Thursday, August 10, 2006

The Currency Exchange Market
The currency exchange market is an inter-bank or inter-dealer market that was established in 1971 when floating exchange rates began to materialize. In addition, it is an Over-The-Counter market, meaning that transactions are conducted between any two counter parties that agree to trade via the telephone or electronic network. Trading is thus not centralized, as is the case with many stock markets (i.e., NYSE, ASE, CME) or as the case for currency futures and currency options, which trade on special exchanges. Dealers often "advertise" exchange rates using a distribution network, such as the one provided by Reuters or Bridge. Dealers then use the information obtained there (or directly) to "agree" to a rate and a trade.

The major dealing centers today are: London, with about 30% of the market, New York, with 20%, Tokyo, with 12%, Zurich, Frankfurt, Hong Kong and Singapore, with about 7% each, followed by Paris and Sydney with 3% each.

In terms of trading volume, the currency exchange market is the worlds largest market, with daily trading volumes in excess of $1.5 trillion US dollars. This is orders of magnitude larger than the bond or stock market. For example, the New York Stock Exchange has a daily trading volume of approximately $60 billion. Thus, the currency exchange market is by far the most liquid market in the world today. Because of the volume in trading, it is impossible for individuals or companies to affect the exchange rates. In fact, even central banks and governments find it increasingly difficult to affect the exchange rates of the most liquid currencies, such as the US dollar, Japanese Yen, Euro, Swiss Frank, Canadian Dollar or Australian Dollar.

The currency exchange market is a true 24-hour market, 5 days a week. There are dealers in every major time zone. Trading begins Monday morning in Sydney (which corresponds to 3pm EST, Sunday) and then daily moves around the globe through the various trading centers until closing Friday evening at 4:30pm EST in New York.

Today, over 85% of all currency exchange transactions involve a few major currencies: the US Dollar (USD), Japanese Yen (JPY), Euro (EUR), Swiss Frank (CHF), British Pound (GBP), Canadian Dollar (CAD), and Australian Dollar (AUD). In the currency exchange market, most of the currencies are traded only against the US Dollar. The term cross rate refers to an exchange rate between two non-dollar currencies. Trading between two non-dollar currencies usually occurs by first trading one against the US Dollar and then trading the US Dollar against the second non-dollar currency. Because of this, the spread in the exchange rate between two non-dollar currencies is often higher. (There are a few non-dollar currencies that are traded directly, such as GBP/EUR or EUR/CHF.) The following directly traded currency pairs make up the vast majority of the trading volume and are thus considered to be the most important ones: EUR/USD, USD/JPY, EUR/JPY, USD/CAD, EUR/GBP, GBP/USD, USD/CHF, AUD/USD, and AUD/JPY.
How currency trading is done traditionally
Currency trading is always done with currency pairs, such as EUR/USD, and so it is useful to consider the currency pair as an instrument, which can be bought or sold.

Buying the currency pair implies buying the first, base currency and selling (short) an equivalent amount of the second, quote currency (to pay for the base currency). (It is not necessary for the trader to own the quote currency prior to selling, as it is sold short.) A speculator buys a currency pair, if she believes the base currency will go up relative to the quote currency, or equivalently that the corresponding exchange rate will go up.
Selling the currency pair implies selling the first, base currency (short), and buying the second, quote currency. A speculator sells a currency pair, if she believes the base currency will go down relative to the quote currency, or equivalently, that the quote currency will go up relative to the base currency.
After buying a currency pair, the trader will have an open position in the currency pair. Right after such a transaction, the value of the position will be close to zero, because the value of the base currency is more or less equal to the value of the equivalent amount of the quote currency. In fact, the value will be slightly negative, because of the spread involved.

In todays currency market, a trade goes through a three-step process:

the trader communicates the currency pair and the amount he/she would like to trade with another dealer.
the dealer responds with a bid and an ask price
the trader responds to the bid and ask price with one of:
buy (by saying "Mine" or "I buy" or "I take")
sell (by saying "yours" or "I give you" or "I sell")
refuse.
The transaction occurs if the final response is either a buy or a sell. The dealer is required to quote a "good" market price, since he does not know whether the trader will buy or sell.

