit of other
currency. This can be different from the standard way of quoting in the spot foreign
exchange markets.
The trade unit of each contract is then a certain amount of other currency, for instance
EUR 125,000. Most contracts have physical delivery, so for those held at the end of the
last trading day, actual payments are made in each currency. However, most contracts
are closed out before that.
Investors use these futures contracts to hedge against foreign exchange risk. They can
also be used to speculate and, by incurring a risk, attempt to profit from rising or
falling exchange rates. Investors can close out the contract at any time prior to the
contract's delivery date.
Currency futures were first created at the Chicago Mercantile Exchange (CME) in
1972, less than one year after the system of fixed exchange rates was abandoned along
with the gold standard. Some commodity traders at the CME did not have access to the
inter-bank exchange markets in the early seventies, when they believed that significant
changes were about to take place in the currency market. They established the
International Monetary Market (IMM) and launched trading in seven currency futures
on May 16, 1972. Today, the IMM is a division of CME. In the second quarter of 2005,
an average of 332,000 contracts with a notional value of USD 43 billion were traded
every day. Most of these are traded electronically nowadays.
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The Advantages of Trading Currency Futures

Currency futures trade nearly 24 hours. Traders looking to profit from market
movements can act any time of the day or night during the trading week to take
advantage of changing market conditions. CME currency futures trade virtually
24 hours per day during the trading week, and XPRESSTRADE gives you the
ability to trade in the open-outcry pits or on the Globex electronic platform, day
or night.

FX markets are deep and liquid. Traders can enter the market and exit positions
efficiently. Since their inception, CME currency futures have produced an
active trading environment through which customers collectively place trades
worth up to $32.1 billion (CME single-day notional volume record, December
9, 2002). The success of FX futures has created a robust trading environment.

Currency futures offer diversification. In today's equity market environment,

diversification is a critical factor in individual portfolio management. Because
exchange rates march to their own beat, currency futures can offer valuable
diversification for an investment portfolio that has equity market risk. On a historical
basis, changes in exchange rates have had very low correlations with price movements
in stock market values and interest rates. This lack of any systematic relationship can
lower portfolio risk and generate positive returns when other markets are in a
depressed state.

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OPTIONS ON FUTURE CONTRACTS

INTRODUCTION
Options on futures contracts have added a new dimension to futures trading. Like
futures, options provide price protection against adverse price moves. Present-day
options trading on the floor of an exchange began in April 1973 when the Chicago
Board of Trade created the Chicago Board Options Exchange (CBOE) for the sole
purpose of trading options on a limited number of New York Stock Exchange-listed
equities. Options on futures contracts were introduced at the CBOT in October 1982
when the exchange began trading Options on U.S. Treasury Bond futures.
What Are Options?
There are two basic types of options on futures contracts: "calls" and "puts." A call
option on futures contracts conveys the right (but not the obligation) to the buyer to
purchase a specific futures contract (for example, a corn contract for a December 1997
delivery month) at a particular price during a specified period of time. A put option
conveys the right (but not the obligation) to the buyer to sell a specific futures contract
at a given price during a specified period of time. The price for which the futures
contract can be brought (in the case of a call option) or sold (in the case of a put
option) under the terms of the option contract is referred to as the option's strike price
or exercise price. The date on which an option expires--the date after which it can no
longer be exercised--is the option's expiration date. The price of a specific option, that
is, the amount of money paid by the buyer of an option and received by the seller of
any option, is the option premium.
Where Are Options Traded?
Options are traded on the same exchanges as those of the underlying futures contracts.
There are 11 different commodity exchanges in the U.S. as well as abroad. The major
domestic agricultural crops are traded on the Chicago Board of Trade, the Kansas City
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Board of Trade, the Minneapolis Grain Exchange, the New York Cotton Exchange, and
the Coffee, Sugar and Cocoa Exchange.

How Are Options Traded?

