A PROJECT REPORT ON THE STUDY OF FOREX MARKET AND RISK MANAGEMENT

(SUBMITTED IN PARTIAL FULFILLMENT FOR THE AWARD OF MASTERS DEGREE IN BUSINESS ADMINISTRATION)

UNDER THE GUIDENCE OF: MS. PUJA MANN H.O.D., M.B.A. Dept., M . SANDEEP JAG!AN !e"t# e , M.B.A Dept.

SUBMITTED BY: SHIKHA SRIDHAR MBA/04/54 $004%$00&

N.C.COLLEGE OF ENGINEERING, ISRANA (KURUKSHETRA UNI ERSITY, KURUKSHETRA)

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ACKNOWLEDGEMENT
Every person who touches heights, reaches that level with the grand support, blessings of his /her loved ones, guides, teachers, elders.He cant deny the fact that they are the people behind his success. I am very thankful to the people who provided me their help and support. I owe my special thanks to M!. PUJA MANN H!", #$% "epartment& for her grand support, guidance, and for being a helping hand in every possible way in this pro'ect. I am very thankful to M". SANDEEP JAGLAN for the completion of this pro'ect. I would also like to e)tend my thanks to my supporting faculty of N.C.C.E., ISRANA, KURUKSHETRA UNI ERSITY. THANK YOU ALL# (ecturer, #$% "epartment& for devoting his precious time and for leaving no stone unturned

EXECUTI E SUMMARY
+he pro'ect undertaken is based on the study of foreign e)change market and risk management in general as well as in the fore) market. FOREIGN EXCHANGE MARKET$ ,oreign e)change market is a market where foreign currencies are bought - sold. ,oreign e)change market is a system facilitating mechanism through which one countrys currency can be e)changed for the currencies of another country. +he purpose of foreign e)change market is to permit transfers of purchasing power denominated in one currency to another i.e. to trade one currency for another. +he pro'ect covers various trading areas of fore) market such as, spot market, forward market, derivatives, currency futures, currency swaps etc. It helps in understanding various trend patterns and trend lines. .hat considerations are kept in mind while trading in fore) market and why one should enter such market is studied under this pro'ect. %nother part of this pro'ect covers /isk #anagement in general as well as in fore) market. R%!& M'(')*+*(, 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 conse0uences of a particular risk. % person has to face risk whether hes in business or is entering the fore) market.1o, he uses various strategies and methods to overcome that risk. +he data used in this pro'ect has been collected from websites based on related topics and various books of fore) market and risk management. +he information displayed may be limited,as each and every aspect related with the pro'ect that is provided by the avilable sources might not be complete in all respects.

OBJECTI ES OF THE STUDY

+o study ,ore) market - /isk management in general as well as in fore) market. +o have a knowledge of different types of fore) markets and various 0uotations in ,ore) markets. +o study risk in the ,ore) market as well as volatility in ,ore) market. +o have a knowledge of how people trade in fore) market. +o study the factors that force different types of people in different markets. +o study various strategies of risk management.

HISTORY
B"%*- .%!,/"0 /- F/"*1 ,"'2%()
Initially, the value of goods was e)pressed in terms of other goods, i.e. an economy based on barter between individual market participants. +he obvious limitations of such a system encouraged establishing more generally accepted means of e)change 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. !riginally, coins were simply minted from the preferred metal, but in stable political regimes the introduction of a paper form of governmental I!4s gained acceptance during the #iddle %ges. 1uch I!4s, often introduced more successfully through force than persuasion were the basis of modern currencies. $efore the ,irst .orld .ar, most central banks supported their currencies with convertibility to gold. %lthough paper money could always be e)changed 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. %t times, the ballooning supply of paper money without gold cover led to devastating inflation and resulting political instability. +o protect local national interests, foreign e)change controls were increasingly introduced to prevent market forces from punishing monetary irresponsibility.

In the latter stages of the 1econd .orld .ar, the $retton .oods agreement was reached on the initiative of the 41% in 6uly 1733. +he $retton .oods 8onference re'ected 6ohn #aynard 9eynes suggestion for a new world reserve currency in favour of a system built on the 41 dollar. !ther international institutions such as the I#,, the .orld $ank and :%++ were created in the same period as the emerging victors of ..* searched for a way to avoid the destabilising monetary crises which led to the war. +he $retton .oods agreement resulted in a system of fi)ed e)change rates that partly reinstated the gold standard, fi)ing the 41 dollar at 41"25/o; and fi)ing the other main currencies to the dollar < and was intended to be permanent. +he $retton .oods system came under increasing pressure as national economies moved in different directions during the si)ties. % number of realignments kept the system alive for a long time, but eventually $retton .oods collapsed in the early seventies following president =i)on>s suspension of the gold convertibility in %ugust 17?1. +he dollar was no longer suitable as the sole international currency at a time when it was under severe pressure from increasing 41 budget and trade deficits. +he following decades have seen foreign e)change trading develop into the largest global market by far. /estrictions on capital flows have been removed in most countries, leaving the market forces free to ad'ust foreign e)change rates according to their perceived values. $ut the idea of fi)ed e)change rates has by no means died. +he EE8 introduced a new system of fi)ed e)change rates in 17?7, the European #onetary 1ystem. +his attempt to fi) e)change rates met with near e)tinction in 177*<72, when pent<up economic pressures forced devaluations of a number of weak European currencies. =evertheless, the 0uest for currency stability has continued in Europe with the renewed attempt to not only fi) currencies but actually replace many of them with the Euro back in *@@1.

+his pro'ect is fairly advanced now and the final structure and fi)ed levels were decided in #ay 177B. %fter 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 #illennium. +he lack of sustainability in fi)ed foreign e)change rates gained new relevance with the events in 1outh East %sia in the latter part of 177?, where currency after currency was devalued against the 41 dollar, leaving other fi)ed e)change rates, in particular in 1outh %merica, looking very vulnerable. $ut 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. +he si;e of foreign e)change markets now dwarfs any other investment market by a large factor. It is estimated that more than 41"1, *@@ billion is traded every day, far more than the world>s stock and bond markets combined.

INTRODUCTION TO TRADING FOREX

F/"*%)( E13.'()*

+his short introduction e)plains the basics of trading ,ore) online, a brief e)planation of the markets and the ma'or benefits of trading ,ore) online. +here are also two scenarios describing the implications of trading in a bear as well as bull market to better ac0uaint you with some of the risks and opportunities in the largest and most li0uid market in the world.

O ER IEW
,oreign e)change , fore) or 'ust ,ore) are all terms used to describe the trading of the world>s many currencies. +he fore) market is the largest market in the world, with trades amounting to more than C1.5 trillion every day. +his is more than one hundred times the daily trading on the =D1E =ew Dork 1tock E)change& . #ost fore) trading is speculative , with only a few percent of market activity representing governments> and companies> fundamental currency conversion needs.

4nlike trading on the stock market, the fore) market is not carried out by a central e)change, but on the EinterbankF market , which is thought of as an !+8 over the counter & market. +rading takes place directly between the two counterparts necessary to make a trade, whether over the telephone or on electronic networks all over the world. +he main centres for trading are 1ydney, +okyo, (ondon, ,rankfurt and =ew Dork. +his worldwide distribution of trading centres means that the fore) market is a *3<hour market.

TRADING FOREX
% currency trade is the simultaneous buying of one currency and selling of another one. +he currency combination used in the trade is called a cross for e)ample, the Euro/41 "ollar, or the :$ Gound/6apanese Den.&. +he most commonly traded currencies are the so<called Ema'orsF H E4/41", 41"6GD, 41"8H, and :$G41". +he most important fore) market is the spot market as it has the largest volume. +he market is called the spot market because trades are settled EimmediatelyF or on the spot. In practice this means within two banking days.

FORWARD OUTRIGHTS
,or 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. +his is because if you trade e.g. =!96GD, you get almost ?I annual& interest in =orway and close to @I in 6apan. 1o, if you borrow money in 6apan, to finance the trade as you must have one currency with which to buy or another, and place it in =orway you have a positive interest rate differential. +his differential has to be calculated and added to your account. Dou can have both a positive and a negative interest rate differential, so it may work for or against you when you make a trade. +he 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. +he interest rate differential varies according to the cross you are trading.

TRADING ON MARGIN
+rading on margin means that you can buy and sell assets that represent more value than the capital in your account. ,ore) trading is usually done with relatively little margin since currency e)change rate fluctuations tend to be less than one or two percent on any given day. +o take an e)ample, a margin of *.@I means you can trade up to C5@@,@@@ even though you only have C1@,@@@ in your account. In terms of leverage this corresponds to 5@J1, because 5@ times C1@,@@@ is C5@@,@@@, or put another way, C1@,@@@ is *.@I of C5@@.@@@. 4sing this much leverage gives you the possibility to make profits very 0uickly, but there is also a greater risk of incurring large losses and even being completely wiped out. +herefore, it is inadvisable to ma)imi;e your leveraging as the risks can be very high.

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RESEARCH METHODOLOGY
+o define the research methodology, one has to go step by step. %ny research methodology involves following stepsJ I. G/!$(E# /E8!:=I+I!= II. 14/KED !, (I+E/%+4/E III. HDG!+HE1I1 ,!/#4(%+I!= IK. /E1E%/8H "E1I:= K. 1%#G(E "E1I:= KI. "%+% 8!((E8+I!= KII. %=%(D1I1 %=" I=+E/G/E+%+I!=. RESEARCH PROBLEM$ % problem properly defined is half solved. It is very necessary for any research that research problem should be recogni;ed. It is critical to any research. !nce problem is identified, it is to be formulated properly. Initially the plan is stated in a broad and general way and then it is properly defined in specific terms. Groblem formulation means defining a problem precisely. In this study our research problem isJ +HE 1+4"D !, ,!/EL #%/9E+ %=" /I19 #%=%:E#E=+. LITERATURE SUR EY$ +o do any research, we have to review/study previous literature. ,or this we studied 6ournals, #aga;ines - $ooks of ,!/EL - /I19 #%=%:E#E=+ and also the search engine www.google.com. +o get good results in any research, it is very essential that this review of literature should be carefully done. +he review of literature survey for this pro'ect includes the followingJ Elliot .ave H +his is considered by most e)perienced traders to be the purest form of technical analysis, since Elliott .ave analysis measures investor psychology. +he .ave shows how the psychology of traders, en masse, moves

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from pessimism to optimism on a stock. +his shift occurs in a specific and measurable. "etecting where a stock is in the pattern can help a trader estimate the future movements of the market. K.B. Advisory Ltd. H +his program offers you daily technical analysis and trading recommendations that are based on sophisticated trading strategies developed by 9eith $lack. It boasts a successful three<year track record. TRL (Technical Research Limited) H +/( is a 1pecialist ,oreign E)change ,orecasting 1ervice that can help you with forecasting and trading analysis in the global foreign e)change markets. +echnical /esearch (imited is rated the =o. 1 ,L %dvisory 1ervice by customers in 27 different countries around the world. PronetAnalytics < +his program is very powerful, and offers real<time analysis for market professionals who are looking for ine)pensive real<time data and e)change feeds with standard and simple graphical trading support. IFR International ,inancing /eview& H I,/ ,ore) .atch has real<time technical analysis of the ,L spot and options markets. It connects you with analysts in (ondon, =ew Dork, $oston, 1an ,rancisco, 1ingapore and 1ydney. I,/ speciali;es in sifting through the vast array of information that clutters up current market participants, and boiling it down to its bare essentials. GMR (Global Mar et Research) H :lobal #arket /esearch provides price forecasting and performance<based +rade 1trategies for the ,L market. Dou can check out their daily newsletter, their ,L +echnicals and intraday updates and analysis through the .eb. !r you can have them E<mailed to you. !"#R$K.com H +his is a resource created by a market professional that has been trading and writing about markets for nearly *@ years. Dou can capitali;e on of his e)perience and his analysis, especially technical analysis, and get a real trader>s take on current market action. %!A&T'$B H 38%1+ sends out key market information and analysis to market participants worldwide, including central banks. It also has an on<line service that gives you fundamental, political, strategic and technical analysis *3 hours a day Fore(TRM H ,ore)+/# is a fore) charting service that pairs 1B world and regional currencies and tracks them every day. +his means ,ore)+/# lets you to 1*

trade any one of the 1B currencies against any of the other 1?. It uses trademarked 1igma $ands and Hurst 8ycle %nalysis to correctly identify overbought/sold ,!/EL markets, where trading risk is at its lowest point in time, and which currency pairs are ready to trade. HYPOTHESIS FORMULATION$ Hypothesis is any assumption for the research effectively - efficiently. +he hypothesis of my research is thatJ ,ore) market is very volatile in nature. It is changing day by day showing a wide growth in economy. "ifferent factors like speculation, hedging forces different people to enter in different market. /isk is there in ,ore) market and various risk management strategies are there to manage it. RESEARCH DESIGN$ /esearch design is a conceptual structure within which research is conducted. E% /esearch design is the arrangement of conditions for collection and analysis of data in a manner that aims to combine relevance to the research purpose with economy in procedures.F /esearch design can be of various types. < < < < "escriptive. E)ploratory. E)perimental. %nalytical.