The currency exchange market described above is referred to as the spot market and the transaction described is referred to as a spot deal. A spot deal consists of a bilateral contract between a party delivering a specified amount of a given currency against receiving a specified amount of another currency from a second counter party, based on an agreed exchange rate, within two business days of the deal date, which is referred to as the settlement date. (The settlement date for USD/CAD is one business day after the deal date.) Speculators rarely deliver, however. Instead, they use what is referred to as a rollover swap. The rollover swap is designed to allow the changing of an old deal date to the current date by simultaneously closing an open position for todays date and opening the same position for the next day at a price reflecting the interest rate differential between the two currencies.

When a trader buys or sells a currency pair, the value of the currency pair, as an instrument, initially is close to zero. This is because (in the case of a buy) the quote currency is sold to buy an equivalent amount of the base currency. As the market rates fluctuate, however, the value of the currency pair position held will also fluctuate. Thus, if the rate for the currency pair goes down, the speculators long position will lose in value and become negative. To ensure that the speculator can carry the risk for the case where the position results in a loss, banks or dealers typically require sufficient collateral to cover those losses. This collateral is typically referred to as margin.

To limit down-side risk, traders often specify a Stop-Loss rate for each open trade. The Stop-Loss specifies that the trade should be closed automatically when the currency exchange rate for the currency pair in question reaches a certain threshold. For long positions, the Stop-Loss rate is always lower than the current exchange rate; for short positions, it is always higher. Traders, at times, also specify a Take-Profit rate for their trades in order to lock in a profit when the exchange rate reaches a certain threshold. For long positions, the Take-Profit rate must be above the current rate, while for short positions, it must be below the current rate.

A trader may also leave an order with a bank, broker or dealer. These so called leave orders are orders that a trade should be executed (in the future) when certain market conditions occur. There are three types of leave orders:

entry orders: specifies that a currency pair should be traded when it reaches a certain exchange rate. Entry orders are used when the trade would not offset a current position.
take-profit orders: are used to clear a position by buying (or selling) the currency pair of the position when the exchange rate reaches a specified level.
stop-loss orders: are used to clear a position by buying (or selling) the currency pair of the position when the exchange rate reaches a specified level.
The Need for Currency Exchange
Currency exchange is necessary in numerous circumstances.

Consumers typically come into contact with currency exchange when they travel. They go to a bank or currency exchange bureau to convert one currency (typically, their "home currency") into another (i.e., the currency of the country they intend to travel to) so they can pay for goods and services in the foreign country. Consumers may also purchase goods in a foreign country or via the Internet with their credit card, in which case they will find that the amount they paid in the foreign currency will have been converted to their home currency on their credit card statement. Although each such currency exchange is a relatively small transaction, the aggregate of all such transactions is significant.

Businesses typically have to convert currencies when they conduct business outside their home country. For example, if they export goods to another country and receive payment in the currency of that foreign country, then the payment must often be converted back to the home currency. Similarly, if they have to import goods or services, then businesses will often have to pay in a foreign currency, requiring them to first convert their home currency into the foreign currency. Large companies convert huge amounts of currency each year; for example, a company such as General Electric (GE) converts tens of billions of dollars each year. The timing of when they convert can have a large affect on their balance sheet and "bottom line.

Investors and speculators require currency exchange whenever they trade in any foreign investment, be that equities, bonds, bank deposits, or real estate. For example, when a Swedish investor buys shares in Sun Microsystems on the NASDAQ, she will have to pay for the shares in U.S. Dollars and likely have to convert Swedish Krona to U.S. Dollars. Similarly, a Japanese real estate investor who sells a New York property may well want to convert the proceeds of the sale in U.S. Dollars to Japanese Yen.

Investors and speculators also trade currencies directly in order to benefit from movements in the currency exchange markets. For example, if an American investor believes that the Japanese economy is strengthening and as a result expects the Japanese Yen to appreciate in value (i.e., go up relative to other currencies), then she may want to buy Japanese Yen and take what is referred to as a long position. Similarly, if an American investor believes that the Euro will go down over time, then she may want to sell Euro to take a short position. Interestingly, investors and speculators can profit equally from currencies becoming stronger (by taking a long position) or from currencies becoming weaker (by taking a short position). Speculators are often day traders, trying to take advantage of market movements in very short time periods; buying a currency and then selling it again may happen within hours or even minutes. They are attracted to currency trading for numerous reasons, including (i) the size and daily volatility of the market, which gives them unparalleled excitement, (ii) the almost perfect liquidity of the currency exchange market, (iii) the fact that the currency exchange market is "open" 24 hours a day market, and (vi) the fact that currencies can be traded with no brokerage charges.