Options contracts are traded in much the same manner as their underlying futures
contracts. There are several important factors to remember when trading options. The
most important one is that trading a call option is completely separate and distinct from
trading a put option. If producers buy or sell a call option, it does not in any way
involve a put option. Trading a put does not involve a call option. Calls and puts are
separate contracts, not opposite sides of the same transaction.
At any given time, there is simultaneous trading in a number of different call and put
options--different in terms of delivery months and strike prices. Option delivery
months are typically the same as those of the underlying futures contract.
Strike prices are listed in predetermined multiples for each commodity. The listed
strike prices will include an at- or near-the-money option, at least five strikes below,
and at least nine strikes above the at-the-money option.
At-the-money is defined as an option whose strike price is equal--or approximately
equal--to the current market price of the underlying futures contract. The five lower
strikes would follow normal intervals. The nine higher strikes would include five
normal intervals above the at-the-money option(s), plus an additional four strikes listed
in even strikes that are double the normal interval.
As prices increase or decrease, additional strike prices are listed as needed so that there
are always five strike prices listed in normal intervals and four strike prices in double
intervals above the current futures price, and at lease five strike prices below the
current futures prices.
An important difference between futures and options is that trading in futures contracts
is based on prices, while trading in options is based on premiums. The premium
depends on market conditions such as volatility, time until expiration, and other
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economic variables affecting the value of the underlying futures contract. How various
factors influence premiums and how and to what extent market price declines are
offset by option profits are among the topics to discuss in detail with a broker.
The premium is the only part of the option contract negotiated in the trading pit; all
other contract terms are predetermined. For an option buyer, the premium represents
the maximum amount that he or she can lose, since the buyer is limited only to his
initial investment. For an option seller, however, the premium represents the maximum
amount he or she can gain, since the option seller faces the possibility of the option
being exercised against him or her. When an option is exercised, the futures position
assigned to an option seller will almost always be a losing one, since only an in-themoney option will normally be exercised by the option buyer.
Reasons for using Options
Options differ considerably from futures. When used prudently, options can be of
immense importance, especially in attempting to preserve the value of an existing
fixed-income

portfolio.

To many in the financial markets, options are considered "insurance" against adverse
price movements while offering the flexibility to benefit from possible favorable price
movement.
The reasons for using options on futures are reflected in the structure of an option
contract.
First, an option, when purchased, gives the buyer the right, but not the obligation, to
buy or sell a specific amount of a specific commodity at a specific price within a
specific period of time. By comparison, a futures contract requires a buyer or seller to
perform under the terms of the contract if an open position is not offset before
expiration.
Second, the decision to exercise the option is entirely that of the buyer.
Third, the purchaser of the option can lose no more than the initial amount of money
invested (premium). That is not the case, however, for the buyer of a futures contract.

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Finally, an option buyer is never subject to margin calls. This enables the purchaser to
maintain a market position, despite any adverse moves without putting up additional
funds.
Options Terminology
There are several important terms the would-be user of options on futures should
understand. They include:
Call option:
Gives the buyer the right, but not the obligation, to buy a specific futures
contract at a predetermined price within a limited period of time.
Put option:
Gives the buyer the right, but not the obligation, to sell a specific futures
contract at a predetermined price within a limited period of time.
Holder:
The buyer of the option.
Premium:
The dollar amount paid by the buyer of the option to the seller.
Writer:
The option seller.
Strike price:
The predetermined price at which a given futures contract can be bought or
sold. Also called the exercise price, these levels are set at regular intervals.
For example, if Treasury bond futures were at 79-00, T-bond option strike
prices would be at 74, 76, 78, 80, 82, and 84.
At-the-money:
An option is at-the-money when the underlying futures price equals, or nearly
equals, the strike price. For example, a T-bond put or call option is at-themoney if the option strike price is 78 and the price of the Treasury bond futures
contract is at, or near, 78-00.
In-the-money:
A call option is in-the-money when the underlying futures price is greater than
the strike price. For example, if Treasury bond futures are at 80-00 and the TPage
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bond call option strike price is 78, the call is in-the-money. The put option is inthe-money when the strike price of the option is greater then the price of the
underlying futures contract. For example, if the strike price of the put option is
80 and T-bond futures are trading at 77-00, the put option is in-the-money.
Out-of-the-money:
A call option is out-of-the-money if the strike price is greater than the
underlying futures price. For example, if T-bond futures are at 80-00 and the Tbond call option has an 82 strike price, the option is out-of-the-money. The put
option is out-of-the-money if the underlying futures price is greater then the
strike price. For example, if T-bond futures are at 77-00, and the T-bond put
option strike price is 76, the put option is out-of-the-money.
Options are considered "wasting assets." In other words, they have a limited life
because each expires on a certain day, although it may be weeks, months, or years
away. The expiration date is the last day the option can be exercised, otherwise it
expires worthless.
For every option buyer there is an option seller. In other words, for every call buyer
there is a call seller; for every put buyer, a put seller. The buyer of the option, unlike
the buyer of a futures contract, need not worry about margin calls. However, the seller
of

the

option

is

generally

required

to

post

margin.

If an option position is covered, the seller holds an offsetting position in the

underlying commodity itself or a futures contract. For example, the seller of a Treasury
bond call option would be covered if he actually owned cash market U.S. Treasury
bonds

or

was

long

the

Treasury

bond

futures

contract.