/esearch "esign of my study is EXPLORATORY 4 ANALYTICAL. DATA COLLECTION$ +he data is of two typesJ G/I#%/D %=" 1E8!="/D. "ata are the facts presented to the researcher from the study environment. +he method of data collection in my study is 1E8!="/D only. $ecause I have collected all the data from books and from websites.

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WHY TRADE FOREX

56 ./7" ,"'2%()
!ne of the ma'or advantages of trading fore) is the opportunity to trade *3 hours a day from 1unday evening *@J@@ :#+& to ,riday evening **J@@ :#+&. +his gives you a uni0ue opportunity to react instantly to breaking news that is affecting the markets.

S78*"%/" 9%:7%2%,0
+he fore) market is so li0uid that there are always buyers and sellers to trade with. +he li0uidity of this market, especially that of the ma'or currencies, helps ensure price stability and low spreads . +he li0uidity comes mainly from large and smaller banks that provide li0uidity to investors, companies, institutions and other currency market players.

N/ 3/++%!!%/(!
+he fact that fore) is often traded without commissions makes it very attractive as an investment opportunity for investors who want to deal on a fre0uent basis. +rading the Ema'orsF is also cheaper than trading other cross because of the high level of li0uidity. ,or more information on the trading conditions at 1a)o $ank, go to the %ccount 1ummary on your 8lient 1tation and open the section entitled M+rading 8onditionsM found in the top right<hand corner of the %ccount 1ummary.

.;<$= L*>*"')*
.ith a minimum account of 41" 1@,@@@, for e)ample, you can trade up to 41" 5@@,@@@. +he 41" 1@,@@@ is posted on margin as a guarantee for the future performance of your position

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.P"/-%, 8/,*(,%'9 %( -'99%() +'"&*,!

1ince the market is constantly moving, there are always trading opportunities, whether a currency is strengthening or weakening in relation to another currency. .hen you trade currencies, they literally work against each other. If the E4/41" declines, for e)ample, it is because the 4.1. dollar gets stronger against the Euro and vice versa. 1o, if you think the E4/41" will decline that is, that the Euro will weaken versus the dollar&, you would sell E4/ now and then later you buy Euro back at a lower price and take your profits. +he opposite trading scenario would occur if the E4/41" appreciates .

TWO WAYS TO TRADE

+here are two basic approaches to analy;ing currency markets, fundamental analysis and technical analysis. +he fundamental analyst concentrates on the underlying causes of price movements, while the technical analyst studies the price movements themselves.

TECHNICAL ANALYSIS
+echnical analysis focuses on the study of price movements. Historical currency data is used to forecast the direction of future prices. +he premise of technical analysis is that all current market information is already reflected in the price of that currencyN therefore, studying price action is all that is re0uired to make informed trading decisions. +he primary tools of the technical analyst are charts. 8harts are used to identify trends and patterns in order to find profit opportunities. +he most basic concept of technical analysis is that markets have a tendency to trend. $eing able to identify trends in their earliest stage of development is the key to technical analysis.

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FUNDAMENTAL ANALYSIS
,undamental analysis focuses on the economic, social and political forces that drive supply and demand. ,undamental 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. +here are several theories as to how currencies should be valued.

1A

PSYCHOLOGY OF TRADING
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(A). T"'2* ?%,. ' DISCIPLINED P9'($
+he problem with many traders is that they take shopping more seriously than trading. +he average shopper would not spend C3@@ without serious research and e)amination of the product he is about to purchase, yet the average trader would make a trade that could easily cost him C3@@ based on little more than a EfeelingF or Ehunch.F $e sure that you have a plan in place BEFORE you start to trade. +he plan must include stop and limit levels for the trade, as your analysis should encompass the e)pected downside as well as the e)pected upside.

(B). C7, 0/7" 9/!!*! *'"90 '(2 L*, 0/7" P"/-%,! R7($
+his simple concept is one of the most difficult to implement and is the cause of most traders demise. #ost traders violate their predetermined plan and take their profits before reaching their profit target because they feel uncomfortable sitting on a profitable position. +hese 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 0uick to remove stops from their trading on the belief that this will always be the case. 1tops are there to be hit, and to stop you from losing more then a predetermined amountO +he mistaken belief is that every trade should be profitable. If you can get 2 out of A trades to be profitable then you are doing well. How then do you make money with only half of your trades being winnersP Dou simply allow your profits on the winners to run and make sure that your losses are minimal.

1?

(C).D/ (/, +'""0 0/7" ,"'2*!$

+he reason trading with a plan is the Q1 tip is because most ob'ective analysis is done before the trade is e)ecuted. !nce a trader is in a position he/she tends to analy;e the market differently in the EhopesF that the market will move in a favorable direction rather than ob'ectively looking at the changing factors that may have turned against your original analysis. +his is especially true of losses. +raders with a losing position tend to marry their position, which causes them to disregard the fact that all signs point towards continued losses.

D/ (/, @*, ,.* -'"+$

"o not over trade. !ne of the most common mistakes that traders make is leveraging their account too high by trading much larger si;es than their account should prudently trade. (everage is a double<edged sword. 6ust because one lot 1@@,@@@ units& of currency only re0uires C1@@@ as a minimum margin deposit, it does not mean that a trader with C5@@@ in his account should be able to trade 5 lots. !ne lot is C1@@,@@@ and should be treated as a C1@@,@@@ investment and not the C1@@@ put up as margin. #ost traders analy;e the charts correctly and place sensible trades, yet they tend to over leverage themselves. %s a conse0uence of this, they are often forced to e)it a position at the wrong time. % good rule of thumb is to trade with 1<1@ leverage or never use more than 1@I of your account at any given time. +rading currencies is not easy if it was, everyone would be a millionaireO&.

1B

FOREX TRADING EXAMPLES

E1'+89* =
%n investor has a margin deposit with 1a)o $ank of 41"1@@,@@@. +he investor e)pects the 41 dollar to rise against the 1wiss franc and therefore decides to buy 41"*,@@@,@@@ < his ma)imum possible e)posure. +he 1a)o $ank dealer 0uotes him 1.5515<*@. +he investor buys 41" at 1.55*@. "ay 1J $uy 41"*,@@@,@@@ vs 8H, 1.55*@ R 1ell 8H,2,1@3,@@@. ,our days later, the dollar has actually risen to 8H,1.5?35 and the investor decides to take his profit. 4pon his re0uest, the 1a)o $ank dealer 0uotes him 1.5?35<5@. +he investor sells at 1.5?35. "ay 5J 1ell 41"*,@@@,@@@ vs 8H, 1.5?35 R $uy 8H,2,137,@@@. %s the dollar side of the transaction involves a credit and a debit of 41"*,@@@,@@@, the investor>s 41" account will show no change. +he 8H, account will show a debit of 8H,2,1@3,@@@ and a credit of 8H,2,137,@@@. "ue to the simplicity of the e)ample and the short time hori;on of the trade, we have disregarded the interest rate swap that would marginally alter the profit calculation. +his results in a profit of 8H,35,@@@ R appro). 41"*B,A@@ R *B.AI profit on the deposit of 41"1@@,@@@.

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E1'+89* 5$
+he investor follows the cross rate between the Euro and the 6apanese yen. He believes that this market is headed for a fall. %s he is less confident of this trade, he does not fully use the leverage available on his deposit. He chooses to ask the dealer for a 0uote in E4/1,@@@,@@@. +his re0uires a margin of E4/1,@@@,@@@ ) 5I R E4/5@,@@@ R appro). 41"5*,5@@ E4//41"1.@5&. +he dealer 0uotes 11*.@5<1@. +he investor sells E4/ at 11*.@5. "ay 1J 1ell E4/1,@@@,@@@ vs 6GD 11*.@5 R $uy 6GD11*,@5@,@@@. He protects his position with a stop<loss order to buy back the euro at 11*.A@. +wo days later, this stop is triggered as the euro strengthens short term in spite of the investor>s e)pectations. "ay 2J $uy E4/1,@@@,@@@ vs 6GD 11*.A@ R 1ell 6GD11*,A@@,@@@. +he E4/ side involves a credit and a debit of E4/1,@@@,@@@. +herefore, the E4/ account shows no change. +he 6GD account is credited 6GD11*.@5m and debited 6GD11*.Am for a loss of 6GD@.55m. "ue to the simplicity of the e)ample and the short time hori;on of the trade, we have disregarded the interest rate swap that would marginally alter the loss calculation. +his results in a loss of 6GD@.55m R appro).41"5,2@@ 41"/6GD 1@5& R 5.2I loss on the original deposit of 41"1@@,@@@.

*@

F7(2'+*(,'9! E>*"0 T"'2*" S./792 K(/?

8urrency prices reflect the balance of supply and demand for currencies. +wo primary factors affecting supply and demand are interest rates and the overall strength of the economy. Economic indicators such as :"G, 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. +here is a tremendous amount of data released at regular intervals, some of which is more important than others. "ata related to interest rates and international trade is looked at the closest.

(=).I(,*"*!, R',*!
If the market has uncertainty regarding interest rates, then any bit of news regarding interest rates can directly affect the currency markets. +raditionally, 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. 1ome investors will transfer money out of a country>s stock market when interest rates are hiked, causing the country>s currency to weaken. .hich 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 GGI, 8GI, and :"G. :enerally the timing of interest rate moves are known in advance. +hey take place after regularly scheduled meetings by the $!E, ,E", E8$, $!6, and other central banks.

(5).I(,*"(',%/('9 T"'2*
+he trade balance shows the net difference over a period of time between a nations e)ports and imports. .hen a country imports more than it e)ports the trade balance will show a deficit, which is generally considered unfavorable. *1

,or e)ample, if 4.1 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. 1imilarly if trade figures show an increase in e)ports, dollars will flow into the 4nited 1tates and appreciate the value of the currency. ,rom 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 e)pectations then it will trigger a negative price movement.

CURRENCY PAIRS
In the ,ore) market, trading is always in currency pairs, such as E4//41" or 41"/6GD. T"'2%() T*"+%(/9/)%*! Euro / 4.1. "ollar Euro $ritish Gound / 4.1. "ollar 8able or 1terling 4.1. "ollar / 6apanese Den "ollar Den 4.1. "ollar / 1wiss ,ranc "ollar 1wiss 4.1. "ollar / 8anadian "ollar 8anada "ollar %ustralian "ollar / 4.1. %ussie "ollar or "ollar %ussie Euro / $ritish Gound Euro 1terling Euro / 6apanese Den Euro Den Euro / 1wiss ,ranc Euro 1wiss $ritish Gound / 6apanese 1terling Den Den

F/"*1 S0+@/9 C7""*(30 P'%"! E4//41" :$G/41" 41"/6GD 41"/8H, 41"/8%" %4"/41" E4//:$G E4//6GD E4//8H, :$G/6GD

+he base currency<the first currency listed in the currency pair<is the basis for the buy or the sell. %s an e)ample, the 41 "ollar is the base currency for 41"/6GD 41 "ollar/6apanese Den&. +he current bid/ask price for 41"/6GD could be 1@?.*@/1@?.*2, which means you could buy C1 41 for 1@?.*2 6apanese Den, or sell C1 41 for 1@?.*@ 6apanese Den.

**

RISK MANAGEMENT
:enerally, R%!& M'(')*+*(, 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 conse0uences of a particular risk. +raditional risk management focuses on risks stemming from physical or legal causes e.g. natural disasters or fires, accidents, death, and lawsuits&. ,inancial 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. /egardless 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 prioriti;ation 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 1@@I probability of occurring but is ignored by the organi;ation due to a lack of identification ability. ,or e)ample, knowledge risk occurs when deficient knowledge is applied. /elationship risk occurs when collaboration ineffectiveness occurs. Grocess<engagement risk occurs when operational ineffectiveness occurs. +hese risks directly reduce the productivity of knowledge workers, decrease cost effectiveness, profitability, service, 0uality, reputation, brand value, and earnings 0uality. Intangible risk management allows risk management to create immediate value from the identification and reduction of risks that reduce productivity.

*2

/isk management also faces a difficulty in allocating resources properly. +his is the idea of opportunity cost. /esources spent on risk management could be instead spent on more profitable activities. %gain, ideal risk management spends the least amount of resources in the process while reducing the negative effects of risks as much as possible.

