Beginners Manual

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ForexConfidential

SECTION ONE

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I. What is the FX Market? 2

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II. Why Trade FX? 3Enormous Liquidity 3No Slippage 3Market Transparency 3Trending Markets 324-hour Access 3Low to Zero Transaction Cost 4

High Leverage 4Low account Minimums 4No Bear-Only Market 4

Above Average Profit Potential 4

(PAGE 4-6)

III. Brief History of the FX Market 4Gold Exchange Standard 5Bretton Woods Accord 5Smithsonian Agreement 6Free-Floating System 6

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IV. Market Structure 7Overview 7Interbank 7Market Hours 7Markets within the FX Market 8

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V. Key Players in FX Market 10Commercial and Investment Banks 10Central Banks 10The Federal Reserve (Fed) 10The European Central Bank (ECB) 11Bank of England (BoE) 11Swiss National Bank (SNB) 12The Bank of Japan (BOJ) 12Bank of Canada (BoC) 12Corporations 12

Hedge Funds and International Funds 13FX Funds 13Individuals 13

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VI. International Overview 14

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VII. FX Regulations 14CFTC 14NFA 14

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VIII.Your Role in the FX Market 15

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IX. How Can Forex be Accessed? 15

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Part I. What is the FX Market?

The Foreign Exchange market, also referred to as theForex or FX market, is the largest market in the

world with over $1.5 trillion changing hands daily andsoon expected to top $2 trillion. Compare that to theNew York Stock Exchange at $28 billion, the equitiesmarket at $191 billion, and the daily value of the futuresmarket at $437.4 billion, and you will clearly see that theFX market alone is approximately three times the totalamount of the US Equity and Treasury marketscombined.

Unlike other financial markets, the Forex market has nophysical location and no central exchange. It operatesthrough an electronic network of banks, corporations,institutional investors, and individuals trading one cur-rency for another. The lack of a physical exchange en-ables the Forex market to operate on a 24-hour basis,spanning from one time zone to another, across themajor financial centers around the world.

The FX market plays a key role in transferring financialpayments across borders and moving funds and pur-chasing power from one currency to another. This inter-national market plays an extensive and direct role innational economies and has a major impact that

affects our lives and our prosperity. The movement ofdifferent currencies between countries determines avery important price the exchange rate. It is theexchange rate that allows the currencies to be traded

for profit.

There are two major reasons to buy and sell currencies:1) About 5% of daily turnover is from companies andgovernments that buy or sell products and services inforeign countries, then profits made are converted backinto their domestic currency.2) The other 95% is trading for profit or speculation,which translates to the tremendous profitpotential inthis highly lucrative market.

Trading for speculation in the FX market has increased

tremendously throughout the years as institutions andindividuals recognize the high profit potential in thishighly lucrative market. Although speculative trading isincreasing, not everyone involved in Forex is aspeculator. Therefore, there is far less risk ofmanipulation within the FX market. Even in the case ofcentral bank intervention, the overall effect on the FXmarket is relatively insignificant. Forex is a genuinemarket in which the prices of currencies are solelydetermined by the forces of supply and demand. As aresult, all market participants, including individualtraders, are well-protected from artificial manipulation of

prices. Unfortunately, this protection for traders doesnot extend to other markets. In the equity market,everyone is a speculator, including individuals andcorporations. When everyone is speculating for profit,manipulation of prices is inevitable. Consequently,traders in the equity market suffer immensely whenprices are manipulated by various institutions.

Until recently, large international banks dominated theFX market, only allowing access via telephone tradingto major corporations, large funds, and high net worthindividuals. This little known, underexposed, foreignexchange currency market can now be traded onlineand is available to the general public with a minimalcapital investment of $300. Individual investors nowhave the opportunity to trade in the largest and mostliquid financial market in the world.

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Part II. Why Trade FX?

Foreign exchange is by far the preferred market choicefor aggressive traders. The FX market offers

unparalleled liquidity, no slippage, market transparency,trending markets, 24-hour access, low to zerotransaction cost, high leverage, low account minimums,no bear-only market, and most importantly, aboveaverage profit potential.

Enormous Liquidity

The FX market is the most liquid market in the world. Itcan absorb trading volumes and per-trade sizes thatmay overwhelm any other market. Trading essentiallyconsists of two parts: opening a position and closing ofthat position. Liquidity, which is highly correlated with

volume, qualitatively evaluates how easily traders canenter and exit positions. A liquid market enablesparticipants to execute large volume transactions withlittle impact on market prices. On the simplest level, theenormous liquidity alone is powerful enough to attractany investor to the FX market, as it suggests thefreedom to open or close a position at will. In addition,technical analysis, the study of price movements,operates better in liquid markets. Illiquid markets makeit much more difficult to accurately determine entry andexit points.

No SlippageTraders in illiquid markets may experience delays andsubsequently, suffer from slippage. In these markets,there may be delays in the execution of traders ordersand thus, market orders could potentially be filled at adifferent price from the market rate when the order wasinitially placed. Furthermore, traders may experiencedifficulty in exiting or selling positions, which greatlycompromises the ability to clear profitable trades. In theFX market, there is absolutely no slippage traderswill always get in and out at the price they placed theirorders. This is due to the tremendous amount of volume

that the FX market generates.