If the writer did not hold either, he would have an uncovered or "naked" position.

In such instances, margin would be required because the seller would be obligated to
fulfill terms of the option contract in the event the contract is exercised by the buyer. It
is imperative, therefore, that the seller demonstrate the ability to meet any potential

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contractual obligations beforehand. In addition, the seller of uncovered options on
interest rate futures assumes the potential for significant losses.
Motives for Buying and Selling Options
One may be a buyer or seller of call or put options for a variety of reasons.
A call option buyer, for example, is bullish. That is, he or she believes the price of the
underlying futures contract will rise. If prices do rise, the call option buyer has three
courses

of

action available.

The first is to exercise the option and acquire the underlying futures contract at the
strike price. The second is to offset the long call position with a sale and realize a
profit. The third, and least acceptable, is to let the option expire worthless and forfeit
the unrealized profit.
The seller of the call option expects futures prices to remain relatively stable or to
decline modestly. If prices remain stable, the receipt of the option premium enhances
the rate of return on a covered position.
If prices decline, selling the call against a long futures position enables the writer to
use the premium as a cushion to provide downside protection to the extent of the
premium received.

For instance, if T-bond futures were purchased at 80-00 and a call option with an 80
strike price was sold for 2-00, T-bond futures could decline to the 78-00 level before
there would be a net loss in the position (excluding, of course, margin and commission
requirements).
However, should T-bond futures rise to 82-00, the call option seller forfeits the
opportunity for profit because the buyer would likely exercise the call against him and
acquire

futures

position

at

80-00

(the

strike

price).

In many instances, puts will be purchased in conjunction with a long cash or long Tbond futures position for "insurance" purposes. For instance, if an institution is long TPage
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bond futures at 82-00 and a T-bond put option with an 82 strike is purchased for 2-00,
the futures contract could, theoretically, fall to zero and the put option holder could
exercise the option for the 82 strike price, assuming the option had not yet expired.
The seller of put options on fixed-income securities believes interest rates will stay at
present levels or decline. In selling the put option, the writer, of course, receives
income. However, if interest rates rise, the buyer of the put option can require the
writer to take delivery of the underlying instrument at a price greater than that in the
new

market

environment.

Since an option is a wasting asset, an open position must be closed or exercised,

otherwise the option expires worthless. The chart below illustrates what happens to the
buyer and the seller after an option is exercised.
Option Premium Valuation
The price (value) of an option premium is determined competitively by open outcry
auction on the trading floor of the CBOT. The premium is affected by the influx of buy
and sell orders reaching the exchange floor. An option buyer pays the premium in cash
to the option seller. This cash payment is credited to the seller's account.
Prices for T-bond and T-note futures contracts are quoted differently from the options
premiums on these futures. Options on these contracts are quoted in 64th of a point.
Therefore, a quote of -01 in options means 1/64, in futures, 1/32.

The option premium has two components: "intrinsic value" and "time value." The
intrinsic value is the gross profit that would be realized upon immediate exercise of
the option. In other words, intrinsic value is the amount by which the portion is in-themoney. (An option that is out-of-the- money or at-the-money has no intrinsic value.)

For example, in December, a June Treasury bond futures contract is priced at 82-00,
while the June 80 call is priced at 3 10/64. The intrinsic value of the option is 2-00:

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Time value reflects the probability the option will gain in intrinsic value or become
profitable to exercise before it expires.
Time value is determined by subtracting intrinsic value from the option premium:
Several other factors also have an impact on the premium. One is the relationship
between the underlying futures price and strike price. The more an option is in-themoney, the more it is worth.
A second factor is volatility. Volatile prices of the underlying commodity can
stimulate option demand, enhancing the premium. The greater the volatility, the greater
the chance the option premium will increase in value and the option will be exercised;
thus,

buyers

pay

more

while

writers

demand

higher

premiums.

A third factor affecting the premium is time until expiration. Since the underlying
value of the futures contract changes more within a longer time period, option
premiums are subject to

greater fluctuation.

Some parallels can be drawn between the time value component of an option premium
and the premium charged for an automobile insurance policy. The longer the term of
the policy, the greater the probability a claim will be made by the policyholder. This, of
course, presents a greater risk to the insurance company. To compensate for this
increased risk, the insurer charges a greater premium.