+he ,ore) #arket is the largest and most li0uid financial market in the world. 1ince 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. +herefore, the ,ore) 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 reasonsJ #any traders come with false e)pectations of the profit potential, and lack the discipline re0uired for trading. 1hort term trading is not an amateur>s game and is not the way most people will achieve 0uick riches. 1imply because ,ore) trading may seem e)otic or less familiar then traditional markets i.e. e0uities, futures, etc.&, it does not mean that the rules of finance and simple logic are suspended. !ne cannot hope to make e)traordinary gains without taking e)traordinary risks, and that means suffering inconsistent trading performance that often leads to large losses. +rading currencies is not easy, and many traders with years of e)perience still incur periodic losses. !ne must reali;e that trading takes time to master and there are absolutely no short cuts to this process. +he most enticing aspect of trading ,ore) is the high degree of leverage used. (everage seems very attractive to those who are e)pecting to turn small amounts of money into large amounts in a short period of time. However, leverage is a double<edged sword. 6ust because one lot C1@,@@@& of currency only re0uires C1@@ as a minimum margin deposit, it does not mean that a trader with C1,@@@ in his account should be easily able to trade 1@ lots. !ne lot is C1@,@@@ and should be treated as a C1@@,@@@ investment and not the C1@@@ put up as margin. #ost traders analy;e 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 conse0uence, often end up forced to e)it a position at the wrong time. *3

,or e)ample, if your account value is C1@,@@@ and you place a trade for 1 lot, you are in effect, leveraging yourself 1@ to 1, which is a very significant level of leverage. #ost professional money managers will leverage no more then 2 or 3 times. +rading in small increments with protective stops on your positions will allow one the opportunity to be successful in ,ore) trading.

UTILIAING STOP LOSS ORDER

% 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. % stop<loss order placed on a $uy or (ong& position is a stop<loss order to 1ell and close that position. % stop<loss order placed on a 1ell or 1hort& position is a stop<loss order to $uy and close that position. % stop<loss order remains in effect until the position is li0uidated or the client cancels the stop<loss order. %s an e)ample, if an investor is (ong $uy& 41" at 1*@.*?, they might wish to put in a stop<loss order to 1ell at 117.37, which would limit the loss on the position to the difference between the two rates 1*@.*?<117.37& should the dollar depreciate below 117.37. % stop<loss would not be e)ecuted and the position would remain open until the market trades at the stop<loss level. 1top<loss orders are an essential tool for controlling your risk in currency trading.

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RISK WARNING
+rading foreign currencies is a challenging and potentially profitable opportunity for educated and e)perienced investors. However, before deciding to participate in the ,ore) market, you should carefully consider your investment ob'ectives, level of e)perience and risk appetite. #ost importantly, do not invest money you cannot afford to lose. +here is considerable e)posure to risk in any foreign e)change transaction. %ny 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 li0uidity of a currency. #oreover, the leveraged nature of ,L trading means that any market movement will have an effect on your deposited funds proportionally e0ual to the leverage factor. +his may work against you as well as for you. +he possibility e)ists that you could sustain a total loss of initial margin funds and be re0uired to deposit additional funds to maintain your position. If you fail to meet any margin call within the time prescribed, your position will be li0uidated and you will be responsible for any resulting losses. Investors may lower their e)posure to risk by employing risk<reducing strategies such as >stop<loss> or >limit> orders. +here are also risks associated with utili;ing an internet<based deal e)ecution software application including, but not limited, to the failure of hardware and software and communications difficulties.

OBJECTI ES OF RISK MANAGEMENT

#ere survivalN Geace of mindN (ower risk management costs and thus higher profitsN ,airly stable earningsN (ittle or no interruption of operationsN 8ontinued growthN 1atisfaction of the firms sense of social responsibility desire for a good imageN 1atisfaction of e)ternally imposed obligations. *A

STEPS IN THE RISK MANAGEMENT PROCESS

+he core of the process is a series of five stepsJ

Establish the conte)t Identify risks %nalyse risks Evaluate risks +reat risks

In parallel with the core process, communication - consultation is re0uired to ensure ade0uate information is provided and conclusions are disseminated. #onitoring and review is an intrinsic part of the process re0uired to ensure that the process is e)ecuted in a timely fashion and the identification, analysis, evaluation and treatment are kept up to date.

1. E!,'@9%!. ,.* 3/(,*1,

Establishing the conte)t includes planning the remainder of the process and mapping out the scope of the e)ercise, the identity and ob'ectives of stakeholders, the basis upon which risks will be evaluated and defining a framework for the process, and agenda for identification and analysis.

5.I2*(,%-%3',%/(
%fter establishing the conte)t, the ne)t step in the process of managing risk is to identify potential risks. /isks are about events that, when triggered, will cause problems. Hence, risk identification can start with the source of problems, or with the problem itself.

*?

S/7"3* '('90!%! /isk sources may be internal or e)ternal to the system that is the target of risk management. E)amples of risk sources areJ stakeholders of a pro'ect, employees of a company or the weather over an airport.

P"/@9*+ '('90!%! /isks are related to identified threats. ,or e)ampleJ the threat of losing money, the threat of abuse of privacy information or the threat of accidents and casualties. +he threats may e)ist with various entities, most important with shareholder, customers and legislative bodies such as the government.

.hen 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. ,or e)ampleJ stakeholders withdrawing during a pro'ect may endanger funding of the pro'ectN privacy information may be stolen by employees even within a closed networkN lightning striking a $oeing ?3? during takeoff may make all people onboard immediate casualties. +he chosen method of identifying risks may depend on culture, industry practice and compliance. +he identification methods are formed by templates or the development of templates for identifying source, problem or event. 8ommon risk identification methods areJ

O@B*3,%>*!C@'!*2 R%!& I2*(,%-%3',%/( !rgani;ations and pro'ect teams have ob'ectives. %ny event that may endanger achieving an ob'ective partly or completely is identified as risk.

!b'ective<based risk identification is at the basis of 8!1!>s Enterprise /isk #anagement < Integrated ,ramework S3*('"%/C@'!*2 R%!& I2*(,%-%3',%/( In scenario analysis different scenarios are created. +he scenarios may be the alternative ways to achieve an ob'ective, or an analysis of the interaction of forces in, for e)ample, a market or battle. %ny event that triggers an undesired scenario alternative is identified as risk.

T'1/(/+0C@'!*2 R%!& I2*(,%-%3',%/( +he ta)onomy in ta)onomy<based risk identification is a breakdown of possible risk sources. $ased on the ta)onomy and

*B

knowledge of best practices, a 0uestionnaire is compiled. +he answers to the 0uestions reveal risks.

C/++/(C"%!& C.*3&%() In several industries lists with known risks are available. Each risk in the list can be checked for application to a particular situation.

D.A!!*!!+*(,
!nce risks have been identified, they must then be assessed as to their potential severity of loss and to the probability of occurrence. +hese 0uantities 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. +herefore, in the assessment process it is critical to make the best educated guesses possible in order to properly prioriti;e the implementation of the risk management plan. +he fundamental difficulty in risk assessment is determining the rate of occurrence since statistical information is not available on all kinds of past incidents. ,urthermore, evaluating the severity of the conse0uences impact& is often 0uite difficult for immaterial assets. %sset valuation is another 0uestion that needs to be addressed. +hus, best educated opinions and available statistics are the primary sources of information. =evertheless, 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 prioriti;ed. +hus, there have been several theories and attempts to 0uantify risks. =umerous different risk formulae e)ist, but perhaps the most widely accepted formula for risk 0uantification isJ R',* /- /337""*(3* multiplied by the %+8'3, /- ,.* *>*(, e0uals "%!& (ater research has shown that the financial benefits of risk management are not so much dependent on the formulae used. +he most significant factor in risk management seems to be that

*7

1.& risk assessment is performed fre0uently and *.& it is done using as simple methods as possible. In business it is imperative to be able to present the findings of risk assessments in financial terms. /obert 8ourtney 6r. I$#, 17?@& proposed a formulae for presenting risks in financial terms. +he 8ourtney formulae was accepted as the official risk analysis method for the 41 governmental agencies. +he formulae proposes calculation of %(E %nnualised (oss E)pectancy& and compares the e)pected loss value to the security control implementation costs cost<benefit analysis&.

P/,*(,%'9 R%!& T"*',+*(,!

!nce risks have been identified and assessed, all techni0ues to manage the risk fall into one or more of these four ma'or categoriesJ

T"'(!-*" A>/%2'(3* R*273,%/( ('&' M%,%)',%/() A33*8,'(3* ('&' R*,*(,%/()

Ideal use of these strategies may not be possible. 1ome of them may involve trade offs that are not acceptable to the organi;ation or person making the risk management decisions.

R%!& '>/%2'(3*
Includes not performing an activity that could carry risk. %n e)ample would be not buying a property or business in order to not take on the liability that comes with it. %nother would be not flying in order to not take the risk that the airplane were to be hi'acked. %voidance 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. =ot entering a business to avoid the risk of loss also avoids the possibility of earning the profits.

2@

R%!& "*273,%/(
Involves methods that reduce the severity of the loss. E)amples include sprinklers designed to put out a fire to reduce the risk of loss by fire. +his 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. #odern 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 developmentN any problems encountered in earlier phases meant costly rework and often 'eopardi;ed the whole pro'ect. $y developing in increments, software pro'ects can limit effort wasted to a single increment. % current trend in software development, spearheaded by the E)treme Grogramming community, is to reduce the si;e of increments to the smallest si;e possible, sometimes as little as one week is allocated to an increment.

R%!& "*,*(,%/(
Involves accepting the loss when it occurs. +rue self insurance falls in this category. /isk 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. %ll risks that are not avoided or transferred are retained by default. +his includes risks that are so large or catastrophic that they either cannot be insured against or the premiums would be infeasible. .ar is an e)ample since most property and risks are not insured against war, so the loss attributed by war is retained by the insured. %lso any amounts of potential loss risk& over the amount insured is retained risk. +his 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 organi;ation too much.

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R%!& ,"'(!-*"
#eans causing another party to accept the risk, typically by contract or by hedging. Insurance is one type of risk transfer that uses contracts. !ther times it may involve contract language that transfers a risk to another party without the payment of an insurance premium. (iability among construction or other contractors is very often transferred this way. !n the other hand, taking offsetting positions in derivatives is typically how firms use hedging to financially manage risk. 1ome ways of managing risk fall into multiple categories. /isk 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. +his is different from traditional insurance, in that no premium is e)changed between members of the group up front, but instead losses are assessed to all members of the group.

C"*',* ,.* 89'(

"ecide 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. ,or e)ample, a risk concerning the image of the organi;ation should have top management decision behind it whereas I+ management would have the authority to decide on computer virus risks. +he risk management plan should propose applicable and effective security controls for managing the risks. ,or e)ample, an observed high risk of computer viruses could be mitigated by ac0uiring and implementing anti virus software. % good risk management plan should contain a schedule for control implementation and responsibile persons for those actions. +he risk management concept is old but is still not very effectively measured

2*

6.I+89*+*(,',%/(
,ollow all of the planned methods for mitigating the effect of the risks. Gurchase 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.

;.R*>%*? '(2 *>'97',%/( /- ,.* 89'(

Initial risk management plans will never be perfect. Gractice, e)perience, 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. /isk analysis results and management plans should be updated periodically. +here are two primary reasons for thisJ 1. to evaluate whether the previously selected security controls are still applicable and effective, and *. to evaluate the possible risk level changes in the business environment. ,or e)ample, information risks are a good e)ample of rapidly changing business environment.

F/"*%)( E13.'()* R%!& M'(')*+*(, G7%2*9%(*!

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Dour business is open to risks from movements in competitors> prices, raw material prices, competitors> cost of capital, foreign e)change rates and interest rates, all of which need to be ideally& managed. +his section addresses the task of managing e)posure to ,oreign E)change movements. +hese /isk #anagement :uidelines are primarily an enunciation of some good and prudent practices in e)posure management. +hey have to be understood, and slowly internali;ed and customi;ed so that they yield positive benefits to the company over time. It is imperative and advisable for the %pe) #anagement to both be aware of these practices and approve them as a policy. !nce that is done, it becomes easier for the E)posure #anagers to get along efficiently with their task.

(=).E18/!7"* A('90!%!
%n E)posure can be defined as a 8ontracted, Gro'ected or 8ontingent 8ash ,low whose magnitude is not certain at the moment. +he magnitude depends on the value of variables such as ,oreign E)change rates and Interest rates. +he company will determine and analy;e its ,oreign E)change e)posures.

D*,*"+%(',%/($
+he following cash flows/ transactions will be considered for the purpose of e)posure management.

'"%'@9* E C'!. F9/?! T"'(!'3,%/( T08* 8ontracted ,oreign 8urrency 8ash ,lows $oth 8apital and /evenue in

,oreign Interest /ates, whether ,loating or ,i)ed

nature %ll Interest Gayments/ /eceipts

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8ash ,lows from Hedge +ransactions Gro'ected/ 8ontingent 8ash ,lows

%ll !pen hedge transactions $oth 8apital and /evenue in

nature 8ash ,lows above C1@@,@@@/< in value will be brought to the notice of the E)posure #anager, as soon as they are pro'ected. It is the responsibility of the E)posure #anager to ensure that he receives the re0uisite information on e)posures from various sections of the company in time.