Commercial and Investment Banks trade currencies as a service for their commercial banking, deposit and lending customers. These institutions also generally participate in the currency market for hedging and proprietary trading purposes.

Governments and central banks trade currencies to improve trading conditions or to intervene in an attempt to adjust economic or financial imbalances. Although they do not trade for speculative reasons --- they are a non-profit organization --- they often tend to be profitable, since they generally trade on a long-term basis.
What is Currency Exchange?
Currency exchange is the trading of one currency against another. Professionals refer to this as foreign exchange, but may also use the acronyms Forex or FX.
45 Hints to Avoid Losing Money In FOREX

1) Knowledge Deficiency ?Most new FOREX traders don take the time to learn what drives currency rates (primarily fundamentals). When news or a statement is due out they must close out their positions and sit out the best trading opportunities. They are taught to only trade after the market calms down. So essentially they miss the whole move and then trade the random noise that follows a fundamental price move. Just think for a moment about technically trading the aftermath of a price move; there is no potential.

2) Overtrading - Trading often with tight stops and tiny profit targets will only make the broker rich. The desire to ust?make a few hundred dollars a day by locking in tiny profits whenever possible is a losing strategy.

3) Over leveraged - Leverage is a two way street. The brokers want you to use high leverage because that means more spread income because your position size determines the amount of spread income; the bigger the position the more spread income the broker earns.

4) Relying on Others ?/SPAN> Real traders play a lone hand; they make their own decisions and don rely on others to make their trading decisions for them; there is no halfway; either trade for yourself or have someone else trade for you.

5) Stop Losses ?/SPAN> Putting tight stop losses with retail brokers is a recipe for disaster. When you put on a trade commit to a reasonable stop loss limit that allows your trade a fair chance to develop.

6) Demo Accounts ?/SPAN> Broker demo accounts are a shill game of sorts; theye not as time sensitive as real accounts and therefore give the impression that time sensitive trading systems, such as short-term moving average crossovers can be consistently profitably traded; once you start dealing with real money reality is quick to set in.

7) Trading During Off Hours ?/SPAN> Bank FX traders, option traders, and hedge funds have a huge advantage during off hours; they can push the currencies around when no volume is going through and the end game is new traders get fleeced trying to trade signals. There is only one signal during off hours ?stay out.

8) Trading a Currency, Not a Pair ?/SPAN> Being right about a currency is half a trade; success or failure depends upon being right about the second currency that makes up the pair.

9) No Trading Plan - Make money is not a trading plan. A trading plan is a blueprint for trading success; it spells out what you see your edge as being; if you don have an edge, you don have a plan, and likely youl wind up a statistic (part of the 95% of new traders that lose and quit).

10) Trading Against Prevailing Trend ?/SPAN> There is a huge difference between buying cheaply on the way down and buying cheaply. What was a low price quickly becomes a high price when youe trading against the trend.

11) Exiting Trades Poorly ?/SPAN> If you put on a trade and it not working make sure you exit properly; don compound the damage. If youe in a winning trade don talk yourself out of the position because youe bored or want to relieve stress; stress is a natural part of trading; get use to it.

12) Trading Too Short-term ?If youe profit target is less than 20 points don do the trade; the spread you pay to enter the trade makes the odds way against you when you go for these tiny profits.

13) Picking Tops and Bottoms - Looking for bargains works well at the supermarket but not trading foreign exchange; try to trade in the direction the price is going and youe results will improve.

14) Being Too Smart ?/SPAN> The most successful traders I know are high school graduates. They keep it simple and don look beyond the obvious; their results are excellent.

15) Not Trading Around News Time ?/SPAN> Most of the big moves occur around news time. The volume is high and the moves are real; there is no better time to trade fundamentally or technically than when news is released; this is when the real money adjusts their positions and as a result the prices changes reflect serious currency flow (compared to quiet times when Bank traders rule the market with their customer order flow.