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CURRENCY SWAPS
Currency Swaps are derivative products that help manage exchange rate and interest
rate exposure on long-term liabilities. A Currency Swap involves exchange of interest
payments denominated in two different currencies for a specified term, along with
exchange of principals. The rate of interest in each leg could either be a fixed rate, or a
floating rate indexed to some reference rate, like the LIBOR.
Consider a corporate who has a USD loan with interest rate at a spread over 6-month
LIBOR. The corporate faces the following risks:

Currency risk: If the rupee depreciates against USD, it will be more expensive
for the corporate to service its loan

Interest rate risk: An upward movement in LIBOR would increase the cost of
servicing the loan

In order to hedge its risks the corporate can enter into a currency swap where it moves
from USD floating rate loan to a INR fixed rate loan. The currency swap could be
represented as follows:
Currency Swaps therefore enable a swap into both, a different currency and a different
interest rate basis. Some of the advantages of currency swaps are:

Enables moving a liability from one currency into another

Can be customized

Can be reversed at any time (at a cost or benefit)

Off Balance Sheet, and does not change the terms of the existing liability.
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Currency swaps can be structured to synthetically move liabilities in one currency to
another depending on which risks and what costs are acceptable. The interest rates on
either of the legs can be floating or fixed.

It is also possible to move rupee liabilities into foreign currencies through currency
swaps. Corporates wishing to match currency of loan repayments with currency of
receivables (for example, exporters having a long tenor Rupee liabilities) could enter
into such swaps. Corporates could also undertake such swaps if they wish to take
advantage of lower interest rates in return for exchange rate risk.
Consider a corporate that has an INR 25 Crores loan at 9% fixed rate, repayable bullet
at the end of two years. If this corporate wishes to swap its liability into a USD loan,
the structure of the loan would be as follows:
The cash flows in this swap would be as follows:
At inception
None. The loan is notionally converted from INR into USD at current USDINR spot
rate. These will then be the principal amounts on which the interest will be computed.
.Every 6 months
Company pays to the bank 6 month USD LIBOR plus a spread on the notional USD
principal
Company receives from the bank Rupee interest @ 9% on the notional INR principal
.At maturity
Company receives INR principal from IDBI Bank.
Pays USD principal to the IDBI Bank.
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The company therefore gains from a lower interest rate loan, for which it bears the cost
of INR depreciation against USD during the tenor of the swap.
Currency swaps can be used to move from any currency to any other desired currency
and interest rate.

For example, a corporate could swap its INR liability into JPY to benefit from the low
JPY interest rates. The risk of adverse JPY/USD exchange rate movement can be
limited to desired levels at a price. Such products can be customized to suit specific
corporate interest.
It is also possible to structure swaps to hedge specific risks. For example, there could
be swap such that only the principal amount of a foreign currency loan is protected at
current exchange rates (Principal Only Swap). Coupon swaps swaps involving only
interest payments and no principal amounts is another such variant.

THE EXCHANGE OF PRINCIPAL AT INCEPTION AND AT MATURITY

In an interest rate swap, we were concerned exclusively with the exchange of cash
flows relating to the interest payments on the designated notional amount. However,
there was no exchange of notional at the inception of the contract. The notional amount
was the same for both sides of the currency and it was delineated in the same currency.
Principal exchange is redundant.
However, in the case of a currency swap, principal exchange is not redundant. The
exchange of principal on the notional amounts is done at market rates, often using the
same rate for the transfer at inception as is employed at maturity.
For example, consider the US-based company ("Acme Tool & Die") that has raised
money by issuing a Swiss Franc-denominated Eurobond with fixed semi-annual
coupon payments of 6% on 100 million Swiss Francs. Upfront, the company receives

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100 million Swiss Francs from the proceeds of the Eurobond issue (ignoring any
transaction fees, etc.). They are using the Swiss Francs to fund their US operations.

ADVANTAGES OF USING CURRENCY SWAP

.FLEXIBILITY
Currency swaps give companies extra flexibility to exploit their comparative
advantage in their respective borrowing markets.
Interest rate swaps allow companies to focus on their comparative advantage in
borrowing in a single currency in the short end of the maturity spectrum vs. the longend of the maturity spectrum.
Currency swaps allow companies to exploit advantages across a matrix of currencies
and maturities.
The success of the currency swap market and the success of the Eurobond market are
explicitly linked.
.EXPOSURE
Because of the exchange and re-exchange of notional principal amounts, the currency
swap generates a larger credit exposure than the interest rate swap.
Companies have to come up with the funds to deliver the notional at the end of the
contract. They are obliged to exchange one currency's notional against the other
currency's notional at a fixed rate. The more actual market rates have deviated from
this contracted rate, the greater the potential loss or gain.

