Successful Trading

Understanding Forex Fundamentals
By: Dr. Ned Gandevani© 2006
 

What is Forex Market?
The Forex market is a financial instrument where one country's currency is converted to another. This market is a tool which allows multi national companies to exchange currencies to facilitate international trade and financial transactions. In a global economy, many of these companies need to exchange their home currency for a foreign currency to pay for their purchases and direct investments. Currency for payment of imports, direct investments, account payables are made possible by this conversion process. The opposite is also true when these same companies convert foreign currency back to their home currency due to export and receivables abroad. Thus, one can see why this market is a vital tool in the global economy. The system for establishing exchange rates has gone through major milestones over time.

Over 1.9 trillion dollars is traded daily in the Forex market, making it the largest financial market in the world. It trades around the clock, allowing all interested parties to react to any market conditions from political turmoil to financial instabilities of any country.

Conversely, this huge liquid market provides great trading opportunities for traders and speculators alike. Only 5% of daily activity is from multi nationals and governments who buy and sell currency related products. The remaining 95% is purely speculative trading.

The most traded currencies include; US Dollar, Japanese Yen, Euro, British Pound, Swiss Franc, Canadian Dollar and Australian Dollar. These currencies which are called “the Majors” comprise of about 85% of all daily transactions.  There is no specific centralized location or exchange for trading FX, (such as the NYSE, CME and the CBOT to name a few). It is all conducted Over The Counter (OTC) or “interbank”.

A Brief Historical Background.
Since its recognition in 1876, the foreign exchange market has evolved through three major phases; the gold standard, fixed exchange rate, and currently the floating rate system.

Gold Standard – It is defined as the use of gold as a base value for the currency of a country. From 1876 to 1913, each country could convert its currency into gold at a specified rate. Thus, gold was used as a guarantee and a convertibility rate for a country’s money.  However, when World War I began in 1914, the gold standard was abandoned due to the fact that countries did not adhere to it. Each country had to finance its war expenses and had to circulate more money without having proper gold to back it up.  Nevertheless, some countries reverted back to the gold standard in the 1920s. During the Great Depression, the gold standard was totally suspended due to a banking panic in the United Stated and Europe. Consequently, this resulted in severe restrictions on international trades for this period.

Fixed Exchange Rates – In July of 1944-45, nations gathered at the United Nations Monetary and Financial Conference in Bretton Woods New Hampshire, to discuss the postwar recovery of Europe and other monetary issues such as unstable exchange rates and restrictive protectionist trade policies.

In the 1930s, many of the world’s major economies lacked any stable currency exchange rates and used restrictive trade policies. A decade later, the United States and Great Britain proposed the creation of new financial institutions to boost trade and to stabilize exchange rates.

The delegates at Bretton Woods reached an agreement known as the Bretton Woods Agreement to establish a postwar international monetary system of convertible currencies, fixed exchange rates and free trade. To facilitate these objectives, the agreement created two international institutions: the International Monetary Fund (IMF) and the International Bank for Reconstruction and Development (the World Bank). The main intention was to provide economic aid for reconstruction of postwar Europe. An initial loan of $250 million was made to France in 1947, this was the World Bank’s first act.

The Bretton Woods Agreement which called for fixed exchange rates between currencies lasted until 1971. During this period, governments would intervene to avoid exchange rates from fluctuating more than one percent above or below their initially established levels.

By 1971, the US dollar appeared to be overvalued; the foreign demand for U.S. dollar was substantially less than the supply of dollars for sale. To adhere to the Bretton Woods agreement, the USA had to protect its gold stock fixed at $35 per ounce which was linked to its dollar. However, it did not have enough gold reserves to justify its huge dollar liabilities of dollar balances held by official institutions in other countries. America’s credibility was on the line due to its balance of payments problems. Therefore, it actively participated in the international exchange markets operations which made the fixed rate system unsustainable over time, ultimately breaking down in 1971 and finally collapsing in 1973. 

To fix the US dilemma, representatives from all major countries gathered and signed the Smithsonian Agreement which devalued the US dollar relative to other major currencies. It was agreed to rest the dollar’s value and allow a fluctuation for 2 percent in either direction from the newly set rates.

Floating Exchange Rate System – By 1973, it was evident that the Smithsonian Agreement nations were still unable to hold their agreement to keep the exchange rates within the agreed boundaries. As a result, currencies were allowed to fluctuate at much wider levels according to market forces. However, history has witnessed that the capital

market should ultimately be left alone so that market forces dictate and set values for currencies. Thus, the official boundaries were all eliminated.

By 1978, most countries had moved de facto to a floating exchange rate system. On that year, the International Monetary Fund (IMF) member countries were authorized to adopt the exchange arrangement of their choices; fixed or floating, tied to another currency or to a basket of currencies.