16) Ignore Technical Condition ?/SPAN> Determining whether the market is over-extended long or over-extended short is a key determinant of near time price action. Spike moves often occur when the market is all one way.

17) Emotional Trading ?/SPAN> When you don pre-plan youe trades essentially it a thought and not an idea; thoughts are emotions and a very poor basis for doing trades. Do people generally say intelligent things when they are upset and emotional; I don think so.

18) Lack of Confidence ?Confidence only comes from successful trading. If you lose money early in your trading career it very difficult to gain true confidence; the trick is don go off half-cocked; learn the business before you trade.

19) Lack of Courage to Take a Loss ?/SPAN> There is nothing macho or gutsy about riding a loss, just stupidity and cowardice. It takes guts to accept your loss and wait for tomorrow to try again. Getting married to a bad position ruins lots of traders. The thing to remember is the market does crazy things often so don get married to any one trade; it just a trade. One good trade will not make you a trading success; rather it monthly and annual performance that defines a good trader.

20) Not Focusing on the Trade at Hand ?/SPAN> There is no room for fantasizing in successful trading. Counting up and mentally spending profits you haven made yet is mental masturbation and does you no good. Same with worrying about a loss that hasn happened yet. Focus on your position and have a reasonable stop loss in place at the time you do the trade. Then be like an astronaut ?sit back and enjoy the ride; no sense worrying because you have no real control; the market will do what it wants to do.

21) Interpreting FOREX News Incorrectly ?/SPAN> Fact is the press only has a very superficial understanding of the news they are reporting and tend to focus on one element and miss the point. Learn to read the source documents and understand it for real.

22) Lucky or Good ?Your account balance changes don tell you the whole story about your trading; fact is if your taking a lot of risk and making money you will eventually crash and burn. Look at the individual trade details; focus on your big loses and losing streaks. Ask yourself this; if I had a couple of consecutive losing streaks or a couple of consecutive big loses, how would my account balance look. Generally, traders making money without big daily loses have the best chance of sustaining positive performance. The others are accidents waiting to happen.

23) Too Many Charity Trades ?/SPAN> When you make money on a well thought out trade don give back half on a whim; invest your profits from good trades on the next good trade.

24) Courage Under Fire ?/SPAN> When a policeman breaks down the door to a drug dealers apartment he is scared but he does it anyway. When a fireman climbs onto the roof of a burning building he is scared but does it anyway; and gets the job done. Same with trading; it ok to be scared but you have to pull the trigger; no trigger ?no trades ?no profits ?no trader.

25) Quality Trading Time ?/SPAN> I suggest 3 hours a day of quality, focused trading time; that about all your brain allows. When your trading being 100% focused; half way is bullshit?it doesn work. Don even think that time spent in front of the computer watching the rates has any correlation to profitability; it doesn. Spend less time but when your trading be 100% focused on trading.

26) Rationalizing ?/SPAN> Killer. Absolute Killer. Put your trade on and let it run. If it hits your reasonable pre-determined stop your out. Think of yourself as a prizefighter; you just got knocked out. Moving your stop is like getting up after being crushed with a knockout blow; it pointless; things will only get worse. Don ignore the obvious; your wrong ?get out. Come back the next day and try again. A small loss will not hurt you; a catastrophic loss will.

27) Mixing Apples and Oranges ?Have you ever done this; you see the EURUSD trading higher so you buy GBPUSD because it asn moved yet? That a mistake. Most of the time the reason the GBPUSD hasn moved yet is because its already overbought or some 4:30am UK news was bearish. Don mix apples and oranges; if EURUSD looks bid buy EURUSD.

28) Avoiding the Hard Trades ?/SPAN> Bank FX traders have an axiom; the harder the trade is to do the better the trade. This I learned from experience; when I needed to buy EURUSD and it was hard to get them that when it necessary to pay up and get the business done. When it easy to get them then sit back and wait for better levels. So if your trying to get into a trade or more importantly get out of a trade don putz around for a few points; get your business done.

29) Too Much Detail ?/SPAN> If your trading more than 2 indicators then you need to clean house. Having many indicators stifles trading and finds reasons not to trade. A setup and a trigger is all you need.

30) Giving Up Too Easy ?/SPAN> Your first trade of the day may not be your best but certainly it no reason to quit. I have a preset daily trading limit and I use it; you can make money by making excuses; getting trades wrong is natural and should be expected.