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This potential exposure is magnified with time. Volatility increases with
time. The longer the contract, the more room for the currency to move to
one side or other of the agreed upon contracted rate of principal exchange.
This explains why currency swaps tie up greater credit lines than regular interest rate
swaps.

PRICING
We price or value currency swaps in the same way that we learned how to price
interest rate swaps, using a discounted cash flow analysis having obtained the zero
coupon version of the swap curves.
Generally, currency swaps transact at inception with a net present value of zero. Over
the life of the instrument, the currency swap can go in-the-money, out-of-the-money or
it can stay at-the-money.
CONCLUSION
Currency swaps allow companies to exploit the global capital markets more efficiently.
They are an integral arbitrage link between the interest rates of different developed
countries.
The future of banking lies in the securitization and diversification of loan portfolios.
The global currency swap market will play an integral role in this transformation.
Banks will come to resemble credit funds more than anything else, holding diversified
portfolios of global credit and global credit equivalents with derivative overlays used
to manage the variety of currency and interest rate risk.

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Derivatives
Commodities whose value is derived from the price of some underlying asset like
securities, commodities, bullion, currency, interest level, stock market index or
anything

else

are

known

as

Derivatives.

In more simpler form, derivatives are financial security such as an option or future
whose value is derived in part from the value and characteristics of another security,
the

underlying

asset.

It is a generic term for a variety of financial instruments. Essentially, this means you
buy a promise to convey ownership of the asset, rather than the asset itself. The legal
terms of a contract are much more varied and flexible than the terms of property
ownership.

In

fact,

its

this

flexibility

that

appeals

to

investors.

When a person invests in derivative, the underlying asset is usually a commodity,

bond, stock, or currency. He bet that the value derived from the underlying asset will
increase or decrease by a certain amount within a certain fixed period of time.
Futures and options are two commodity traded types of derivatives. An options
contract gives the owner the right to buy or sell an asset at a set price on or before a
given date. On the other hand, the owner of a futures contract is obligated to buy or
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sell

the

asset.

The other examples of derivatives are warrants and convertible bonds (similar to
shares in that they are assets). But derivatives are usually contracts. Beyond this, the
derivatives range is only limited by the imagination of investment banks. It is likely
that any person who has funds invested, an insurance policy or a pension fund, that
they are investing in, and exposed to, derivatives wittingly or unwittingly.
Shares or bonds are financial assets where one can claim on another person or
corporation; they will be usually be fairly standardized and governed by the property.
Derivatives securities or derivatives products are in real terms contracts rather than
solid as it fairly sounds.
SIGNIFICANCE OF THE STUDY
Forex market is changing day by day showing a wide growth in the economy.
Forex market is more volatile in nature.
There are different factors like speculation, hedging which force different people to
enter in different markets.
There is risk in Foreign market and various Risk management strategies are there
to manage it.
Risk management is done in order to minimize the adverse effects of potential
losses at the least possible cost.
How a person manages risk in foreign market, it depends upon his needs and
perception.
How a person trades in foreign market.
Due to all these factors, one can interpret that foreign market plays a significant role in
economy of any country and risk is managed by different strategies in foreign market
to maximize profit in the long run and that give a boost to the economy.

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ANALYSIS AND INTERPRETATIONS

Understanding Strategy and Analysis

All successful traders have a carefully thought out system that they follow to make
profitable trades. This system is generally based on a strategy that allows them to find
good trades. And the strategy is based on some form of market analysis. Successful
traders need some way to interpret and even predict some of the movements of the
market.
There are two basic approaches to analysing market movements, in both equity
markets and the FOREX market. These are technical analysis and fundamental
analysis. However, technical analysis is much more likely to be used by traders. Still,
its good to have an understanding of both types of analysis, so that you can decide
which type would work best for your system.