Market Transparency

Market transparency is highly desired in a tradingenvironment. It is a condition in which marketparticipants are able to observe the detailed information

in the trading process. Ultimately, the greater themarket transparency, the more efficient the marketbecomes. The FX market offers the highest level ofmarket transparency out of all financial markets.

Informed traders are better off than uninformed tradersbecause most financial markets could be exploited bythose with private information. Traders in all financialmarkets rely on market transparency because it allowsthem to see a transparent spread, which enables themto employ their premeditated strategies while stillflexible enough to accommodate an ever-changingmarketplace. With the transparency of information,traders can exercise their risk management strategiesin accordance to their fundamental and technicalapproaches.

For example, in the case of Enron, inaccurate reportingby officers of the company resulted in the downfall ofthe company and losses of many shareholders. Marketswhere this could occur are considered a poor tradingmarket. Furthermore, market transparency ensures theability to trade from live, executable prices. Markets thatdo not offer executable prices and force traders toabsorb slippage, obviously compromise traders profitpotential.

Trending Markets

Although currency prices in the FX market may bevolatile, they generally repeat themselves in cycles,creating trends. The trends can be analyzed by tradersusing technical tools. Since technical analysisstatistically works better in markets characterized bycycles and trends, traders benefit from this attribute ofForex. The entire premise of technical analysis is basedon the study of price movements. Through this analysis,traders can identify trends and capture key entry andexit points at which they should execute their tradesand maximize their profit potential.

24-hour AccessForex is a true 24-hour, 6 days a week, market. FXtrading begins each day in Australia and moves aroundthe globe as the business day begins in each financialcenter first to Tokyo, then London, and New York.

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Unlike any other financial market, investors can re-spond to currency fluctuations caused by economic,social, and political events at the time they occur re-gardless if it is daytime or nighttime. The only breaks in

trading occur during a brief period over the weekend. Atrader is able to put on a trade during the London ses-sion, follow it during the New York session, and closethe trade in the middle of the following day during theTokyo session. This type of market access is invaluableto a market participant who needs to react quickly toglobal events.

Low to Zero Transaction Cost

The amount of cost to execute trades has droppedconsiderably in recent years. Transaction costs includeall the expenses to actually execute a trade. Because

transaction costs reduce profits, the lower thetransaction costs, the more beneficial it is for the trader.Markets that have centralized exchanges tend to havehigher transaction costs due to exchange and clearingfees associated with trading. Active stock and futurestraders often see substantial portions of their grossprofits going to broker commissions, exchange fees,and data/chart feeds. Transaction costs can also beincreased with faulty executions. As regards the FXmarket, there are minimal to no brokerage fees andzero exchange and clearing fees since it is an over-the-counter market.. What you see is what you get, allowing

you to make quick decisions on your trades withouthaving to account for fees that may affect yourprofit/loss or slippage.

High Leverage

The FX market provides traders with access to muchhigher leverage than other financial markets. FX traderscan benefit from leverage in excess of 100 times theircapital versus the 10 times capital that is typicallyoffered to professional equity day traders. In the FXmarket, the margin deposit for leverage is not a downpayment on a purchase of equity; instead, it is a

performance bond, or good faith deposit, to ensureagainst trading losses. This is very useful to short-termday traders who need the enhancement in capital togenerate quick returns.

Low Account Minimums

Many individuals believe that entering the highlylucrative foreign exchange market requires large initialtrading capital. This was indeed true prior to 1996,

without the integration of online trading into the FXmarket. Today, individuals can get Started with a mini-account for as little as $300.

No Bear-Only Market

One of the biggest advantages of trading FX is thatthere is no fear of a bear-only market. In many markets,high-return investments can often be difficult to sell afterthey are bought. However, in Forex, the major currencypairs always have buyers and sellers; hence, the FXinvestor should never worry about being stuck in atrade due to lack of market interest.

Above Average Profit Potential

There is no question that speculative trading in Forexoffers huge profit potential. It is an exciting way to earnexceptionally high returns on ones investment capital.

Part III. Brief History of the FX Market

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The Foreign Exchange market, (FX or Forex) as weknow it today, originated in 1973. However, money hasbeen around in one form or another since the time ofthe Egyptian Pharaohs. While the Babylonians are

credited with the first use of paper bills and receipts,Middle Eastern moneychangers were the first currencytraders exchanging coins of one culture for another.During the middle ages, paper bills emerged as analternative form of currency besides coins. These paperbills represented transferable third party payments offunds, which made foreign exchange much easier andless cumbersome for merchants and traders.

From the infantile stages of Forex during the MiddleAges to World War I (WWI), the Forex market wasrelatively stable and without much speculative activity.

After WWI, it became very volatile and speculativeactivity increased ten fold. Speculation in the Forexmarket was not looked on as favorable by mostinstitutions and the public in general. The GreatDepression and the removal of the gold standard in1931 created a serious lull in Forex activity. From 1931until 1973, the Forex market went through a series ofchanges. These changes greatly impacted the globaleconomies at the time. There was little if anyspeculation in the Forex market during these times.