A('90!%!
+hese e)posures will be analy;ed and the following aspects will be studiedJ

,oreign 8urrency 8ash ,lows/ 1chedules Kariability of 8ash flows < how certain are the amounts and/ or value datesP Inflow<!utflow #ismatches / :aps +ime #ismatches / :aps 8urrency Gortfolio #i) ,loating / ,i)ed Interest /ate ratio

(5). MARKET FORECASTS

%fter determining its E)posures, the company has to form an idea of where the market is headed. +he company will focus on forecasts for the ne)t A months, as forecasts for periods beyond A months can be unreliable. +he focus of the %pe) #anagement is to be aware of J

the "irection or the $ig +rend in rates. the underlying assumptions behind the forecasts the Grobability that can be assigned to the forecast coming true the possible e)tent of the move

25

+he /isk %ppraisal e)ercise and $enchmarking decisions will be based on such forecasts.

(D).RISK APPRAISAL
+his e)ercise is aimed at determining where the company>s e)posures stand vis<S<vis market forecasts. +he following /isks will be considered.

=.R%!& ,/ ,.* E18/!7"* /" '97* ', R%!& ( AR)

:iven a particular view or forecast, K%/ tries to determine by how much the companys underlying cash flows are affected.

5. F/"*3'!, R%!&
.hat is the likelihood of the rate actually moving to )).)))) and what is the likelihood of a forecast going wrong. It is imperative to know this before deciding on a $enchmark and devising a hedging strategy.

D. M'"&*, '(2 T"'(!'3,%/( R%!&

+his will take into consideration the risks attached with each particular market and the likelihood of a transaction not going through smoothly. ,or instance,

+he /upee is given to sudden swings in sentiment, whereas the "eutschemark is generally more predictable. +he monetary and time costs of hedging with a nationali;ed bank are generally higher than with a private/ foreign bank.

6. S0!,*+! R%!&
+he risks that arise through gaps or weaknesses in the E)posure #anagement system. ,or e)ampleJ R*8/",%() G'8 where there are delays/ errors in reporting e)posures to the

E)posure #anagement cell I+89*+*(,',%/( G'8 where there is a gap between the decision to hedge and the implementation of such hedge decision. 2A

(6). BENCHMARKING
+his e)ercise aims to state where the company would like its e)posures to reach. 1. +he company will set a $enchmark for its E)posure #anagement practices. *. +he $enchmarks will be set for A months periods. 2. +he $enchmark will reflect and incorporate the followingJ i. ii. iii. iv. +he !b'ective of E)posure #anagement, or in other words, M1hould E)posure #anagement be conducted on a Grofit 8entre or 8ost 8entre basisPM +he ,orecasts discussed and agreed upon earlier. #athematically, the $enchmark should be the Grobabilistic E)pectation of the rate in 0uestion. +he ,orecast risk, #arket and +ransaction risk, and 1ystems risk as determined earlier. /oom for error in keeping with the 1top (oss Golicy to be decided

3. +he $enchmark will be realistic and achievable. S7))*!,%/(!$ 8ompanies whose e)posures are of long<term 8apital nature can look to manage them on a P"/-%, 8entre basis, since the e)posures are not open to day<to<day business risks. 8ompanies whose e)posures are of short<term /evenue nature should manage them on a C/!, 8entre basis, since the e)posures impact the G-( %ccount directly. % small note on the Grofit/ 8ost centre conceptJ P"/-%, C*(,"* under this concept, the E)posure #anager is re0uired to generate a =E+ profit on the e)posure over time. +his is an aggressive stance implying a high degree of risk appetite on the part of %pe) #anagement. % 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. +he $enchmarks under a Grofit<8entre concept would take the form of E+he total cost of a foreign currency loan should be reduced by at least *5 bp over

2?

C/!, C*(,"*

a one year period, from the forecasted rate of e). I p.a.F. under this concept, the E)posure #anager would be re0uired to ensure that the cashflows of the company are not adversely affected beyond a certain point. +his is a defensive strategy, implying a lower risk appetite. % company whose cash<flows are volatile, or whose underlying business is not on a very sound footing would be advised to adopt this concept. +he $enchmarks under a 8ost<8entre concept would take the form of E,oreign E)change fluctuations should add no more than )I to the cost of Imported /aw #aterial over and above the budgeted cost.F

(;). HEDGING
+his is the most visible and glamori;ed part of the E)posure #anagement function. However, the +rader is like the "river in a car rally, who needs to follow the general directions of the =avigator. 1. Hedging strategies will be designed to meet the E)posure #anagement ob'ectives, as represented by the $enchmarks *. +he E)posure #anagement 8ell will be accorded full operational freedom to carry out the hedging function on a day to day basis 2. Hedges will be undertaken only after appropriate 1top<(oss and +ake<Grofit levels have been predetermined 3. +he company will use all hedging techni0ues available to it, as per need and re0uirement. In this regard, it will pass a $oard /esolution authori;ing the use of the followingJ

/upee<,oreign 8urrency ,orward 8ontracts 8ross 8urrency ,orward 8ontracts ,orward<to<,orward 8ontracts ,/%s 8urrency 1waps

2B

Interest /ate 1waps 8urrency !ptions Interest /ate !ptions !thers, as may be re0uired.

S7))*!,%/($ Indian companies with si;eable 41 "ollar denominated e)posures are e)tremely vulnerable to sudden drastic moves in the 41"<I=/ rate. +hey can, to an e)tent, insulate themselves from such shocks by undertaking hedges in currencies other than /upee< "ollar. ,or instance, a "ollar payable can be hedged by selling a currency say 1terling Gound& in order to buy "ollars, instead of selling the /upee. +he choice of currency would, of course, depend on the trend and forecast for the currency s& at that point of time. It is easier and safer to generate profits from a 8ross<8urrency ,orward 8ontract and a /s 1 (ac profit thereon is e0uivalent to saving a 1@ paisa depreciation in the /upee on 41" 1 million&

(F). STOPLOSS
E)posure #anagement should not be undertaken without having a 1top<(oss policy in place. % 1top<(oss policy is based on the following two fundamental principlesJ 1. +o err is human *. % stitch in time saves nine It is appropriate to recount here some words from a speech "r %lan :reenspan, 8hairman of the 41 ,ederal /eserve, delivered in "ecember 177?, on the %sian financial crisis. He says,

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E+here is a significant bias in political systems of all varieties to substitute hope read, wishful thinking& for possibly difficult pre<emptive policy moves. +here is often denial and delay in instituting proper ad'ustments /eality eventually replaces hope and the cost of the delay is a more abrupt and disruptive ad'ustment than would have been re0uired if action had been more preemptive. .hether an E)posure is hedged or not, it is assumed that the decision to hedge/ not to hedge is backed by a Kiew or ,orecast, whether implicit or e)plicit. %s such, 1top (oss is nothing but a commitment to reverse a decision when the view is proven to be wrong. S7))*!,%/(!$ 1top (osses should be activated when

8ritical levels in the rate being monitored are reached, which clearly tell that the view held has been proven wrong. +he factors/ assumptions behind a view either change or are proven wrong. +he E)posure #anager should be accorded fle)ibility to set appropriate 1top< (osses for each trade.

+he E)posure #anager should, however, make sure he has set a stop<loss for positions he enters into, on an a priori basis.

.hile $enchmarks will be based upon the $ig +rend and will incorporate a certain amount of room for error, the E)posure #anager should be careful to not violate the $enchmark on the wrong side.

(G). REPORTING AND RE IEW

+here needs to be continuous monitoring whether the E)posures are headed where they are intended to reach. %s such, the E)posure #anagement activities need to be reported and reviewed.

R*8/",%()
+he E)posure #anager will prepare the following /eports on a regular basisJ 3@

R*8/", N'+* #+# /eport E)posure =%K /eport K%/ /eport

W.', %, !./?! P*"%/2%3%,0 +he #ark<to<#arket Grofit/ (oss status on !pen ,orward "aily, closing 8ontracts +he %ll<in<all e)change/ interest rate achieved on each ,ortnightly E)posure, and profitability vis<S<vis the $enchmark E)pected changes in overall E)posure due to forecasted #onthly e)change/ interest rate movements

R*>%*?
% monthly /eview meeting will consider the followingJ I!!7* E)posure Gerformance O( ,.* @'!%! /E)posure =%K /eport P/%(,! ,/ @* "*>%*?*2 Is the $enchmark being met/ betteredP .hat are the chances of the $enchmark being violated on the wrong sideP /easons for the $enchmark #arket 1ituation /eviews of market developments ,orecasts of market movements being violated on the wrong side Is the $ig +rend still in placeP !r has it changedP "oes the $enchmark need to be changedP Is the strategy working wellP !r does it need to be fine<tuned/ overhauledP !perational problems to be solved

$enchmarking +he above two Hedging 1trategy !perational issues

#+# and E)posure =%K /eports

E)posure #anager>s e)periences

(H). CONCLUSION
E)posure #anagement is an essential part of business and should be viewed with !b'ectivity. It is neither a license to print money nor is it a cause for getting trapped in a

31

,ear Gsychosis, and should be viewed with the same clarity of vision as, say, Groduction or #arketing is viewed. Having said that, it should be remembered that

%ll that has been stated above cannot start happening straightaway Installing Hedging, /eporting and /eview systems that work takes time and effort +here will be a (earning 8urve to be overcome when setting $enchmarks +here will be initial losses, which should be viewed as what they are < initial losses.

+here has to be a long<term commitment to E)posure #anagement, because it is today an activity, which no company can afford to ignore.

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. 1ignificant changes in the international economic and political landscape have led to uncertainty regarding the direction of foreign e)change rates. +his uncertainty leads to volatility and the need for an effective vehicle to hedge foreign e)change 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 e)posure to foreign e)change rate risk will have specific foreign e)change hedging needs and this website can not possibly cover every e)isting foreign e)change hedging situation. +herefore, we will cover the more common reasons that a foreign e)change hedge is placed and show you how to properly hedge foreign e)change rate risk.

3*

F/"*%)( E13.'()* R',* R%!& E18/!7"* < ,oreign e)change rate risk e)posure is
common to virtually all who conduct international business and/or trading. $uying and/or selling of goods or services denominated in foreign currencies can immediately e)pose you to foreign e)change rate risk. If a firm price is 0uoted ahead of time for a contract using a foreign e)change rate that is deemed appropriate at the time the 0uote is given, the foreign e)change rate 0uote may not necessarily be appropriate at the time of the actual agreement or performance of the contract. Glacing a foreign e)change hedge can help to manage this foreign e)change rate risk.

I(,*"*!, R',* R%!& E18/!7"* < Interest rate e)posure refers to the interest rate
differential between the two countries> currencies in a foreign e)change contract. +he interest rate differential is also roughly e0ual to the McarryM cost paid to hedge a forward or futures contract. %s a side note, arbitragers are investors that take advantage when interest rate differentials between the foreign e)change 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. 8onversely, an arbitrager may buy when the 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.

F/"*%)( I(>*!,+*(, E S,/3& E18/!7"* C ,oreign 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 e)poses the investor to foreign e)change rate risk and speculative risk. ,or e)ample, an investor buys a particular amount of foreign currency in e)change for domestic currency& in order to purchase shares of a foreign stock. +he investor is now automatically e)posed to two separate risks. ,irst, the stock price may go either up or down and the investor is e)posed to the speculative stock price risk. 1econd, the investor is e)posed to foreign e)change rate risk because the foreign e)change rate may either appreciate or depreciate from the time the investor first purchased the foreign stock and the time the investor decides to

32

e)it the position and repatriates the currency e)changes the foreign currency back to domestic currency&. +herefore, 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&. Glacing a foreign e)change hedge can help to manage this foreign e)change rate risk.

H*2)%() S8*379',%>* P/!%,%/(! C ,oreign currency traders utili;e foreign e)change

hedging to protect open positions against adverse moves in foreign e)change rates, and placing a foreign e)change hedge can help to manage foreign e)change rate risk. 1peculative positions can be hedged via a number of foreign e)change hedging vehicles that can be used either alone or in combination to create entirely new foreign e)change hedging strategies.

