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Thursday, September 25, 2008

ForexGen |Keeps Spreads Tight

Financial factors are vital to fundamental analysis. Changes in a government's monetary or fiscal

policies are bound to generate changes in the economy, and these will be reflected in the

exchange rates. Financial factors should be triggered only by economic factors. When

governments focus on different aspects of the economy or have additional international

responsibilities, financial factors may have priority over economic factors. This was painfully true

in the case of the European Monetary System (EMS) in the early 1990s. The realities of the

marketplace revealed the underlying artificiality of this approach.

The role of interest rates. Using the interest rates independently from the real economic

environment translated into a very expensive strategy. Because foreign exchange, by definition,

consists of simultaneous transactions in two currencies, then it follows that the market must focus

on two respective interest rates as well. This is the interest rate differential, a basic factor in the

markets. Traders react when the interest rate differential changes, not simply when the interest

rates themselves change. For example, if all the G-5 countries decided to simultaneously lower

their interest rates by 0.5 percent, the move would be neutral for foreign exchange, because the

interest rate differentials would also be neutral. Of course, most of the time the discount rates are

cut unilaterally, a move that generates changes in both the interest differential and the exchange

rate. Traders approach the interest rates like any other factor, trading on expectations and facts.

For example, if rumor says that a discount rate will be cut, the respective currency will be sold

before the fact. Once the cut occurs, it is quite possible that the currency will be bought back, or

the other way around. An unexpected change in interest rates is likely to trigger a sharp currency

move

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Trade systems on Forex | ForexGen

Trading with brokers. Foreign exchange brokers, unlike equity brokers, do not take positions for

themselves; they only service banks. Their roles are to bring together buyers and sellers in the

market, to optimize the price they show to their customers and quickly, accurately, and faithfully

executing the traders' orders. The majority of the foreign exchange brokers execute business via

phone using an open box system — a microphone in front of the broker that continuously

transmits everything he or she says on the direct phone lines to the speaker boxes in the banks.

This way, all banks can hear all the deals being executed. Because of the open box system used

by brokers, a trader is able to hear all prices quoted; whether the bid was hit or the offer taken;

and the following price. What the trader will not be able to hear is the amounts of particular bids

and offers and the names of the banks showing the prices. Prices are anonymous. The anonymity

of the banks that are trading in the market ensures the market's efficiency, as all banks have a fair

chance to trade.

Sometimes brokers charge a commission that is paid equally by the buyer and the seller. The fees

are negotiated on an individual basis by the bank and the brokerage firm.

Forward Market | ForexGen

Forward Market.

Two tools are used on the forward Forex: forward outright deals and exchange

deals or swaps. A swap deal is a combination of a spot deal and a forward outright deal.

According to figures published by the Bank for International Settlements, the percentage share of

the forward market was 57 percent in 1998. (See Figure 1.2). Translated into U.S. dollars, out of

an estimated daily gross turnover of US$1.49 trillion, the total forward market represents US$900

billion. In the forward market there is no norm with regard to the settlement dates, which range

from 3 days to 3 years. Volume in currency swaps longer than one year tends to be light but,

technically, there is no impediment to making these deals. Any date past the spot date and within

the above range may be a forward settlement, provided that it is a valid business day for both

currencies. The forward markets are decentralized markets, with players around the world

entering into a variety of deals either on a one-on-one basis or through brokers. The forward price

consists of two significant parts: the spot exchange rate and the forward spread. The spot rate is

the main building block. The forward spread is also known as the forward points or the forward

pips. The forward spread is necessary for adjusting the spot rate for specific settlement dates

different from the spot date. It holds, then, that the maturity date is another determining factor of

the forward price.