Gold Exchange Standard

The Gold Exchange Standard, which prevailedbetween 1876 and WWI, dominated the internationaleconomic system. Under the gold exchange standard,currencies gained a new phase of stability as they weresupported by the price of gold. It abolished the age-oldpractice in which kings and rulers arbitrarily debasedmoney and triggered inflation.

However, the gold exchange standard had itsweakness. As an economy strengthened, it wouldimport heavily from abroad until it ran down its goldreserves required to back its money. As a result, money

supply would shrink, interest rates would rise, andeconomic activity would slow down to the extent ofrecession. Ultimately, prices of goods would bottom out,appearing attractive to other nations. Consequently, thiswould cause a rush in buying sprees that would inject

the economy with enough gold to increase its moneysupply, drive down interest rates, and recreate wealthinto the economy. Such patterns prevailed throughoutthe gold standard until the outbreak of WWI, which

interrupted trade flows and the free movement of gold.

Several other major transformations occurred after theGold Exchange Standard, leading to the birth of thecurrent FX market: the Bretton Woods Accord,Smithsonian Agreement, and the Free-Floating System.

Bretton Woods Accord

The first major transformation, the Bretton WoodsAccord, occurred toward the end of World War II. A totalof 44 countries, including the United States, GreatBritain, and France met in New Hampshire in July 1944,

to design a new economic order.

The design of the Bretton Woods framework was tohave the United States become an anchor for all freeworld currencies. The accord aimed at installinginternational monetary stability by preventing moneyfrom fleeing across nations and restricting speculationin the world currencies. Major currencies were peggedto the dollar, which was in turn tied to gold at a value of$35 per ounce. The dollar was the primary reserve

currency and member countries were able to sellcurrency to the Federal Reserve in exchange for gold atthe present rate. In addition to these interventions, theInternational Monetary Fund (IMF) and the InternationalBank for Reconstruction and Development (WorldBank) were established to ensure that the BrettonWoods system would operate effectively.

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Once the Bretton Woods Agreement was founded, theparticipating countries agreed to try and maintain thevalue of their currency with a narrow margin against thedollar and a corresponding rate of gold as needed.

Countries were prohibited from devaluing theircurrencies to their trade advantage and were onlyallowed to do so for devaluations of less than 10%.

Trading under the Bretton Woods system had uniquecharacteristics. Since exchange rates were fixed,intense trading took place around devaluation orrevaluation, known as creeping pegs. Speculationagainst the British pound in 1967 demonstratedcreeping pegs patterns. Despite all the efforts by theBank of England and other central banks to support thepound, the pound was devalued. This failure was

monumental because it was the first time that thecentral bank intervention failed under the BrettonWoods system. The failure of the central bankintervention continued with the dollar in the followingyears. As the Bretton Woods system was highlydependant on a strong US dollar, the dollar began toexperience pressure in 1968, causing extremespeculation on the future of this system. The Agreementwas finally abandoned in 1971, and the US dollar wouldno longer be convertible into gold.

Smithsonian Agreement

After the Bretton Woods Accord came to an end, theSmithsonian Agreement was signed in December of1971. This agreement was similar to the Bretton Woods

Accord, but it allowed for a greater fluctuation band forforeign currencies.

The Smithsonian Agreement strived to maintain fixedexchange rates, but to do so without the backing ofgold. Its key difference from the Bretton Woods systemwas that the value of the dollar could float in a range of2.25%, as opposed to just 1% under Bretton Woods.

Ultimately, the Smithsonian Agreement proved to beunfeasible as well. Without exchange rates fixed togold, the free market gold price shot up to $215 perounce. Moreover, the U.S. trade deficit continued togrow, and from a fundamental standpoint, the US dollar

needed to be devalued beyond the 2.25% parametersestablished by the Smithsonian Agreement. In light ofthese problems, the foreign exchange market wasforced to close in February of 1972.

In 1972, the European community tried to move awayfrom their dependency on the dollar. The EuropeanJoint Float was established by West Germany, France,Italy, the Netherlands, Belgium, and Luxemburg. Bothagreements made mistakes similar to the BrettonWoods Accord and by 1973, collapsed.

Free-Floating System

The collapse of the Smithsonian agreement and theEuropean Joint Float in 1973 signified the official switchto the free-floating system. This occurred by default as

there were no new agreements to take their place.Governments were now free to peg their currencies,semi-peg, or allow them to freely float. In 1978, the free-floating, system was officially mandated.

The value of the US dollar was to be determinedentirely by the market, as its value was not fixed to anycommodity, nor was the fluctuation of its exchange rateconfined to certain parameters. While this did providethe US dollar, and other currencies by default, the agil-ity required to adapt to a new and rapidly evolvinginternational trading environment, it also set the stage

for unprecedented inflation.

Europe tried to gain independence from the dollar bycreating the European Monetary System in July of1978. This, like all of the earlier agreements, failed in1993.