H/? T/ T"'2* F/"*1 S733*!!-7990$ F/"*1 T"'2%() R%!& M'(')*+*(,

T"'2%() ,.* M'"&*,!
+rading the markets for speculation purposes is a challenging task that numerous amounts of people have embarked on. "o you know anyone who successfully makes money tradingP +he 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. +hat usually means he is not a successful trader. .ith the type of leverage that is offered in the futures, options and fore) 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. .hy should they teach if they can be trading the

33

daylights out of it and be making millions with the 3@@J1 leverage that some fore) platforms offer. !n the other hand numerous people have made millions trading. (ook at the list of 8+%s on I%1:.com, look at 6ohn .. Henry, #a) %nsbacher, .arren $uffet, Geter (ynch and all the #arket .i;ards. I recommend reading the market wi;ards book for some inspiration. +he problem is that most traders go into trading with the wrong attitude. Have you ever heard this phrase EI am tired of working I need to trade to get rich.F It takes ? years to complete medical school and there is no green arrow red arrow system for performing heart surgery. +rading will pay you much more than doctors make so you should e)pect to have to do more work than doctors do for a longer period of time to get wealthy and become a market wi;ard. .hile 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 hypothesi;ed 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. $y edge, I mean something that will make the trader make more money than he looses. %n edge can be discretional or algorithmic as long as the trader makes money in the long run. % perfect e)ample of this is the game of black'ack. +he house has a very slight edge less than not more than *I. $ut by repetitive play they consistently end up profitable. +his is because they have a set approach, and edge, and they dont get emotional when a player goes on a winning streak. :ood traders put themselves in the position of a casino. +raders can make money discretionally by following support and resistance levels, watching the volume, si;e and market action. !r, traders can create a trading system by back<testing a certain edge. 8alculate the systems e)pectancy, develop trading and risk

35

management rules, and follow those rules religiously to generate profits. =umerous people will try to sell systems. It is very important that with any system traders create a reevaluation point. $y reevaluation point I mean a point where the trader starts to 0uestion the systems effectiveness and begins to look for other systems that he e)pects to fair profitable over time. +he 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
=. I(,"/273,%/(
+he spot market accounts for nearly a third of global foreign e)change turnover. It can be broadly divided into two tiersJ T +he interbank market where currency is bought and sold for delivery and settlement within two days, with the banks acting as EwholesalersF or Emarket makersF.

3A

T +he retail market made up of private traders, who deal over the telephone or the internet through intermediaries brokers&. +he fore) market has no centrali;ed e)changes. %ll trades are over<the<counter deals, agreed and settled by individual counterparties known to one another. +he fore) market is truly global and operates *3 hours a day, #onday to ,riday. "aily trading commences in .ellington, =ew Uealand and follows the sun to inter alia& 1ydney, +okyo, Hong 9ong, 1ingapore, $ahrain, ,rankfurt, :eneva, Uurich, Garis, (ondon, =ew Dork, 8hicago and (os %ngeles before starting again.

5. C7""*(30 8'%"! '(2 ,.* "',* /- *13.'()*

Every foreign e)change transaction is an e)change between a pair of currencies. Each currency is denoted by a uni0ue three<character International 1tandardi;ation !rgani;ation I1!& code e.g. :$G represents sterling and 41" the 41 dollar&. 8urrency pairings are e)pressed as two I1! codes separated by a division symbol e.g. :$G/41"&, the first representing the Ebase currencyF and the other the Esecondary currencyF. +he rate of e)change is simply the price of one currency in terms of another. ,or e)ample :$G/41" R 1.5535 denotes that one unit of sterling the base currency& can be e)changed for 1.5535 41 dollars the secondary currency&. +he base currency is the one that you are buying or selling. +his elementary point is often lost on beginners. E)change rates are usually written to four decimal places, with the e)ception of 6apanese yen which is written to two decimal places. +he rate to two out of four& decimal places is known as the Ebig figureF while the third and fourth decimal places together measure the EpointsF or EpipsF. ,or instance, in :$G/41" R 1.5535 the Ebig figureF is 1.55 while the 35 i.e. the third and fourth decimal places& represents the points.

5.=. B%2 /--*" !8"*'2

%s with other financial commodities, there is a buying price EofferF or EaskF price& and a selling price EbidF price&. +he difference is known as the Ebid<offer spreadF or Ethe

3?

spreadF. +he spread is written in a particular format, best demonstrated by way of an e)ample. :$G/41" R 1.5535/5@ means that the bid price of :$G is 1.5535 41" and the offer price is 1.555@ 41". +he spread in this case is 5 points.

5.5.T.* +'B/" 8'%"%()!

%ll pairings with the 41 dollar are known as the Ema'orsF. +he Ebig fourF ma'ors areJ < E4//41" denoting euro/41dollar :$G/41" denoting sterling/41 dollar known as EcableF& 41"/6GD denoting 41 dollar /6apanese yen 41"/8H, denoting 41 dollar/1wiss franc.

5.D.C"/!!"',*!
Gairings of non<41 dollar currencies are known as EcrossesF. .e can derive cross e)change rates for :G$, E4/, 6GD and 8H, from the aforementioned ma'or pairs. E)change rates must be consistent across all currencies, or else it will be possible to EroundtripFand make riskless profits. +he following Ema'orF e)change rates red& imply the Ecross ratesF blue&. %n illustration of how cross rates are computed is given in %ppendi) %.

D. B70%() *:7'9! !*99%()

Every purchase of the base currency implies a reciprocal sale of the secondary currency. (ikewise, sale of the base currency implies the simultaneous purchase of the secondary currency. ,or e)ample, when I sell 1 :$G, I am simultaneously buying 1.5535 41". (ikewise, when I buy 1 :$G, I am simultaneously selling 1.555@ 41". .e can e)press this e0uivalence by inverting the :$G/41" e)change rate and rotating the bid and offer reciprocals, to derive the 41"/:$G rate i.e. 41"/:$G R 1/1.555@& bidN 1/1.5535& offer R @.A321/22 +his means that the bid price of one 41" is @.A321 :$G or A3.21p& and the offer price 3B

of one 41" is @.A322 :$G or A3.22p&. =ote that 41" has now become the base currency and that the spread is * points.

6. P"'3,%3'9 !8/, ,"'2%()

6.= U(%,! /- ,"'2%() I 9/,!
%s we have already seen, every fore) transaction is an e)change of one currency for another. +he basic unit of trading for private investors is known as a ElotF which consists of 1@@,@@@ units of the base currency although some brokers may arrange trading in mini<lots&. T 4sing the data in +able %, the purchase of a single lot of :$G/41" will involve the purchase of 1@@,@@@ :$G at a price of 1.5B5* 41" R 15B,5*@ 41". T 1imilarly, the sale of a single lot of :$G/41" entails the sale of 1@@,@@@ :$G at 1.5B3? 41" R 15B,3?@ 41".

6.5 M'")%(
% private investor who purchases a :$G/41" lot does not have to put down the full value of the trade 15B,5*@ 41"&. Instead, the buyer is re0uired to put down a deposit known as EmarginF which enables the investor to gear up the trade si;e to institutional level. 1ince the sale of one currency involves the simultaneous purchase of another, the seller of a :$G/41" lot will have bought a volume of 41", and will also have to put down margin trade. +he currency denomination depends on the brokerage through which you e)ecute your trade. If you are dealing through an %merican broker say online&, then it is likely that you will have to deposit margin in 41" even if you are resident in the 49. for the value of the deal 15B,3?@ 41"&. +he normal margin re0uirement is between 1I and 5I of the underlying value of the

37

.ith 5,@@@ 41" in your margin account and with margin re0uirement of *.5I, you can open positions worth *@@,@@@ 41". Dour positions will be valued continuously. If the funds in your margin account drop below the minimum re0uired to support your open positions, then you may be asked to provide additional funds. +his is known as a Emargin callF. If your trade is denominated in a currency other than that accepted by the broker, you will have to convert your gains and losses back into an acceptable currency. ,or e)ample, if you trade a 41"/6GD pair, then your gains and losses will be denominated in 6GD. If your brokers home currency is 41", then your profits and losses will be converted back to 41" at the relevant 41"/6GD offer rate.

6.D C9/!%() /7,

%n open position is one that is live and ongoing. %s long as the position is open, its value will fluctuate in accordance with the e)change rate in the market. %ny profits and losses will e)ist on paper only and will be reflected in your margin account. +o close out your position, you conduct an e0ual and opposite trade in the same currency pair. ,or e)ample, if you have gone long in one lot of :$G/41" at the prevailing offer price& you can close out that position by subse0uently going short in one :$G/41" lot at the prevailing bid price&. Dour opening and closing trades must the conducted through the same intermediary. Dou cannot open a :$G/41" position with $roker % and close it out through $roker $.

;. W/"&*2 *1'+89*
;.= B*,,%() /( ' "%!*
%ssume that you start with a clean slate and that the current :G$/41" rate is 1.5B3?/5*. T Dou e)pect the pound to appreciate against the 41 dollar, so you buy a single lot of 1@@,@@@ :$G at the offer price of 1.5B5* 41". T +he value of the contract is 1@@,@@@ L C1.5B5* R C15B, 5*@.

5@

+he broker wants margin of *.5I in 41", so you must ensure that you deposit at least *.5I selling of 15B,5*@ sterling 41" for R 41 2,7A2 dollars 41" at the in bid your rate. margin Dour account gain isJ T :$G/41" duly appreciates to 1.A@@@/@5 and you decide to close out your position by your 1@@,@@@ L 1.A@@@ H 1.5B5*& 41" R 1,3B@ 41", the e0uivalent of 1@ 41" per point T Dour rate of return is 1,3B@/2,7A2 R 2?.25I, on an e)change rate movement of less than 1I. T +his illustrates the to positive effect your of buying would on margin. beenJ Had :$G/41" fallen 1.5?@@/?5, loss have

1@@,@@@ L

1.5B5* H 1.5?@@& 41" R 1,5*@ 41", a return of H2B.25I

+he lesson is that margin trading magnifies your rate of profit or loss.

F. S3"**(C@'!*2 !8/, ,"'2%()

+he technology for trading fore) has evolved from the telephone and tele) not forgetting voice dealing& through to the modern Electronic $roking 1ystem E$1& that enables Estraight through processingF administrative functionality. E$1<type technology is now available to individual, private investors who can receive live, streaming data from and transact directly through their chosen brokers. +he 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. 1+G& with integrated 0uotation, transactional and

% private trader re0uiresJ

T % margin account broker with internet access and a fast connection T % computer terminal capable of running several programmes simultaneously T Groprietary software to open and manage positions and to display technical analysis tools. T 1ufficient monitors to handle market data, submit dealing instructions, display technical analysisN and for keeping tabs on open positions, managing orders e.g. stop loss, +G!, limit etc.& and viewing the state of the margin account. ,or demonstrations of the kind of proprietary software available, visit Gronet %nalytics www.pronetanalytics.com& and

51

=ostradamus

www.nostradamus.co.uk&

Gronet %nalytics provides the only chart<based software package approved by %ssociation of 8ambistes Internationale, the governing body of professional fore) trading. ,rom early *@@2, a new spot trading software package from 41 provider :ain 8apital will be available through the 49 online margin broker Easy*+rade www.easy*trade.com&, better known for its futures online global trading platform. E.e will build our re0uired margin into the bid<offer spread,F says Easy*+rade chief e)ecutive "avid .enman. EIt will be free to use after that.F $efore you splash out on the full kit, why not does a test drive by renting a dealing desk at an organi;ation like +raderHouse www.traderhouse.net&.

G. F7(2'+*(,'9 '(2 ,*3.(%3'9 '('90!%!

.ithout the apparatus for making sense of the currency market, any trade represents a pure gamble. +here are two broad schools of analysis, which are not mutually e)clusive.

G.=F7(2'+*(,'9'('90!%!
,undamental analysis is the application of micro and macroeconomic theory to markets, with the aim of predicting future trends. 1o what fundamental forces drive currency marketsP

('). T.* @'9'(3* /- ,"'2*$ 8urrencies 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 e)cess of e)ports over imports. +rends are important too. %n improving balance of trade should cause the relevant currency to appreciate relative to those associated with a deteriorating or stable balance of trade. b&. R*9',%>* %(-9',%/( "',*!$ If country % is suffering a higher rate of price inflation

5*

than country $, then %s currency ought to weaken relative to $s in order to restore Epurchasing power parityF.

c&. I(,*"*!, "',*!$ International capital flows seek the highest inflation<ad'usted returns, creating additional demand for high real interest<rate currencies and pushing up their rates of e)change.

d&. E18*3,',%/(! '(2 !8*379',%/($ #arkets anticipate events. 1peculation on, say, the future rate of inflation may be enough to move the e)change 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. +he solution, some argue, lies in technical analysis.

G.5T*3.(%3'9 '('90!%!
+echnical analysis is concerned with predicting future price trends from historical price and volume data. +he underlying a)iom of technical analysis is that all fundamentals including e)pectations& are factored into the market and are reflected in e)change rates. +he 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. +he following is the briefest of introductions to the technical analytical tools used to identify trends and recurring patterns in a volatile marketplace. %spiring fore) dealers are advised to undergo proper training in technical analysis, although true proficiency comes with practice, endurance and e)perience.

TREND CLASSIFICATIONS
52

DRAWING TRENDLINES
+he 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. ,or an up trendline to be drawn, there must be at least two low points in the graph where the *nd low point is higher than the first. % price low is the lowest price reached during a counter trend move.

BULLISH TREND LINES

53

TREND, ANALYSIS AND TIMING

55

#arkets don>t move straight up and down. +he direction of any market at any time is either $ullish 4p&, $earish "own&, or =eutral 1ideways&. .ithin those trends, markets have countertrend backing - filling& movements. In a general sense M#arkets move in wavesM, and in order to make money a trader must catch the wave at the right time.