Fundamental Analysis
In fundamental analysis, you are basically valuing either a business, for equity
markets, or a country, for FOREX. If you think it's hard enough to value one company,
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you should try valuing a whole country. It can be quite difficult to do, but there are
indicators that can be studied to give insight into how the country works. A few
indicators you might want to study are: Non-farm payrolls, Purchasing Managers
Index (PMI), Consumer Price Index (CPI), Retail Sales, and Durable Goods.
Most traders in the FOREX market only use fundamental analysis to predict long-term
trends. However, some traders do trade short-term based on the reactions to different
news releases. There are also quite a variety of meetings where you can get quotes and
commentary that can affect markets just as much as any news release or indicator
report. These meetings are often discuss interest rates, inflation, and other issues that
have the ability to affect currency values.
Even changes in how things are worded in statements addressing these types of issues,
such as the Federal Reserve chairman's comments on interest rates, can cause volatility
in the market. Two important meetings that you should watch for are the Federal Open
Market Committee and the Humphrey Hawkins Hearings.
Just by reading the reports and examining the commentary, a FOREX fundamental
analyst can get a better understanding of most long-term market trends. Keeping up on
these developments will also allow short-term traders to profit from extraordinary
happenings. If you do decide to follow a fundamental strategy, you will want to keep
an economic calendar handy at all times so you know when these reports are released.
Your broker may also be able to provide you with real-time access to this kind of
information.
Technical Analysis
Just like their counterparts in the equity markets, technical analysts in the FOREX
market analyze price trends. The only real difference between technical analysis in
FOREX and technical analysis in equities is the time frame. FOREX markets are open
24 hours a day.
Because of this, some forms of technical analysis that factor in time have to be
modified so that they can work in the 24-hour FOREX market. Some of the most

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common forms of technical analysis used in FOREX are: Elliott Waves, Fibonacci
studies, Parabolic SAR, and Pivot points.
A lot of technical analysts combine technical indicators to make more accurate
predictions. (The most common tendency is to combine Fibonacci studies with Elliott
Waves.) Others prefer to create entire trading systems in an effort to repeatedly locate
similar buying and selling condition.

FINDINGS
Trading by Numbers Eighteen Tips
You can never have too many tips or tricks up your sleeve when you are trading. Most
of the tips Im including here are received wisdom, trading truisms that you should
remember. They apply to all markets, but are particularly useful in a volatile and
technical market like the FOREX
1. Pay attention to the market. Exit and enter trades based on market information.
Dont wait for a price you think the currency should hit when the market has
changed direction on you.
2. There are times when, due to a lack of liquidity or excessive volatility, you
should not trade at all. On a similar note, never trade when you are sick. You
cant count on yourself to be alert to the shifts of the markets, and make good
decisions.
3. Trading systems that work in an up market may not work in a down market,
and a system that works for trending markets, or for range bound markets may
not work in other markets. Have a system for each type of market.
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4. Up market and down market patterns are ALWAYS there, but you have to look
for the dominant trends. Always select trades that move with the trends
5. During the blowout stage of the market, either up or down, the risk managers
are usually issuing margin call position liquidation orders. They don't generally
check the screen to see whats overbought or oversold; they just keep issuing
liquidation orders. Make sure you stay out of their way.
6. Trust your instincts. If something feels wrong about a trade, dont make it. Its
better to be superstitious than to loose money.
7. Rumour is king. Buy when you hear the rumour, sell when you hear the news.
8. The first and last ticks are always the most expensive. Get in the market late,
and out early. And never trade in the direction of a gap, either opening or
closing.
9. When everyone else is in, it's time for you to get out. If a stock or currency is
overbought, its time to exit your position.
10. Dont worry about missing out on an opportunity to trade. There will always be
another good one just around the corner. If the trade you are considering
doesnt meet all your entry signals but it seems to good to pass up, remember,
youre never going to run out of trades you can make.
11. Dont get too confident. No one can predict the market with 100% accuracy.
You need to always expect the unexpected. If you become uneasy, or the
market becomes choppy, exit your trades.
12. Don't turn three losing trades in a row into six. When youre off, turn off the
screen, do something else. Often the best way to break a streak of consecutive
loses is to not trade for a day.
13. Measure your success by the profit made in a day, not on a trade. Its even
better to measure it over two or three days. A successful traders goal is to
make money, not to win on every trade.
14. Scalpers reduce the number of variables affecting market risk by being in a
position only for a few seconds. Day traders reduce market risk by being in
trades for minutes. If you convert a scalp or day trade into a position trade, you
probably didnt analyze the risks of the trade properly.
15. There is no secret to understanding the market. You can spend much of your
valuable time and money looking for these kinds of secrets. Its better to take
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the time to create a solid trading system, and realize that the secret to success is
hard work.
16. Never ask for someone else's opinion, they probably didnt do as much
homework as you did anyways.
17. When the market is going up, say it out loud. When the market is going down,
say that out loud too. Youll be amazed at how hard it is to say what is going on
right in front of you when you want it the market to be doing something else.