The major currencies today move independently ofother currencies. The currencies are traded by anyonewho wishes to trade. This has caused a recent influx ofspeculation by banks, hedge funds, brokerage houses,and individuals. Central banks intervene on occasion to

move or attempt to move currencies to their desiredlevels. The underlying factor that drives todays Forexmarket, however, is supply and demand. The free-floating system is ideal for todays markets.

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Part IV. Market Structure

Overview

Unlike other financial markets, the Forex market has no

physical location and no central exchange; hence, it isconsidered an over-the-counter (OTC) market. The FXmarket operates through an electronic network ofbanks, corporations, institutional investors, andindividuals trading one currency for another. Forextraders and market makers are all linked to one anotherround the clock via computers, telephones, and faxeswhere currency denominations, amounts, settlementdates, and prices are negotiable. The lack of a physicalexchange enables the Forex market to operate on a 24-hour basis, spanning from one time zone to another,across the major financial centers around the world.

The FX market is organized into a hierarchy, whichconsists of participants with different ranking. Thestandards that determine the participants positions arecredit access, volume of transactions, and level ofsophistication; those with superiority in these measuresreceive priority in the FX market. At the top of thehierarchy is the interbank market, which generates thehighest volume in trades.

Interbank

Interbank is a credit-approved system where banks

trade on the sole basis of their credit relationships withone another. In the interbank market, the largest banksare able to trade with each other directly, via interbankbrokers or through electronic brokering systems suchas Reuters and EBS. While all the banks can see therate that everyone is dealing at, each bank has a spe-cific credit relationship with the other bank and trade atthe rates being offered.

Other institutions in the market, such as corporations,online FX market makers, and hedge funds trade FXthrough commercial banks. However, many banks

(community banks and banks in emerging markets),corporations, and institutional investors do not haveaccess to these rates because they do not haveestablished credit relationships with large commercial

banks. Subsequently, these smaller participants areobligated to trade FX through a large bank, and often,this equates to much less competitive rates. The ratesbecome less and less competitive as it trickles down thehierarchy of participants. Eventually, the customers ofbanks and foreign exchange agencies receive the leastcompetitive rates. However, in the late 1990s,technological advances have eliminated the barriersthat existed between the interbank and end-users ofFX. Since 1996, retail clientele can connect directly tomarket makers via online trading. Average traders canenjoy the competitive rates and trade alongside the

worlds largest banks.

The FX market is no longer reserved for bigcorporations; it is now made available to all types ofconsumers. Furthermore, the boundless opportunity totrade foreign exchange awaits all aspiring corporationsand individual traders.

Market HoursThe spot FX market is unique to any other market in theworld since trading is available. 24 hours a day.Somewhere around the world, a financial center is openfor business, and banks and other institutions exchangecurrencies every minute of the day with only minor gapson the weekend. The FX market opens at 5 pm (EST)on Sunday and close at 1 pm (EST) on Friday.

The major financial centers around the world overlapdue to their time zones. The International Date Line islocated in the Western Pacific. Each business day

begins in Wellington, New Zealand, then Sydney,Australia, followed by the Asian financial marketsstarting with Tokyo, Japan, Hong Kong, China, andfinally Singapore. Only a few hours later, markets willopen in the Middle East. When the markets in Tokyoare starting to wind down, Europe opens for business.

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Markets within the FX Market

Although spot trading accounts for 48% of all FXtransactions worldwide, the three main markets, Tokyo,London, and New York, represent almost 70% of theworlds FX volume. Foreign exchange activity does notflow evenly, and throughout the course of theinternational trading day, there are certain marketscharacterized by very heavy trading activity in some (orall) currency pairs. At other times, the same marketsare characterized by light activity in some (or all) cur-rency pairs. Foreign exchange activity tends to be themost active when markets overlap, particularly the U.S.markets and the major European markets; i.e., when itis morning in New York and afternoon in London.

As Japans economy has dwindled over the pastdecade, Japanese banks have been unable to committo FX, the large amounts of capital they once did in the1980s. Despite this, Tokyo is the first major market toopen, and many large participants use it to get a readon dynamics or to begin scaling into positions.

Approximately 10% of all FX trading volume takes placeduring the Tokyo session. Trading can be relatively thin.

Finally, New York and other major U.S. centers start their day. Towards the late afternoon in the United States, thenext day arrives in the Western Pacific areas and the process begins again. Hence, the FX market is opened 6days a week, 24 hours a day.

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Hedge funds and banks have been known to use theTokyo lunch hour to run important stop and optionbarrier levels. Japanese yen, New Zealand dollar, and

Australian dollar pairs tend to be the biggest movers

during Tokyo hours as other currencies are quite thinand usually remain constant.

London is by far the most important and influential FXmarket, with approximately 30% of all worldwidetransactions. Most big banks dealing desks stem fromLondon and the market is responsible for roughly 28%of the total world spot volume. London tends to be themost orderly market due to the large liquidity and ease

of completing transactions. Most large marketparticipants use London hours to complete seriousforeign exchange deals.