However, by the late 1990's, only large financial institutions were dominant forces in the FX market. In recent years, due to the advent of technology and internet access, many other speculators and traders have been able to participate actively in those markets.

Now, currency speculators and Forex traders are able to utilize their knowledge and trading experience to take advantage of these new opportunities. In this manual, you will learn how to trade the FX markets with low risk and the potential for significant profits.

Forex markets behave based on the non-linear dynamic systems theory. Like their counterpart markets such as equity futures, they exhibit stable habitual patterns. Through my own research in capital markets, I have deciphered the unique patterns of the FX market which constitutes the Winning Edge Forex System. In the following sections, I’ll go over the dynamic characteristics of the Forex markets.


Foreign Exchange
The foreign exchange market or Forex transactions, do not take place in a particular physical location or building. Multi national companies, banks and professional traders all exchange currencies through a commercial bank over a telecommunications network. Now, with the advent of internet broad band, all foreign exchange transactions are done electronically online.  In the following section, I go over briefly of the two major foreign exchange markets; spot market, and futures market.

Spot Market – Most foreign exchange transactions are done to convert currencies.

The market where the spot rate is transacted is known as the spot market. The average daily trading by banks around the world is about 1.9 trillion dollars, of which more than $200 billion is conducted in the U.S.  

Spot Market Structure- Many banks conduct and facilitate foreign exchange transactions, however, only the top 20 handle approximately 50 percent of the total transactions. Deutsche Bank (Germany), Citibank, and J.P. Morgan Chase are the largest leasers if foreign exchange trading. Many major banks and financial institutions have formed alliances together. For example, FX Alliance (www.fxall.com) is integrated to 57 of the world’s leading foreign exchange banks.

The high level of connectivity among leading foreign exchange banks provides a similar rate for various currencies among banks and other financial institutions for trading currencies. If there are any large discrepancies at any given time among the posted rates, other banks would buy the lower rate and sell them at higher price for profit.

There is however a foreign currency futures market which unlike spot market has a physical building named the Chicago Mercantile Exchange (www.cme.com). Although currency futures are not as active as the spot market, it is used for speculation and hedging purposes. 


Characteristics of the Forex Market
The Winning Edge Forex System is based on my proprietary market model which constructs on two pillars; Chaos Theory and Behavioral Finance.  Let us go over each pillar and components briefly so you could appreciate the amazing power of the systems accuracy and high winning probability.

Chaos Theory
This theory which covers non-linear dynamic systems behavior, asserts that the FX market behaves within specific boundaries called Strange Attractors. Strange Attractors act as gravitational orbits. Market participants, due to their hopes and fear factors create an Expansion and Contraction phenomenon. Since the FX market is global, the price level representing Strange Attractors are not fixed but vary in a dynamic matter. Winning Edge students have learned that the strange attractors in the S&P market, as an example, is rather fixed since the market’s behavior is based on dominant US market participants as the primary market. This phenomenon is seen in the market in a dynamic range bound pattern. The Winning Edge Forex proprietary indicators, paint bars indicators, identify these dynamic levels.


Behavioral Finance
The other pillar for the market model utilized in the developing of the Winning Edge Forex System is behavioral finance. This financial perspective that asserts behind any market move and price fluctuations provides the frame work to analyze the threshold of pain and pleasure. The market participants’ psychology follows the universal principal of expansion and contraction which exemplifies hope and fear. Conversely, we see that any of the Forex market moves are in a step down or step up format.  Generally, when the market moves up, it continues its upward move until it reaches the inherent boundary of the market known as our strange attractors. Once it reaches these levels, it will pause to form a range bound move, ultimately continuing either in its previous upward move, or revering the direction of the trend. 

Trend in Forex Market
In general, the currency market is more trending rather than range bound. This is due to the fact that it is influenced heavily by fundamental factors which seem to have a more lasting influence.  As a result, The Winning Edge Forex System is based on technical analysis which enables us to utilize trending behavior of the market for maximizing the system’s profit.  Although 95% of the volume of the FX trading is speculation, the significant portion of trading is directed by major international banks and institutions which are usually influenced by fundamental and macro economic factors rather than micro economic and trading developments.

Forex Market Profile
Forex markets are comprised of “major” currency pairs and other less liquid currency pairs known as “exotic” pairs. It’s imperative to recognize that currency pairs exhibit rather two distinct patterns. One set is generally more trending rather than range bound, and others are range bound and therefore less trending. In other words, a Forex trader should not look for a one-size fit all approach to trading the market. The Winning Edge Forex System recognizes this issue that some of the currency pairs exhibit discrete behaviors. To be a successful Forex trader, you need to understand the underlying characteristics of each Forex market. For instance, EUR/USD which is among the most active currency pairs constitutes about 1/3 of the Forex trading according to the most recent survey by Bank for International Settlements (BIS) of currency markets.  Furthermore, EUR/USD is influenced by other Euro-crosses such as EUR/GBP, EUR/CHF, and EUR/JPY. This means that if the dollar is weak, you should see an increase in EUR/USD. However, this increase would show an erratic and relatively volatile move. This is due to the fact that other currency pairs like USD/CHF would appreciate which in turn pushes down and reduces EUR/CHF. Conversely, this chain reaction creates a counter moves for the EUR/USD.  This is while originally EUR/USD was in its upward move. As a result, EUR/USD exhibits a “backing and filing” behavior in which it tests important support and resistance levels. The Winning Edge Forex System shows you how to take the most advantage of these types of behavior for maximum profits.