HOW TO AVOID TYPICAL PITFALLS AND START MAKING MORE

MONEY IN YOUR FOREX TRADING
1. Trade pairs, not currencies - Like any relationship, you have to know both
sides. Success or failure in forex trading depends upon being right about both
currencies and how they impact one another, not just one.
2. Knowledge is Power - When starting out trading forex online, it is essential
that you understand the basics of this market if you want to make the most of
your investments.
3. Unambitious trading - Many new traders will place very tight orders in order
to take very small profits. This is not a sustainable approach because although
you may be profitable in the short run (if you are lucky), you risk losing in the
longer term as you have to recover the difference between the bid and the ask
price before you can make any profit and this is much more difficult when you
make small trades than when you make larger ones.
4. Over-cautious trading - Like the trader who tries to take small incremental
profits all the time, the trader who places tight stop losses with a retail forex
broker is doomed. As we stated above, you have to give your position a fair
chance to demonstrate its ability to produce. If you don't place reasonable stop
losses that allow your trade to do so, you will always end up undercutting
yourself and losing a small piece of your deposit with every trade.
5. Independence - If you are new to forex, you will either decide to trade your
own money or to have a broker trade it for you. So far, so good. But your risk
of losing increases exponentially if you either of these two things:
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Interfere with what your broker is doing on your behalf (as his strategy might
require a long gestation period);
Seek advice from too many sources - multiple input will only result in multiple
losses. Take a position, ride with it and then analyse the outcome - by yourself,
for yourself.
6. Tiny margins - Margin trading is one of the biggest advantages in trading
forex as it allows you to trade amounts far larger than the total of your deposits.
However, it can also be dangerous to novice traders as it can appeal to the
greed factor that destroys many forex traders. The best guideline is to increase
your leverage in line with your experience and success.
7. No strategy - The aim of making money is not a trading strategy. A strategy is
your map for how you plan to make money. Your strategy details the approach
you are going to take, which currencies you are going to trade and how you
will manage your risk. Without a strategy, you may become one of the 90% of
new traders that lose their money.
8. Trading Off-Peak Hours - Professional FX traders, option traders, and hedge
funds posses a huge advantage over small retail traders during off-peak hours
(between 2200 CET and 1000 CET) as they can hedge their positions and move
them around when there is far small trade volume is going through (meaning
their risk is smaller). The best advice for trading during off peak hours is
simple - don't.
9. The only way is up/down - When the market is on its way up, the market is on
its way up. When the market is going down, the market is going down. That's
it. There are many systems which analyse past trends, but none that can
accurately predict the future. But if you acknowledge to yourself that all that is
happening at any time is that the market is simply moving, you'll be amazed at
how hard it is to blame anyone else.
10. Trade on the news - Most of the really big market moves occur around news
time. Trading volume is high and the moves are significant; this means there is
no better time to trade than when news is released. This is when the big players
adjust their positions and prices change resulting in a serious currency flow.
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11. Exiting Trades - If you place a trade and it's not working out for you, get out.
Don't compound your mistake by staying in and hoping for a reversal. If you're
in a winning trade, don't talk yourself out of the position because you're bored
or want to relieve stress; stress is a natural part of trading; get used to it.
12. Don't trade too short-term - If you are aiming to make less than 20 points
profit, don't undertake the trade. The spread you are trading on will make the
odds against you far too high.

13. Don't be smart - The most successful traders I know keep their trading simple.
They don't analyse all day or research historical trends and track web logs and
their results are excellent.
14. Tops and Bottoms - There are no real "bargains" in trading foreign exchange.
Trade in the direction the price is going in and you're results will be almost
guaranteed to improve.
15. Ignoring the technicals- Understanding whether the market is over-extended
long or short is a key indicator of price action. Spikes occur in the market when
it is moving all one way.
16. Emotional Trading - Without that all-important strategy, you're trades
essentially are thoughts only and thoughts are emotions and a very poor
foundation for trading. When most of us are upset and emotional, we don't tend
to make the wisest decisions. Don't let your emotions sway you.
17. Confidence - Confidence comes from successful trading. If you lose money
early in your trading career it's very difficult to regain it; the trick is not to go
off half-cocked; learn the business before you trade. Remember, knowledge is
power.