New York is the second most important market thatrepresents approximately 16% of total worldwide mar-ket volume. In the United States spot market, the major-ity of deals are executed between 8am and 12pm, whenEuropean traders are still active. Trading often be-comes slower in the afternoon as liquidity dries up. Infact, there is a drop of over 50% in trading activity sinceCalifornia never served to bridge the gap between theU.S. and Asia. As a result, traders tend to pay lessattention to market development in the afternoon. NewYork is greatly affected by the U.S. equity and bondmarkets, thus the pairs will often move closely intandem with the capital markets.

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Part V. Key Players in the FX Market

With the advances of technology and especially theopening on the Internet, the foreign exchange market

has expanded from simple foreign exchange and banktransactions to a more speculative nature. Today, anincreasing number of FX transactions are trading forprofit or speculation, which translates to the tremendousprofit-potential in this highly lucrative market. There arefive major players in the FX market;Commercial/Investment Banks, Central Banks,Corporations, Hedge/International Funds, andindividuals.

Commercial and Investment Banks

Commercial and investment banks account for the

largest portion of FX trading volume. The lnterbankmarket caters to both the majority of commercialturnovers as well as enormous amounts of speculativetrading everyday. Their primary role in the FX market isessentially selling currencies, as other participantsexecute trades through them. Banks trade currenciesbecause it is highly lucrative and it limits their creditexposure on Letters of Credit. Banks gain profits byacting on their clients behalf and making trades. Aboutthree quarters of all foreign exchange trading isbetween banks. They generate billions of dollars worthof currency in a days volume.

Below is a list of the top financial institutions in theworld as rated by Euromoney Magazine in their May,2001 edition.

Central Banks

Central banks play a significant role in the FX market asthey can influence spot price fluctuations. Central banksgenerally do not speculate in currencies, but they use

currencies to promote acceptable trading conditions totheir banking industries by affecting money supply andinterest rates through open market operations or theactive trading of government securities. Central banksalso often attempt to restore order to volatile marketsthrough interventions. The reasons for central bankinterventions may be a result of a variety of factors: torestore stability, protect a certain price level, slow downcurrency movements, or to reverse a trend. An examplewould be the recent intervention by the Bank of Japanto push down the value of the yen. On the surface, thismay disturb many traders to make their investment

decisions. However, it has been proven time and againthat central banks can only influence currency valuesfor short periods. Over time, the markets adjust to thechanges, creating trend formations that may be verybeneficial to traders. Trend strategies may guide FXtraders to take advantage of these trends in the market.

Central banks normally keep sizeable amounts offoreign currencies on hand; hence, their influence is sogreat that the mere mention of central banksinterventions would violently move the market. As theirinvestments are generally more long-term, central

banks trades are quite profitable. The major centralbanks include: The Federal Reserve, European CentralBank, Bank of England, Swiss National Bank, Bank ofJapan, and Bank of Canada.

The Federal Reserve (Fed):

The Federal Reserve Board (Fed)is the central bank of the UnitedStates. They are responsible forsetting and implementing monetary

policy. The board consists of a 12-member committee,which comprise the Federal. Open Market Committee

(FOMC). The voting members of the FOMC are theseven Governors of the Federal Reserve Board, plusfive Presidents of the twelve district reserve banks. TheFOMC holds 8 meetings per year, which are widelywatched for interest rate announcements or changes in

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growth expectations. The Fed has a high degree ofindependence to set monetary authority. They are lesssubject to political influences, as most members areassigned long term positions that allow them to remain

in office through periods of alternate party dominance inboth the Presidency and Congress. The U.S. Treasuryis responsible for issuing government debt and formaking fiscal policy decisions. Fiscal policy decisionsinclude determining the appropriate level of taxes andgovernment spending. The U.S. Treasury is the actualgovernment body that determines dollar policy. That is,if. they feel that the USD rate in the foreign exchangemarket is under- or overvalued, they are in the positionof giving the NY Federal Reserve Board the instructionsto intervene in the FX market by physically selling orbuying USD. Therefore, the Treasurys view on dollar

policy, and changes to that view, is very important tothe currency market.

The European Central Bank (ECB):

The European Central Bank (ECB)is the governing body responsiblefor determining the monetarypolicy of the countries participatingin the European Member Union

(EMU). The Executive Board of the EMU consists of thePresident and Vice President of the ECB and four othermembers. These individuals along with the governors of

the national central banks comprise the GoverningCouncil. The ECB is set up so that the Executive Boardimplements the policies dictated by the GoverningCouncil. New monetary policy decisions are typicallymade by a majority vote in biweekly meetings, with thePresident having the casting vote in the event of a tie.The primary objective of the European Central Bank isto maintain price stability. ECB is considered inflationparanoid as it has strong German influence. ECB aandthe ESCB are independent institutions from both na-tional governments and other EU institutions, givingthem total control over monetary and currency policy.

The European central bank is a strict monetarist andmuch more likely to keep interest rates high. Two edictsof monetary policy are: to keep a harmonized Con-sumer Price Index (CPI) below 2% and an M3 annualgrowth (Money supply) around 4.5%. Refinance rate isthe main weapon used by the

ECB to implement EU monetary policy. ECB watchesthe fiscal discipline of its members closely. ECB isconsidered an untested central bank and doubts lingeras to how they will react to any future crisis. The ECB

keeps close tabs on budget deficits of the individualcountries as the Stability and Growth Pact states thatthey must be kept below 3% of Gross DomesticProduction (GDP). The ECB does intervene in the FXmarkets, especially when inflation is a concern.Comments by members of the Governing Councilfrequently move the EUR and are widely watched by FXmarket participants.