DRAWING ARIOUS TRENDLINES

DRAWING TRENDLINES

5A

TRENDLINES "rawing +rendlines will help to determine when a trend is changing.

TREND
+he direction of trend is absolutely essential to trading and analy;ing the market.

5?

In the ,oreign E)change ,L& #arket it is possible to profit from 4G and "own movements, because of the buying of one currency and selling against the other currency e.g. $uy 41 "ollar 1ell :erman #ark. e). 4p +rend chart.

H. T%8! -/" '!8%"%() !8/, ,"'2*"!

%ndy 1hearman, a director of fore) day<trading service +rader House =etwork 49& has E1even Gillars of .isdomF for 5B aspiring fore) tradersJ <

1& trade

"ont

be

under<capitali;ed

or

you

will

lose

trading

opportunities.

*& "ont suspend your daily successful& economic activity while you are learning to currencies. 2& :et an education. #ake time to practice and to check markets every day. 3& "ecide what your monetary goals are and devise a trading plan to reali;e them. /emember that you have overheads and that risk is involved. Dour target remuneration must screen. A& $e decisive. !ver<caution will cost you money. Dou cant make any profits if you dont trade. "ont agoni;e too long over a deal and trust your instincts. ?& .atch your back. =ever leave your trading screen even momentarily without putting stop losses in place. % pee is a long time in the fore) market. E+rading fore) is a bit like life in a combat ;one,F says 1hearman. E+here are bouts of frenetic, e)hilarating and even panic<stricken activity interspersed with periods of uneventful ness. =o one can physically trade *3 hours a day. Dou need your rest and recreation.F +rader House has come up with a novel solution. It has set up a tutorial centre with a night school for those with a day 'ob& and a dealing room at the 8ottesmore 8ountry 8lub in .est 1usse). Dou can play hard in the fore) 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. .ho needs the (otteryO not only be realistic but must include a risk premium. 5& 8hoose a good broker H preferably one that feeds live, streaming prices to your

CURRENCY FORWARD

57

% forward contract that locks<in the price an entity can buy or sell currency on a future date. In currency forward contracts, the contract holders are obligated to buy or sell the currency at a specified price, at a specified 0uantity, and on a specified future date. +hese contracts cannot be transferred. %lso known as Moutright forward currency transaction.M

CURRENCY FUTURES
% transferable futures contract that specifies the price at which a specified currency can be bought or sold at a future date. 8urrency future contracts allow investors to hedge against foreign e)change risk. 1ince these contracts are marked<to<market daily, investors can<<by closing out their position<<e)it from their obligation to buy or sell the currency prior to the contract>s delivery date. % 37""*(30 -7,7"*, also FX -7,7"* or -/"*%)( *13.'()* -7,7"*, is a futures contract to e)change one currency for another at a specified date in the future at a price e)change rate& that is fi)ed on the last trading date. +ypically, one of the currencies is the 41 dollar. +he )rice of a future is then in terms of 41 dollars per unit of other currency. +his can be different from the standard way of 0uoting in the spot foreign e)change markets. +he trade *nit of each contract is then a certain amount of other currency, for instance E4/ 1*5,@@@. #ost 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. E1'+89* Geter buys 1@ 1eptember 8#E Euro ,L ,utures, at 1.*?12 41"/E4/. %t the end of the day, the futures close at 1.*?B3

A@

41"/E4/. +he change in price is @.@@?1 41"/E4/. %s each contract is over E4/ 1*5,@@@, and he has 1@ contracts, his profit is 41" B,B?5. %s with any future, this is paid to him immediately. #ore generally, each change of @.@@@1 41"/E4/ the minimum tick si;e&, is a profit or loss of 41" 1*.5 per contract. Investors use these futures contracts to hedge against foreign e)change risk. +hey can also be used to speculate and, by incurring a risk, attempt to profit from rising or falling e)change rates. Investors can close out the contract at any time prior to the contract>s delivery date. 8urrency futures were first created at the 8hicago #ercantile E)change 8#E& in 17?*, less than one year after the system of fi)ed e)change rates was abandoned along with the gold standard. 1ome commodity traders at the 8#E did not have access to the inter<bank e)change markets in the early seventies, when they believed that significant changes were about to take place in the currency market. +hey established the International #onetary #arket I##& and launched trading in seven currency futures on #ay 1A, 17?*. +oday, the I## is a division of 8#E. In the second 0uarter of *@@5, an average of 22*,@@@ contracts with a notional value of 41" 32 billion were traded every day. #ost of these are traded electronically nowadays V1W.

T.* A2>'(,')*! /- T"'2%() C7""*(30 F7,7"*!

8urrency futures trade nearly *3 hours. +raders 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. 8#E currency futures trade virtually *3 hours per day during the trading week, and LG/E11+/%"E gives you the ability to trade in the open<outcry pits or on the :lobe) electronic platform, day or night.

,L markets are deep and li0uid. +raders can enter the market and e)it positions efficiently. 1ince their inception, 8#E currency futures have produced an active A1

trading environment through which customers collectively place trades worth up to C2*.1 billion 8#E single<day notional volume record, "ecember 7, *@@*&. +he success of ,L futures has created a robust trading environment. 8urrency futures offer diversification. In today>s e0uity market environment, diversification is a critical factor in individual portfolio management. $ecause e)change rates march to their own beat, currency futures can offer valuable diversification for an investment portfolio that has e0uity market risk. !n a historical basis, changes in e)change rates have had very low correlations with price movements in stock market values and interest rates. +his lack of any systematic relationship can lower portfolio risk and generate positive returns when other markets are in a depressed state.

OPTIONS ON FUTURE CONTRACTS

INTRODUCTION
!ptions on futures contracts have added a new dimension to futures trading. (ike futures, options provide price protection against adverse price moves. Gresent<day options trading on the floor of an e)change began in %pril 17?2 when the 8hicago $oard of +rade created the 8hicago $oard !ptions E)change 8$!E& for the sole purpose of trading options on a limited number of =ew Dork 1tock E)change<listed e0uities. !ptions on

A*

futures contracts were introduced at the 8$!+ in !ctober 17B* when the e)change began trading !ptions on 4.1. +reasury $ond futures.

W.', A"* O8,%/(!J

+here are two basic types of options on futures contractsJ McallsM and Mputs.M % 3'99 /8,%/( on futures contracts conveys the right but not the obligation& to the buyer to purchase a specific futures contract for e)ample, a corn contract for a "ecember 177? delivery month& at a particular price during a specified period of time. % 87, /8,%/( 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. +he 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 !,"%&* 8"%3* or *1*"3%!* 8"%3*. +he date on which an option e)pires<<the date after which it can no longer be e)ercised<< is the option>s e)piration date. +he 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 /8,%/( 8"*+%7+.

W.*"* A"* O8,%/(! T"'2*2J

!ptions are traded on the same e)changes as those of the underlying futures contracts. +here are 11 different commodity e)changes in the 4.1. as well as abroad. +he ma'or domestic agricultural crops are traded on the 8hicago $oard of +rade, the 9ansas 8ity $oard of +rade, the #inneapolis :rain E)change, the =ew Dork 8otton E)change, and the 8offee, 1ugar and 8ocoa E)change.

H/? A"* O8,%/(! T"'2*2J

!ptions contracts are traded in much the same manner as their underlying futures contracts. +here are several important factors to remember when trading options. +he 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

A2

a put option. +rading a put does not involve a call option. 8alls and puts are separate contracts, not opposite sides of the same transaction. %t 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. !ption delivery months are typically the same as those of the underlying futures contract. 1trike prices are listed in predetermined multiples for each commodity. +he 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. A,C,.*C+/(*0 is defined as an option whose strike price is e0ual<<or appro)imately e0ual<<to the current market price of the underlying futures contract. +he five lower strikes would follow normal intervals. +he 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. %s 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. %n important difference between futures and options is that trading in futures contracts is based on prices, while trading in options is based on premiums. +he premium depends on market conditions such as volatility, time until e)piration, and other economic variables affecting the value of the underlying futures contract. How various factors influence premiums and how and to what e)tent market price declines are offset by option profits are among the topics to discuss in detail with a broker. +he premium is the only part of the option contract negotiated in the trading pitN all other contract terms are predetermined. ,or an option buyer, the premium represents the ma)imum amount that he or she can lose, since the buyer is limited only to his initial investment. ,or an option seller, however, the premium represents the ma)imum amount

A3

he or she can gain, since the option seller faces the possibility of the option being e)ercised against him or her. .hen an option is e)ercised, the futures position assigned to an option seller will almost always be a losing one, since only an in<the<money option will normally be e)ercised by the option buyer.

R*'!/(! -/" 7!%() O8,%/(!

!ptions differ considerably from futures. .hen used prudently, options can be of immense importance, especially in attempting to preserve the value of an e)isting fi)ed< income portfolio. +o many in the financial markets, options are considered MinsuranceM against adverse price movements while offering the fle)ibility to benefit from possible favorable price movement. +he reasons for using options on futures are reflected in the structure of an option contract. ,irst, an option, when purchased, gives the buyer the right, but not the obli+ation, to buy or sell a specific amount of a specific commodity at a specific price within a specific period of time. $y comparison, a futures contract re,*ires a buyer or seller to perform under the terms of the contract if an open position is not offset before e)piration. 1econd, the decision to e)ercise the option is entirely that of the b*yer. +hird, the purchaser of the option can lose no more than the initial amount of money invested premium&. +hat is not the case, however, for the buyer of a futures contract. ,inally, an option buyer is never sub'ect to margin calls. +his enables the purchaser to maintain a market position, despite any adverse moves without putting up additional funds.

O8,%/(! T*"+%(/9/)0

A5

+here are several important terms the would<be user of options on futures should understand. +hey includeJ

3'99 /8,%/($
:ives the buyer the right, but not the obligation, to buy a specific futures contract at a predetermined price within a limited period of time.

87, /8,%/(J
:ives the buyer the right, but not the obligation, to sell a specific futures contract at a predetermined price within a limited period of time.

./92*"J
+he buyer of the option.

8"*+%7+$
+he dollar amount paid by the buyer of the option to the seller.

?"%,*"$
+he option seller.

!,"%&* 8"%3*$
+he predetermined price at which a given futures contract can be bought or sold. %lso called the exercise price, these levels are set at regular intervals. ,or e)ample, if +reasury bond futures were at ?7<@@, +<bond option strike prices would be at ?3, ?A, ?B, B@, B*, and B3.

',C,.*C+/(*0J
%n option is at<the<money when the underlying futures price e0uals, or nearly e0uals, the strike price. ,or e)ample, a +<bond put or call option is at<the<money if the option strike price is ?B and the price of the +reasury bond futures contract is at, or near, ?B<@@.

%(C,.*C+/(*0$
% call option is in<the<money when the underlying futures price is greater than the strike price. ,or e)ample, if +reasury bond futures are at B@<@@ and the +<bond

AA

call option strike price is ?B, the call is in<the<money. +he put option is in<the< money when the strike price of the option is greater then the price of the underlying futures contract. ,or e)ample, if the strike price of the put option is B@ and +<bond futures are trading at ??<@@, the put option is in<the<money.

/7,C/-C,.*C+/(*0$
% call option is out<of<the<money if the strike price is greater than the underlying futures price. ,or e)ample, if +<bond futures are at B@<@@ and the +<bond call option has an B* strike price, the option is out<of<the<money. +he put option is out<of<the<money if the underlying futures price is greater then the strike price. ,or e)ample, if +<bond futures are at ??<@@, and the +<bond put option strike price is ?A, the put option is out<of<the<money. 8all option I(C,.*C+/(*0 A,C,.* +/(*0 O7,C/-C,.*C+/(*0 Gut option ,utures Y 1trike ,utures R 1trike ,utures X 1trike

,utures X 1trike ,utures R 1trike ,utures Y 1trike

!ptions are considered Mwasting assets.M In other words, they have a limited life because each e)pires on a certain day, although it may be weeks, months, or years away. +he e)piration date is the last day the option can be e)ercised, otherwise it e)pires worthless. ,or every option buyer there is an option seller. In other words, for every call buyer there is a call sellerN for every put buyer, a put seller. +he 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 re0uired to post margin.

If an option position is 3/>*"*2, the seller holds an offsetting position in the underlying commodity itself or a futures contract. ,or e)ample, the seller of a +reasury bond call option would be covered if he actually owned cash market 4.1. +reasury bonds or was long the +reasury bond futures contract. If the writer did not hold either, he would have an 7(3/>*"*2 or MnakedM position. In

A?

such instances, margin would be re0uired because the seller would be obligated to fulfill terms of the option contract in the event the contract is e)ercised by the buyer. It is imperative, therefore, that the seller demonstrate the ability to meet any potential contractual obligations beforehand. In addition, the seller of uncovered options on interest rate futures assumes the potential for significant losses.

M/,%>*! -/" B70%() '(2 S*99%() O8,%/(!