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SUGGESTIONS
1. Take it like a man - If you decide to ride a loss, you are simply displaying
stupidity and cowardice. It takes guts to accept your loss and wait for tomorrow
to try again. Sticking to a bad position ruins lots of traders - permanently. Try to
remember that the market often behaves illogically, so don't get commit to any
one trade; it's just a trade. One good trade will not make you a trading success;
it's ongoing regular performance over months and years that makes a good
trader.
2. Focus - Fantasizing about possible profits and then "spending" them before you
have realized them is no good. Focus on your current position(s) and place
reasonable stop losses at the time you do the trade. Then sit back and enjoy the
ride - you have no real control from now on, the market will do what it wants to
do.
3. Don't trust demos - Demo trading often causes new traders to learn bad habits.
These bad habits, which can be very dangerous in the long run, come about
because you are playing with virtual money. Once you know how your broker's
system works, start trading small amounts and only take the risk you can afford
to win or lose.
4. Stick to the strategy - When you make money on a well thought-out strategic
trade, don't go and lose half of it next time on a fancy; stick to your strategy
and invest profits on the next trade that matches your long-term goals.
5. Trade today - Most successful day traders are highly focused on what's
happening in the short-term, not what may happen over the next month? If
you're trading with 40 to 60-point stops focus on what's happening today as the
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market will probably move too quickly to consider the long-term future.
However, the long-term trends are not unimportant; they will not always help
you though if you're trading intraday.
6. The clues are in the details - The bottom line on your account balance doesn't
tell the whole story. Consider individual trade details; analyse your losses and
the telling losing streaks.
7. Generally, traders that make money without suffering significant daily losses
have the best chance of sustaining positive performance in the long term.
8. Simulated Results - Be very careful and wary about infamous "black box"
systems. These so-called trading signal systems do not often explain exactly
how the trade signals they generate are produced. Typically, these systems only
show their track record of extraordinary results - historical results. Successfully
predicting future trade scenarios is altogether more complex. The high-speed
algorithmic capabilities of these systems provide significant retrospective
trading systems, not ones which will help you trade effectively in the future.
9. Get to know one cross at a time - Each currency pair is unique, and has a
unique way of moving in the marketplace. The forces which cause the pair to
move up and down are individual to each cross, so study them and learn from
your experience and apply your learning to one cross at a time.
10. Risk Reward - If you put a 20 point stop and a 50 point profit your chances of
winning are probably about 1-3 against you. In fact, given the spread you're
trading on, it's more likely to be 1-4. Play the odds the market gives you.
11. Trading for Wrong Reasons - Don't trade if you are bored, unsure or reacting
on a whim. The reason that you are bored in the first place is probably because
there is no trade to make in the first place. If you are unsure, it's probably
because you can't see the trade to make, so don't make one.
12. Zen Trading- Even when you have taken a position in the markets, you should
try and think as you would if you hadn't taken one. This level of detachment is
essential if you want to retain your clarity of mind and avoid succumbing to
emotional impulses and therefore increasing the likelihood of incurring losses.
To achieve this, you need to cultivate a calm and relaxed outlook. Trade in brief
periods of no more than a few hours at a time and accept that once the trade has
been made, it's out of your hands.
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13. Determination - Once you have decided to place a trade, stick to it and let it
run its course. This means that if your stop loss is close to being triggered, let it
trigger. If you move your stop midway through a trade's life, you are more than
likely to suffer worse moves against you. Your determination must be show
itself when you acknowledge that you got it wrong, so get out.

14. Short-term Moving Average Crossovers - This is one of the most dangerous
trade scenarios for non professional traders. When the short-term moving
average crosses the longer-term moving average it only means that the average
price in the short run is equal to the average price in the longer run. This is
neither a bullish nor bearish indication, so don't fall into the trap of believing it
is one.
15. Stochastic - Another dangerous scenario. When it first signals an exhausted
condition that's when the big spike in the "exhausted" currency cross tends to
occur. My advice is to buy on the first sign of an overbought cross and then sell
on the first sign of an oversold one. This approach means that you'll be with the
trend and have successfully identified a positive move that still has some way
to go. So if percentage K and percentage D are both crossing 80, then buy!
(This is the same on sell side, where you sell at 20).
16. One cross is all that counts - EURUSD seems to be trading higher, so you buy
GBPUSD because it appears not to have moved yet. This is dangerous. Focus
on one cross at a time - if EURUSD looks good to you, then just buy
EURUSD.
17. Wrong Broker - A lot of FOREX brokers are in business only to make money
from yours. Read forums, blogs and chats around the net to get an unbiased
opinion before you choose your broker.
18. Too bullish - Trading statistics show that 90% of most traders will fail at some
point. Being too bullish about your trading aptitude can be fatal to your longterm success. You can always learn more about trading the markets, even if you

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are currently successful in your trades. Stay modest, and keep your eyes open
for new ideas and bad habits you might be falling in to.
19. Interpret forex news yourself - Learn to read the source documents of forex
news and events - don't rely on the interpretations of news media or others.

WEBLIOGRAPHY

WWW.BMS.CO.IN
WWW.SCRIBD.COM
WWW.GOOGLE.COM

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