On the other hand, a currency pair like USD/JPY exhibits different price behavior. As the second most actively traded currency, this currency pair counts for about 17% of daily global volume according to the BIS 2004 survey. The Japanese yen represents mainly Asian macroeconomic conditions. Its price movement is pretty much keen to macro economic and fundamental variables of the region. Although China could easily compete with Japan, the yen still remains the key trading currency of that region. This means that the USD/JPY tends to be quite volatile. Historically, USD/JPY depicts more a trending pattern on longer time frames (e.g. daily, weekly) rather than on shorter chart formations of intraday moves. The sustained trending move in USD/JPY is mainly due to its market participants’ dynamics and herd mentality. Japanese investors seem to act in groups and therefore create cluster of support and resistance.  

Overall, you should note that Forex exhibits similar chart pattern and behaviors like other financial markets. I discuss more about these patterns in details in Part III.

Major currency pairs
Trading foreign exchange is simultaneously buying one currency and selling another one. Therefore, you always deal with a pair of currencies. There are six major currency pairs which are called “major markets.” They are:
EUR/USD - Euro dollar and US dollar,
USD/JPY - US dollar and Japanese Yen,
USD/CHF - US dollar and Swiss Frank,
GBP/USD - British Pound and US Dollar,
USD/CAD - US Dollar and Canadian Dollar. 

How to read Forex quotes?
Foreign exchange quotes are easy to understand, as long as you know what the “base” currency is.  Consider 117.40 USD/JPY which is a pair quote between US dollar and the Japanese yen. This says that for every “one” US dollar, you could have 117.40 Japanese yen. In this quote, the US dollar is the base rate which appears on top. Therefore, for every currency where the base rate is the US dollar and appears on top, you would have a foreign currency equivalent to one US dollar.  For another example, let’s look at the currency pair of USD/CHF (US dollar and Swiss franc). If the quote reads 1.2987, it entails that for every dollar you have; you can convert it to 1.2987 Swiss francs. Again, the rate which appears at the top is the base rate.

As a Forex trader, you may wish to focus on US dominated currencies which have higher trading volume and liquidity. As an example, if the US dollar appreciates in value, currency pairs such as USD/CHF, USD/JPY, and USD/CAD all decrease against the greenback. However, if you think that the dollar will devalue, then you should buy EUR/USD, AUD/USD, GBP/USD, and NZD/USD for profit. In these pairs, when USD devalues, the currency pair moves higher. In other words, if you convert a US dollar, you would get less of currencies in the Euro, Australian dollar or the British Pound (also known as Sterling or Cable).

To put it differently if a currency quote appreciates; it increases the value of the base currency.  Conversely, a lower quote means the base currency is weakening.

There are other currency pairs that do no involve US dollar. They are called cross currencies. For example EUR/JPY 139.95, indicates that you can buy 139.95 Japanese Yen with one Euro.  Currency pairs with less trading volume and less demand for exchange are also called exotic currencies. For instance, currencies for Brazil, Mexico, Korea and Russia are part of exotic currencies with US dollar as the base currency. I.e. USD/Real or USD/KRW.

Forex Market Jargons
Traders in Forex markets have their jargons and phrases.  To avoid feeling like an outsider, you should know these jargons; they help you look like a seasoned currency trader:

Aussie – nickname for the Australian dollar
Cable - sterling, pound – they all denote the Great British Pound (GBP)
Figure – refers to any round number like 1.3000
Greenback, buck – refers to the US dollar
Loonie, the little dollar – nicknames for the Canadian dollar|
Kiwi – refers to the New Zealand dollar
Swissie – denotes the Swiss franc
Yard – refers to a billion units, as in “I bought two yards of cable.”

  A sample of trading signals for USD/CHF market:

   
Please click here to read Risk Disclosure.   

Sign Up Now!

Key Benefits

• Day, swing or position trading signals

• Comprehensive manual.

• Precise and objective entry signals.

• Clear exit signals.

• High number of winning trades.

• Course could be take in person, over the phone or on the internet on-line.

• All trainings are one to one for relaxing environment and full attention for each students needs.

Use any of your major credit card to sign up for Winning Edge Forex System

We Accept  PayPal or