!ne may be a buyer or seller of call or put options for a variety of reasons. % call option b*yer, for e)ample, is bullish. +hat 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. +he first is to e)ercise the option and ac0uire the underlying futures contract at the strike price. +he second is to offset the long call position with a sale and reali;e a profit. +he third, and least acceptable, is to let the option e)pire worthless and forfeit the unreali;ed profit. +he seller of the call option e)pects 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 e)tent of the premium received. ,or instance, if +<bond futures were purchased at B@<@@ and a call option with an B@ strike price was sold for *<@@, +<bond futures could decline to the ?B<@@ level before there would be a net loss in the position e)cluding, of course, margin and commission re0uirements&. However, should +<bond futures rise to B*<@@, the call option seller forfeits the opportunity for profit because the buyer would likely e)ercise the call against him and ac0uire a futures position at B@<@@ the strike price&.

AB

+he perspectives of the put buyer and put seller are completely different. +he buyer of the put option believes prices for the underlying futures contract will decline. ,or e)ample, if a +<bond put option with a strike price of B* is purchased for *<@@, while +<bond futures also are at B*<@@, the put option will be profitable for the purchaser to e)ercise if +<bond futures decline below B@<@@.

In many instances, puts will be purchased in con'unction with a long cash or long +<bond futures position for MinsuranceM purposes. ,or instance, if an institution is long +<bond futures at B*<@@ and a +<bond put option with an B* strike is purchased for *<@@, the futures contract could, theoretically, fall to ;ero and the put option holder could e)ercise the option for the B* strike price, assuming the option had not yet e)pired. +he seller of put options on fi)ed<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 b*yer of the put option can re0uire the writer to take delivery of the underlying instrument at a price greater than that in the new market environment. 1ince an option is a wasting asset, an open position must be closed or e)ercised, otherwise the option e)pires worthless. +he chart below illustrates what happens to the buyer and the seller after an option is e)ercised.

F7,7"*! P/!%,%/(! A-,*" O8,%/( E1*"3%!*

8all option B70*" '!!7+*! S*99*" '!!7+*! (ong +<bond/note futures position 1hort +<bond/note futures position Gut option 1hort +<bond/note futures position (ong +<bond/note futures position

A7

O8,%/( P"*+%7+ '97',%/(

+he price value& of an option premium is determined competitively by open outcry auction on the trading floor of the 8$!+. +he premium is affected by the influ) of buy and sell orders reaching the e)change floor. %n option buyer pays the premium in cash to the option seller. +his cash payment is credited to the seller>s account. Grices for +<bond and +<note futures contracts are 0uoted differently from the options premiums on these futures. !ptions on these contracts are 0uoted in A3th of a point. +herefore, a 0uote of <@1 in options means 1/A3, in futures, 1/2*.

+he option premium has two componentsJ Mintrinsic valueM and Mtime value.M +he intrinsic value is the gross profit that would be reali;ed upon immediate e)ercise of the option. In other words, intrinsic value is the amount by which the portion is in<the< money. %n option that is out<of<the< money or at<the<money has no intrinsic value.&

,or e)ample, in "ecember, a 6une +reasury bond futures contract is priced at B*<@@, while the 6une B@ call is priced at 2 1@/A3. +he intrinsic value of the option is *<@@J

$ond futures !ption strike price Intrinsic value

B*<@@ B@<@@ *<@@

Time value reflects the probability the option will gain in intrinsic value or become profitable to e)ercise before it e)pires. +ime value is determined by subtracting intrinsic value from the option premiumJ +ime value R !ption premium < Intrinsic value

?@

R 2 1@/A3 < *<@@ R 1 1@/A3 1everal other factors also have an impact on the premium. !ne is the relationship between the underlying futures price and strike price. +he more an option is in<the< money, the more it is worth. % !*3/(2 factor is volatility. Kolatile prices of the underlying commodity can stimulate option demand, enhancing the premium. +he greater the volatility, the greater the chance the option premium will increase in value and the option will be e)ercisedN thus, buyers pay more while writers demand higher premiums.

% ,.%"2 factor affecting the premium is time until e)piration. 1ince the underlying value of the futures contract changes more within a longer time period, option premiums are sub'ect to greater fluctuation.

1ome parallels can be drawn between the time value component of an option premium and the premium charged for an automobile insurance policy. +he longer the term of the policy, the greater the probability a claim will be made by the policyholder. +his, of course, presents a greater risk to the insurance company. +o compensate for this increased risk, the insurer charges a greater premium.

CURRENCY SWAPS
8urrency 1waps are derivative products that help manage e)change rate and interest rate e)posure on long<term liabilities. % 8urrency 1wap involves e)change of interest payments denominated in two different currencies for a specified term, along with e)change of principals. +he rate of interest in each leg could either be a fi)ed rate, or a floating rate inde)ed to some reference rate, like the (I$!/. 8onsider a corporate who has a 41" loan with interest rate at a spread over A<month (I$!/. +he corporate faces the following risksJ

?1

8urrency riskJ If the rupee depreciates against 41", it will be more e)pensive for the corporate to service its loan Interest rate riskJ %n upward movement in (I$!/ 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 41" floating rate loan to a I=/ fi)ed rate loan. +he currency swap could be represented as followsJ 8urrency 1waps therefore enable a swap into both, a different currency and a different interest rate basis. 1ome of the advantages of currency swaps areJ

Enables moving a liability from one currency into another 8an be customi;ed 8an be reversed at any time at a cost or benefit& !ff $alance 1heet, and does not change the terms of the e)isting liability.

8urrency swaps can be structured to synthetically move liabilities in one currency to another depending on which risks and what costs are acceptable. +he interest rates on either of the legs can be floating or fi)ed. It is also possible to move rupee liabilities into foreign currencies through currency swaps. 8orporates wishing to match currency of loan repayments with currency of receivables for e)ample, e)porters having a long tenor /upee liabilities& could enter into such swaps. 8orporates could also undertake such swaps if they wish to take advantage of lower interest rates in return for e)change rate risk. 8onsider a corporate that has an I=/ *5 8rores loan at 7I fi)ed rate, repayable bullet at the end of two years. If this corporate wishes to swap its liability into a 41" loan, the structure of the loan would be as followsJ +he cash flows in this swap would be as followsJ

.A, %(3*8,%/(
?*

=one. +he loan is notionally converted from I=/ into 41" at current 41"I=/ spot rate. +hese will then be the principal amounts on which the interest will be computed.

.E>*"0 F +/(,.!
8ompany pays to the bank A month 41" (I$!/ plus a spread on the notional 41" principal 8ompany receives from the bank /upee interest Z 7I on the notional I=/ principal

.A, +',7"%,0
8ompany receives I=/ principal from I"$I $ank. Gays 41" principal to the I"$I $ank. +he company therefore gains from a lower interest rate loan, for which it bears the cost of I=/ depreciation against 41" during the tenor of the swap. 8urrency swaps can be used to move from any currency to any other desired currency and interest rate. ,or e)ample, a corporate could swap its I=/ liability into 6GD to benefit from the low 6GD interest rates. +he risk of adverse 6GD/41" e)change rate movement can be limited to desired levels at a price. 1uch products can be customi;ed to suit specific corporate interest. It is also possible to structure swaps to hedge specific risks. ,or e)ample, there could be swap such that only the principal amount of a foreign currency loan is protected at current e)change rates Grincipal !nly 1wap&. 8oupon swaps H swaps involving only interest payments and no principal amounts H is another such variant.

THE EXCHANGE OF PRINCIPAL AT INCEPTION AND AT MATURITY

?2

In an interest rate swap, we were concerned e)clusively with the e)change of cash flows relating to the interest payments on the designated notional amount. However, there was no e)change of notional at the inception of the contract. +he notional amount was the same for both sides of the currency and it was delineated in the same currency. Grincipal e)change is redundant. However, in the case of a currency swap, principal e)change is not redundant. +he e)change 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. ,or e)ample, consider the 41<based company M%cme +ool - "ieM& that has raised money by issuing a 1wiss ,ranc<denominated Eurobond with fi)ed semi<annual coupon payments of AI on 1@@ million 1wiss ,rancs. 4pfront, the company receives 1@@ million 1wiss ,rancs from the proceeds of the Eurobond issue ignoring any transaction fees, etc.&. +hey are using the 1wiss ,rancs to fund their 41 operations.

AD ANTAGES OF USING CURRENCY SWAP

.FLEXIBILITY
8urrency swaps give companies e)tra fle)ibility to e)ploit 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 long<end of the maturity spectrum. 8urrency swaps allow companies to e)ploit advantages across a matri) of currencies and maturities.

?3

+he success of the currency swap market and the success of the Eurobond market are e)plicitly linked.

.EXPOSURE
$ecause of the e)change and re<e)change of notional principal amounts, the currency swap generates a larger credit e)posure than the interest rate swap. 8ompanies have to come up with the funds to deliver the notional at the end of the contract. +hey are obliged to e)change one currency>s notional against the other currency>s notional at a fi)ed rate. +he more actual market rates have deviated from this contracted rate, the greater the potential loss or gain. +his potential e)posure is magnified with time. Kolatility increases with time. +he longer the contract, the more room for the currency to move to one side or other of the agreed upon contracted rate of principal e)change. +his e)plains why currency swaps tie up greater credit lines than regular interest rate swaps.

PRICING
.e 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 ;ero coupon version of the swap curves. :enerally, currency swaps transact at inception with a net present value of ;ero. !ver 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

?5

8urrency swaps allow companies to e)ploit the global capital markets more efficiently. +hey are an integral arbitrage link between the interest rates of different developed countries. +he future of banking lies in the securiti;ation and diversification of loan portfolios. +he global currency swap market will play an integral role in this transformation. $anks will come to resemble credit funds more than anything else, holding diversified portfolios of global credit and global credit e0uivalents with derivative overlays used to manage the variety of currency and interest rate risk.

D*"%>',%>*!
8ommodities whose value is derived from the price of some underlying asset like securities, commodities, bullion, currency, interest level, stock market inde) or anything else are known as E"erivativesF. 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

?A

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. +he legal terms of a contract are much more varied and fle)ible than the terms of property ownership. In fact, its this fle)ibility that appeals to investors. .hen 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 fi)ed period of time. [,utures and [options are two commodity traded types of derivatives. %n [options contract gives the owner the right to buy or sell an asset at a set price on or before a given date. !n the other hand, the owner of a [futures contract is obligated to buy or sell the asset. +he other e)amples of derivatives are warrants and convertible bonds similar to shares in that they are assets&. $ut derivatives are usually contracts. $eyond 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 e)posed to, derivatives H wittingly or unwittingly. 1hares or bonds are financial assets where one can claim on another person or corporationN they will be usually be fairly standardi;ed and governed by the property of securities laws in an appropriate country. !n the other hand, a contract is merely an agreement between two parties, where the contract details may not be standardised. "erivatives securities or derivatives products are in real terms contracts rather than solid as it fairly sounds.

??

SIGNIFICANCE OF THE STUDY

,ore) market is changing day by day showing a wide growth in the economy. ,ore) market is more volatile in nature. +here are different factors like speculation, hedging which force different people to enter in different markets. +here is risk in ,oreign market and various /isk management strategies are there to manage it.

?B

/isk management is done in order to minimi;e 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.

"ue 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 ma)imi;e profit in the long run and that give a boost to the economy.

ANALYSIS AND INTERPRETATIONS

U(2*"!,'(2%() S,"',*)0 '(2 A('90!%!

All successful traders have a carefully thought out system that they follow to make profitable trades. +his system is generally based on a strategy that allows them to find good trades. %nd the strategy is based on some form of market analysis. 1uccessful traders need some way to interpret and even predict some of the movements of the market.

?7

+here are two basic approaches to analysing market movements, in both e0uity markets and the ,!/EL market. +hese are technical analysis and fundamental analysis. However, technical analysis is much more likely to be used by traders. 1till, its good to have an understanding of both types of analysis, so that you can decide which type would work best for your system.

F7(2'+*(,'9 A('90!%!
In fundamental analysis, you are basically valuing either a business, for e0uity markets, or a country, for ,!/EL. If you think it>s hard enough to value one company, you should try valuing a whole country. It can be 0uite difficult to do, but there are indicators that can be studied to give insight into how the country works. % few indicators you might want to study areJ =on<farm payrolls, Gurchasing #anagers Inde) G#I&, 8onsumer Grice Inde) 8GI&, /etail 1ales, and "urable :oods. #ost traders in the ,!/EL 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. +here are also 0uite a variety of meetings where you can get 0uotes and commentary that can affect markets 'ust as much as any news release or indicator report. +hese 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 ,ederal /eserve chairman>s comments on interest rates, can cause volatility in the market. +wo important meetings that you should watch for are the ,ederal !pen #arket 8ommittee and the Humphrey Hawkins Hearings. 6ust by reading the reports and e)amining the commentary, a ,!/EL fundamental analyst can get a better understanding of most long<term market trends. 9eeping up on these developments will also allow short<term traders to profit from e)traordinary

B@

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. Dour broker may also be able to provide you with real<time access to this kind of information.