Bank of England (BoE):

The Bank of England (BoE) is thecentral bank of the United King-

dom. The bank was founded in1694, nationalized in 1946, andgained operational independence

in 1997. The BoE is committed to promoting and main-taining a stable and efficient monetary and financialframework as its contribution to a healthy economy. In1997, parliament passed the Bank of England Act, giv-ing the BoE total independence in setting monetarypolicy. Prior to 1997, the BoE was essentially a govern-mental organization with very little freedom. Treasurysrole in setting monetary policy diminished markedlysince 1997. However, the Treasury still sets inflation

targets for the B0E, currently defined as 2.5% annualgrowth in Retail Prices Index (RPI), excluding mort-gages (RPIX). The treasury is also responsible for mak-ing key appointments at the Central Bank. The BoEsnine member Monetary Policy Committee (MPC) isresponsible for making decisions on interest rates.

Although the MPG has independence in setting interestrates, the legislation provides that in extremecircumstances the government may intervene. TheBank of Englands main policy tool is the minimumlending rate or base rate. Changes to the base rate areusually seen as a clear change in monetary policy. The

BoE most frequently affects monetary policy throughdaily market operations (the buying/selling ofgovernment bonds). The BoE is infamous for attemptingto influence exchange rates through impure marketinterventions.

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Swiss National Bank (SNB):

The Swiss National Bank is thecentral Bank of Switzerland. TheSwiss National Bank enjoys 100%

autonomy in determining the nationsmonetary and exchange rate policies. In December1999, the SNB shifted from a monetarist approach to aninflation-targeting one (2% annual inflation target). Dis-count rate is the official tool used to announce changesin monetary policy; however, it is rarely used as thebank relies more on the 3-month London Interbank Of-fer Rate (LIBOR) to manipulate monetary policy. TheLIBOR is the rate at which major international bankslend to one another; it primarily serves as a benchmarkfor short-term interest rates. SNB officials often affectthe Franc spot movements by making remarks on li-

quidity, money supply, and the currency itself. Interven-tion is frequent; however, most often intervention isused to enforce economic policy. It is also used in openmarket operations, such as raising or lowering interestrates, to affect the value of its currency. As a countrywhere international trade has been the primary sourceof the countrys economic development, its preferenceis for a weaker franc, in order for its exports to remaincompetitive. SNB is highly regarded and the franc isconsidered by most market participants to be theworlds best managed currency.

The Bank of Japan (BOJ):The Bank of Japan (BoJ) is the keymonetary policymaking body inJapan In 1998 the Japanesegovernment passed laws giving the

BoJ operational independence from the Ministry ofFinance (MoF). It was given the complete control overmonetary policy. However, despite the governmentsattempts to decentralize decision-making, the MoF stillremains in charge of foreign exchange policy. The MoFis considered the single most important political andmonetary institution in Japan. MoF officials frequently

make statements regarding the economy, which havenotable impacts on the yen. The BoJ is responsible forexecuting all official Japanese FX transactions at thedirection of the MoF. However, it is important to notethat the Bank of Japan does possess total autonomy

over monetary policy and can have significant indirectimpacts on foreign exchange rates. The BoJs maineconomic tool is the overnight call rate. The call rate iscontrolled by the open market operations and any

changes to it often signify major changes in monetarypolicy. Since the introduction of a floating exchange ratesystem in February 1973, the Japanese economy hasexperienced large fluctuations in Forex rates, with theyen on a long rising trend. The reason for the yensstrength, despite the excessive problems that haveplagued the Japanese economy, is the fact that Japanhas a trade surplus accounting for 3% of GDP. This isthe highest of the G-7 countries and therefore creates astrong inherent demand for the currency for tradepurposes, regardless of their economic conditions. TheJapanese government is notorious for directly

intervening on behalf of the yen through marketinterventions. BoJ interventions are frequent andviolent. As an export-driven country, there are strongpolitical interests in Japan for maintaining a weak yen inorder to keep exports competitive. Accordingly, the BoJhas been known to go into the market and sell off theyen when its rate is perceived to be too strong.

Bank of Canada (BoC):

The Bank of Canada (BoC) is thecentral bank of Canada. TheGoverning Council of the Bank of

Canada is the board that isresponsible for setting monetary policy and is anindependent Central bank that has a tight reign on itscurrency. This council consists of seven members: theGovernor and six Deputy Governors. The BoC does nothave regular periodic policy setting meetings.

Instead, the council meets on a daily basis and maymake changes in policy at any time. Due to its tighteconomic relations with the United States, the Cana-dian dollar has a strong connection to the US dollar.

CorporationsCorporations which comprise a diverse group of smalland large corporations, importers/exporters, financialservice firms, and consumer service firms, were themajor traders in currencies for many years.