31) Jumping the Gun ?/SPAN> Don be penny wise and dollar foolish; wait for your trade signal to be clear; put on your trade and give it a decent size stop loss so that you don get knocked out by random noise. Do trades don?buy lottery tickets (extremely tight stops).

32) Afraid to Take a Loss - trading is not personal; it business. Don think that a poor trade is a reflection on you. It could be your just ahead of your time or a commercial order hits the market and temporarily creates a small unexpected move. Again, place your stop beforehand and NEVER increase your pre-determined risk; if it going bad it will probably get worse; I think that Einstein n motion stays in motion?

33) Over-Relying on Risk Reward ?There is zero advantage in risk reward; if you put a 20 point stop and a 60 point profit your chances are probably 3-1 that you will lose; actually with the spread its more like 4 to 1 (from entry point if it goes down 17 points you lose or up 63 you win; 17/63 is close to 4-1).

34) Trading for Wrong Reasons ?Because the EURUSD is going up is not in itself a reason to buy. Buying EURUSD because its not moving so little risk is even worse; youe paying the toll (spread) without even a hint that you will get a directional move. If your bored don trade; the reason your bored is there is no trade to do in the first place.

35) Rumors ?Rumors are rumors almost 100% of the time; think about where in the motion you heard the rumor; if EURUSD is up 50 points in last 15 minutes and the rumor is dollar negative, well then you missed it. Whenever you trades determine where in the motion you are entering.

36) Trading Short-term Moving Average Crossovers ?This is the money sucker of the century. When the shorter term moving average cross 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. For the life of me I cannot understand why this is bullish or bearish. Easy to set up on software, complete with lights, bells and whistles, and good for the seller getting thousands for the software but in terms of creating profit it a zero.

37) Stochastic ?Another money sucker. Personally I think this indicator is used backwards; when it first signals an overdone condition that when I think the big spike in the verdone?currency pair occurs. To be overbought means strong and oversold means weak. Try buying on the first sign of overbought and selling on the first sign of oversold; youl be with the trend and likely have identified a move with plenty of juice left. So if %k and %d are both crossing 80; buy! (Same on sell side; sell at 20)

38) Wrong Broker ?A lot of FOREX brokers are horrible; get a good one. Read forums and chats in several different places to get an unbiased opinion.

39) Simulated Results ?Watch out for lack box?systems; these are trading systems that don divulge how the trade signals are generated. Great majority of them are absolute garbage. They show you a track record of extraordinary results but think about it; if you could build a trading system with half a dozen filters using the benefit of hindsight, couldn you too come up with a great system. Of course going forward is an entirely different story. High-speed number crunching capabilities allows for building great hindsight trading systems; BEWARE.

40) Inconsistency ?Every business (FOREX trading included) requires a business plan (trading plan). Unless you have taken the time to write down a set of rules that you can and will follow, it likely your trading will remain unfocused and directionless. Make a plan, have rules, follow them set goals that are realistic and you will achieve them.

41) Master of None ?Focus on one currency for technical trading; each currency has a unique way of trading and unless you get intimate with it you will never truly understand its underlying idiosyncrasies. Don spread yourself too thin ?focus ?master one currency at a time.

42) Thinking Long Term ?Don do it. Stay in the moment. Especially if youe a day trader. It doesn matter what happens next week or next month, if your trading with 30 to 50 point stops restrict your thought process to what happening right now. That is not to stay the long-term trend is not important; it is to say the long-term trend will not always help you when your trading a significantly shorter time frame.

43) Overconfidence ?Trading is not easy; statistics show 95% failure rate. If your doing well don take your success for granted; always be on the lookout for ways to improve what youe doing.

44) Getting Pumped Up ?/SPAN> The trick is to maintain an even keel; when you are in a trade you want to think exactly as you would if you didn have a trade on. To do this requires a relaxed disposition; this is not a football game; don get psyched up; relax and try to enjoy it.

45) Staying in the Game ?I don recommend demo trading because traders learn bad habits when trading with play money. I also don think etting it all hang out?right away is wise either. Start off doing trades and taking risk that is relatively small but still makes a difference to you if you win or lose; about a quarter to a third of what you expect to reach as your trading matures is reasonable.

Source from http://www.eurusdtrader.com