T*3.(%3'9 A('90!%!
Just like their counterparts in the e0uity markets, technical analysts in the ,!/EL market analy;e price trends. +he only real difference between technical analysis in ,!/EL and technical analysis in e0uities is the time frame. ,!/EL markets are open *3 hours a day. $ecause of this, some forms of technical analysis that factor in time have to be modified so that they can work in the *3<hour ,!/EL market. 1ome of the most common forms of technical analysis used in ,!/EL areJ Elliott .aves, ,ibonacci studies, Garabolic 1%/, and Givot points. % lot of technical analysts combine technical indicators to make more accurate predictions. +he most common tendency is to combine ,ibonacci studies with Elliott .aves.& !thers prefer to create entire trading systems in an effort to repeatedly locate similar buying and selling condition.

FINDINGS
T"'2%() @0 N7+@*"! I E%).,**( T%8!
You can never have too many tips or tricks up your sleeve when you are trading. #ost of the tips Im including here are received wisdom, trading truisms that you should remember. +hey apply to all markets, but are particularly useful in a volatile and technical market like the ,!/EL

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1. Gay attention to the market. E)it and enter trades based on market information. "ont wait for a price you think the currency should hit when the market has changed direction on you. *. +here are times when, due to a lack of li0uidity or e)cessive volatility, you should not trade at all. !n a similar note, never trade when you are sick. Dou cant count on yourself to be alert to the shifts of the markets, and make good decisions. 2. +rading 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. 3. 4p market and down market patterns are %(.%D1 there, but you have to look for the dominant trends. %lways select trades that move with the trends 5. "uring the blowout stage of the market, either up or down, the risk managers are usually issuing margin call position li0uidation orders. +hey don>t generally check the screen to see whats overbought or oversoldN they 'ust keep issuing li0uidation orders. #ake sure you stay out of their way. A. +rust your instincts. If something feels wrong about a trade, dont make it. Its better to be superstitious than to loose money. ?. /umour is king. $uy when you hear the rumour, sell when you hear the news. B. +he first and last ticks are always the most e)pensive. :et in the market late, and out early. %nd never trade in the direction of a gap, either opening or closing. 7. .hen everyone else is in, it>s time for you to get out. If a stock or currency is overbought, its time to e)it your position. 1@. "ont worry about missing out on an opportunity to trade. +here will always be another good one 'ust 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.

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11. "ont get too confident. =o one can predict the market with 1@@I accuracy. Dou need to always e)pect the une)pected. If you become uneasy, or the market becomes choppy, e)it your trades. 1*. "on>t turn three losing trades in a row into si). .hen youre off, turn off the screen, do something else. !ften the best way to break a streak of consecutive loses is to not trade for a day. 12. $ut, don>t stop trading when youre on a winning streak. 13. #easure your success by the profit made in a day, not on a trade. Its even better to measure it over two or three days. % successful traders goal is to make money, not to win on every trade. 15. 1calpers reduce the number of variables affecting market risk by being in a position only for a few seconds. "ay 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 analy;e the risks of the trade properly. 1A. +here is no secret to understanding the market. Dou can spend much of your valuable time and money looking for these kinds of secrets. Its better to take the time to create a solid trading system, and reali;e that the secret to success is hard work. 1?. =ever ask for someone else>s opinion, they probably didnt do as much homework as you did anyways. 1B. .hen the market is going up, say it out loud. .hen the market is going down, say that out loud too. Doull be ama;ed 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.

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HOW TO A OID TYPICAL PITFALLS AND START MAKING MORE MONEY IN YOUR FOREX TRADING
1. T"'2* 8'%"!, (/, 37""*(3%*! C (ike any relationship, you have to know both sides. 1uccess or failure in fore) trading depends upon being right about both currencies and how they impact one another, not 'ust one. *. K(/?9*2)* %! P/?*" C .hen starting out trading fore) online, it is essential that you understand the basics of this market if you want to make the most of your investments. 2. U('+@%,%/7! ,"'2%() C #any new traders will place very tight orders in order to take very small profits. +his 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. 3. O>*"C3'7,%/7! ,"'2%() C (ike the trader who tries to take small incremental profits all the time, the trader who places tight stop losses with a retail fore) broker is doomed. %s 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. I(2*8*(2*(3* C If you are new to fore), you will either decide to trade your own money or to have a broker trade it for you. 1o far, so good. $ut your risk of losing increases e)ponentially if you either of these two thingsJ Interfere with what your broker is doing on your behalf as his strategy might re0uire a long gestation period&N 1eek advice from too many sources < multiple input will only result in multiple losses. +ake a position, ride with it and then analyse the outcome < by yourself, for yourself.

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A. T%(0 +'")%(! C #argin trading is one of the biggest advantages in trading fore) 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 fore) traders. +he best guideline is to increase your leverage in line with your e)perience and success. ?. N/ !,"',*)0 C +he aim of making money is not a trading strategy. % strategy is your map for how you plan to make money. Dour strategy details the approach you are going to take, which currencies you are going to trade and how you will manage your risk. .ithout a strategy, you may become one of the 7@I of new traders that lose their money. B. T"'2%() O--CP*'& H/7"! C Grofessional ,L traders, option traders, and hedge funds posses a huge advantage over small retail traders during off<peak hours between **@@ 8E+ and 1@@@ 8E+& 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&. +he best advice for trading during off peak hours is simple < don>t. 7. T.* /(90 ?'0 %! 78E2/?( C .hen the market is on its way up, the market is on its way up. .hen the market is going down, the market is going down. +hat>s it. +here are many systems which analyse past trends, but none that can accurately predict the future. $ut if you acknowledge to yourself that all that is happening at any time is that the market is simply moving, you>ll be ama;ed at how hard it is to blame anyone else. 1@. T"'2* /( ,.* (*?! C #ost of the really big market moves occur around news time. +rading volume is high and the moves are significantN this means there is no better time to trade than when news is released. +his is when the big players ad'ust their positions and prices change resulting in a serious currency flow. 11. E1%,%() T"'2*! C If you place a trade and it>s not working out for you, get out. "on>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 stressN stress is a natural part of tradingN get used to it.

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1*. D/(K, ,"'2* ,// !./",C,*"+ C If you are aiming to make less than *@ points profit, don>t undertake the trade. +he spread you are trading on will make the odds against you far too high. 12. D/(K, @* !+'", C +he most successful traders I know keep their trading simple. +hey don>t analyse all day or research historical trends and track web logs and their results are e)cellent. 13. T/8! '(2 B/,,/+! C +here are no real MbargainsM in trading foreign e)change. +rade in the direction the price is going in and you>re results will be almost guaranteed to improve. 15. I)(/"%() ,.* ,*3.(%3'9!C 4nderstanding whether the market is over<e)tended long or short is a key indicator of price action. 1pikes occur in the market when it is moving all one way. 1A. E+/,%/('9 T"'2%() C .ithout that all<important strategy, you>re trades essentially are thoughts only and thoughts are emotions and a very poor foundation for trading. .hen most of us are upset and emotional, we don>t tend to make the wisest decisions. "on>t let your emotions sway you. 1?. C/(-%2*(3* C 8onfidence comes from successful trading. If you lose money early in your trading career it>s very difficult to regain itN the trick is not to go off half< cockedN learn the business before you trade. /emember, knowledge is power.

SUGGESTIONS
1. T'&* %, 9%&* ' +'( C 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. 1ticking to a bad position ruins lots of traders < permanently. +ry to remember that the market often behaves illogically, so don>t get commit to any

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one tradeN it>s 'ust a trade. !ne good trade will not make you a trading successN it>s ongoing regular performance over months and years that makes a good trader. *. F/37! C ,antasi;ing about possible profits and then MspendingM them before you have reali;ed them is no good. ,ocus on your current position s& and place reasonable stop losses at the time you do the trade. +hen sit back and en'oy the ride < you have no real control from now on, the market will do what it wants to do. 2. D/(K, ,"7!, 2*+/! C "emo trading often causes new traders to learn bad habits. +hese bad habits, which can be very dangerous in the long run, come about because you are playing with virtual money. !nce you know how your broker>s system works, start trading small amounts and only take the risk you can afford to win or lose. 3. S,%3& ,/ ,.* !,"',*)0 C .hen you make money on a well thought<out strategic trade, don>t go and lose half of it ne)t time on a fancyN stick to your strategy and invest profits on the ne)t trade that matches your long<term goals. 5. T"'2* ,/2'0 C #ost successful day traders are highly focused on what>s happening in the short<term, not what may happen over the ne)t monthP If you>re trading with 3@ to A@<point stops focus on what>s happening today as the market will probably move too 0uickly to consider the long<term future. However, the long<term trends are not unimportantN they will not always help you though if you>re trading intraday. A. T.* 397*! '"* %( ,.* 2*,'%9! C +he bottom line on your account balance doesn>t tell the whole story. 8onsider individual trade detailsN analyse your losses and the telling losing streaks. ?. :enerally, traders that make money without suffering significant daily losses have the best chance of sustaining positive performance in the long term. B. S%+79',*2 R*!79,! < $e very careful and wary about infamous Mblack bo)M systems. +hese so<called trading signal systems do not often e)plain e)actly how the trade signals they generate are produced. +ypically, these systems only show their track record of e)traordinary results < historical results. 1uccessfully predicting future trade scenarios is altogether more comple). +he high<speed

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algorithmic capabilities of these systems provide significant retrospective trading systems, not ones which will help you trade effectively in the future. 7. G*, ,/ &(/? /(* 3"/!! ', ' ,%+* < Each currency pair is uni0ue, and has a uni0ue way of moving in the marketplace. +he forces which cause the pair to move up and down are individual to each cross, so study them and learn from your e)perience and apply your learning to one cross at a time. 1@. R%!& R*?'"2 < If you put a *@ point stop and a 5@ point profit your chances of winning are probably about 1<2 against you. In fact, given the spread you>re trading on, it>s more likely to be 1<3. Glay the odds the market gives you. 11. T"'2%() -/" W"/() R*'!/(! < "on>t trade if you are bored, unsure or reacting on a whim. +he 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. 1*. A*( T"'2%()C Even when you have taken a position in the markets, you should try and think as you would if you hadn>t taken one. +his 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. +o achieve this, you need to cultivate a calm and rela)ed outlook. +rade 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. 12. D*,*"+%(',%/( C !nce you have decided to place a trade, stick to it and let it run its course. +his 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. Dour determination must be show itself when you acknowledge that you got it wrong, so get out. 13. S./",C,*"+ M/>%() A>*"')* C"/!!/>*"! < +his is one of the most dangerous trade scenarios for non professional traders. .hen the short<term moving average crosses the longer<term moving average it only means that the average price in the short run is e0ual to the average price in the longer run. +his is neither a bullish nor bearish indication, so don>t fall into the trap of believing it is one.

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15. S,/3.'!,%3 < %nother dangerous scenario. .hen it first signals an e)hausted condition that>s when the big spike in the Me)haustedM currency cross tends to occur. #y advice is to buy on the first sign of an overbought cross and then sell on the first sign of an oversold one. +his approach means that you>ll be with the trend and have successfully identified a positive move that still has some way to go. 1o if percentage 9 and percentage " are both crossing B@, then buyO +his is the same on sell side, where you sell at *@&. 1A. O(* 3"/!! %! '99 ,.', 3/7(,! C E4/41" seems to be trading higher, so you buy :$G41" because it appears not to have moved yet. +his is dangerous. ,ocus on one cross at a time < if E4/41" looks good to you, then 'ust buy E4/41". 1?. W"/() B"/&*" < % lot of ,!/EL brokers are in business only to make money from yours. /ead forums, blogs and chats around the net to get an unbiased opinion before you choose your broker. 1B. T// @799%!. C +rading statistics show that 7@I of most traders will fail at some point. $eing too bullish about your trading aptitude can be fatal to your long<term success. Dou can always learn more about trading the markets, even if you are currently successful in your trades. 1tay modest, and keep your eyes open for new ideas and bad habits you might be falling in to. 17. I(,*"8"*, -/"*1 (*?! 0/7"!*9- C (earn to read the source documents of fore) news and events < don>t rely on the interpretations of news media or others.

BIBLIOGRAPHY
o ???.)//)9*.3/+ :!!:(E 1E%/8H E=:I=E o "r. :. 9!+/E1H.%/, /I19 #%=%:E#E=+, HI#%(%D% G4$(I1HI=: H!41E, #4#$%I. o %.9.1E+H, I=+E/=%+I!=%( ,I=%=8I%( #%=%:E#E=+.

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o (EKD, I=+E/=%+I!=%( ,I=%=8I%( #%=%:E#E=+. o K.9.$H%((%, I=+E/=%+I!=%( ,I=%=8I%( #%=%:E#E=+. o 1H%GI/!, I=+E/=%+I!=%( ,I=%=8I%( #%=%:E#E=+.

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