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Corporations main interests in foreign exchange are toperform transactions related to cross border payments.Multinational corporations may need to make paymentsto foreign entities for materials, labor,

marketing/advertising costs, and/or distributions, whichwould require the exchange of currencies. The primaryfocus of multinational corporations in the marketplace isto offset risk by hedging against currency depreciation,which would affect future payments. Now, however, aminority has begun to use the marketplace as aspeculative tool; meaning, they enter the FX marketpurely to take advantage of expected currencyfluctuation. This group of corporations using the FXmarket for speculative purposes is growing, and as veryactive participants, they have a great impact on spotmarket prices. Corporations approach to trading tends

to be longer-term since they use the market for coveringcommercial needs, hedging, and speculations.

Hedge Funds and International

Funds

Global fund managers, hedge, large mutual, pension,and arbitrage funds that invest in foreign securities andother foreign financial instruments are relatively small.

Although they may be small when compared to othermarket participants, they are the most aggressive.These groups can have substantial impacts on spotprice movements as they are constantly re-balancing

and adjusting their international equity and fixed incomeportfolios. These portfolio decisions can be influentialbecause they often involve sizable capital transactions.

A majority of the hedge funds are highly leveraged andactively seeking to profit in whichever way possible.Despite the highly criticized, sometimes devious natureof hedge funds, they are valued by traders becausethey often push the markets to retract from extremelevels. Hedge funds are used by high net worthindividuals investing a minimum of $1 million. One ofthe best known Hedge Funds is the George SorosQuantum Group of Funds that made a billion dollar

profit by shorting the British pound in 1992.

International Funds are non-currency funds consistingof large capital, which exert substantial influence on theFX market. With more and more funds delegated tohedging activities, international funds are becoming a

main driver of international capital and equities trends,which in turn, greatly affects the Forex market.

FX Funds

Funds that invest in the FX are commonly called GlobalMacro funds. These funds depending on size tend totake different positions in the FX market. Many largefunds tend to carry large trade positions, exploitingglobal interest rate differentials. Others tend to seek outopportunities to take advantage of misguided economicpolicies or currencies that overshoot their real value; byentering large positions, they are bethng on a return toequilibrium. Others simply gauge global events andtake a longer-term view on which currencies willstrengthen or weaken in the next six to eight months.Fund participation in the FX market has risen sharply in

recent years and its total trading share is now around20%. There is no doubt that with the increasing amountof money some of these investment vehicles haveunder management, the size and liquidity of the foreignexchange market is very appealing. While relativelysmall compared to other market participants, whenacting together, they can have a profound effect on thecurrency spot movements.

Individuals

Retail spot currency trading is the new frontier of thetrading world. Up until 1996, foreign exchange trading

was only available to large banks, institutions, andextremely high net worth individuals. Prior to onlineretail FX dealers, individuals could not realisticallyparticipate in the FX market from a speculativestandpoint. The interbank market operated as a tightcircle; it acted somewhat like a specialist, as itmanipulated the fates of tiers 2 and 3 to accommodateits own needs. Accordingly, individual traders looking totrade FX could not find a market maker capable ofproviding competitive spreads, fair quotes, andequitable customer service.

With the advancement of technology, the internet, andonline trading platforms, retail clients are provided withaccess to trading that is highly comparable to theofferings of the interbank market. Spreads are slightlywider at 5 pips on most currency pairs, as opposed to

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the interbank standard of 3 pips, but execution isunsurpassed. Now retail clients and multinationalinstitutions can participate in the FX market on a highlyequitable playing field.

Part VII. International Overview

The International Monetary Fund (IMF) is acooperative organization that 182 countries havevoluntarily joined. It exerts an international influenceover world monetary issues, including the foreignexchange market. However, it has no effectiveauthority, either by law or implied, over the domesticpolicies of its members.

.

Part VII. FX Regulations

For many years, the retail online foreign exchangeindustry languished due to the lack of a regulatory

environment to uphold investor protection. In Decemberof 2000, however, Congress passed and the Presidentsigned the Commodities Modernization Act. The Actfinally regulated the foreign exchange industry andplaced its oversight under the auspices of theCommodities Futures Trading Commission(www.cftc.gov).

CFTC

The Commodity Futures Trading Commission (CFTC)was created by Congress in 1974 as an independentagency with the mandate to regulate commodity futures

and option markets in the United States. The agencyprotects market participants against manipulation,abusive trade practices, and fraud. Through effectiveoversight and regulation, the CFTC enables the mar-kets to better serve their important functions in the na-tions economy, providing a mechanism for price recov-ery and a means of offsetting price risk. The CFTC setsforth many of the guidelines that the National Futures

Association is required to follow.

NFA

The National Futures Association (NFA) officially began

its operations on October 1, 1982, with the goal ofmaintaining the integrity of the futures marketplace. Allcompanies trading in futures must become NFAmembers. Those companies that are not registered withthe NFA are subject to closure by the CFTC. Thepassage of the Commodities Modernization Act re-quires that any company trading online forex be regis-tered with the NFA. The NFA has many capital require-ments and makes sure companies maintain high book-keeping and ethical standards in order to be registered.With the passage of the Modernization Act, the NFArequired forex market makers to register as Futures

Commission Merchants (FCMs).

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Part VIII. Your Role in the FX Market

You may not realize it, but you already play a role in theforeign exchange market. Do you have some currencyin your pocket or wallet? Do you have a checking orsavings account? Do you have a mortgage? Do you run

a business? Do you hold stocks, bonds, or otherinvestments with a value expressed in a specificcurrency? A yes response to any of the abovequestions already makes you an investor in thecurrency markets.

When you decide to hold assets in the currency of onecountry, you are investing in that countrys currency andeconomy. At the same time, you are also electing not tohold the currencies of other nations. For example, whenyou hold most of your portfolio (stocks, bonds, bankaccounts, etc.) in US dollars, you are relying heavily on

the integrity and value of the US dollar and economy,including the government that governs it. Concurrently,you are choosing not to hold the Japanese yen, Britishpound, or the euro.

Almost all businessmen, businesswomen, and travelersactively trade currency. If you travel overseas, youwould generally exchange your own currency for thecurrency of the country you are visiting. In view of this, itis not surprising that more and more prudent investorsare deciding to diversify their portfolios by holdingassets in multiple denominations within the FX market.

Part IX. How Can Forex beAccessed?

At the most basic retail level, one can access Forex at

any airport currency booth. For a service fee and amark-up of 5-10%, one can buy or sell currencies. Infact, for many individuals, a trip to the currencyexchange booth overseas is their first introduction toForex.

Investors wishing to speculate in the FX market cannow access Forex through dealers offering marginaccounts as small as $300, with a price spread that isas little as 4-5 pips. High net worth individuals,corporations, or fund managers with private bankingrelationship should be able to trade through their banks,

while corporate clients requiring the actual delivery ofcurrencies would create a credit relationship with aForex dealer.

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SECTION TWO

(PAGE 17)

I. What is Trading? 17

(PAGE 17-24)

II. How a Forex Trade Works? 17What are ISO Codes 17Currency Pairs 17How to Calculate which Currency is 18Increasing or Decreasing in ValueEUR/USD 18

USD/JPY 18Hard and Soft Currencies 20Chart Reading Basics 20Trends 20Lot Sizes and Margin 20Lot Sizes 20Margin 20Risk Management 20Determining Position Size 21What is PIP? 21Calculating Profit/Loss 21Calculating pip values when the dollar 22is the counter currency

Calculating pip values when the dollar 22is the base currencyBid/Ask Spread 22Position Trading 23100 K Account vs. Mini-Account

(PAGE 24-27)

III. Types of Transactions 24Spot Transactions 24Outright Forward Transactions 24Futures Transactions 25Swap Transactions 25Option Transactions 25Settlement and Delivery 26Volumes & Open Interest 26Interest Rollover 26

Trader A buying GBP/USD at 1.5755 27How to Estimate Interest Rollover 27GBP/USD 27USD/JPY 27Triple Rollover on Wednesday 27

(PAGE 28-29)

IV. Types of Orders 28Market Order 28Limit Order (Take Profit Order)Stop-Loss Order 28Entry Order 28Limit Entry Order 28

Stop Entry Order 29

(PAGE 29)

V. Proper Phone Etiquette 29

(PAGE 30)

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Part I. What is trading?

Trading is a unique form of speculation in order togenerate profit. It can be a part-time or full time

business, a profession or just a lifetime passion. Youcan trade almost anything from various commodities,stocks, bonds and of course, currencies. Currencytrading is not gambling; rather it is a game in which atrader, applying different fundamental or technicalanalysis, makes a risk-calculated and educated tradingdecision.

Making logical trading decisions and developing asound and effective trading strategy is an importantfoundation of trading. Successful trading is oftendescribed as optimizing your risk with respect to your

reward or upside. Any trading strategy should have adisciplined method of limiting risk while making the mostout of favorable market moves.

Part II. How a Forex Trade Works?

To begin trading in the FX market, you must familiarizeyourself with how currencies are handled and traded.Hard and soft currencies are traded in pairs andthrough ISO codes. There are five different types oftransactions and six different ways to execute a trade.

Additionally, it is very important to understand somecommon terms surrounding a trade which include: lotsizes and margin, PIP, bid-ask spread, position trading,settlement-delivery, volume, and open interest.

ISO Codes

Currencies in the FX market are not referred to by theirfull names; instead, they are identified by standardizedcodes or ISO Codes, developed by the InternationalOrganization for Standardization. ISO abbreviations areused widely on charts and trading platforms, but theyare rarely used in conversations among traders.

Traders or the media may refer to the currencies bytheir nicknames during everyday conversations.Throughout our training materials, we interchangeablyuse the full names, ISO codes, and nicknames of

currencies to help you get accustomed to the tradinglanguage.

The table below lists the ISO codes and nicknames for

the most commonly traded currencies:

Currency Pairs

In the Forex market, currency trading is always done incurrency pairs, such as USD/CAD or USD/JPY,reflecting the exchange rate between the twocurrencies. An exchange rate is merely the ratio of onecurrency valued against another currency. For instance,the USD/JPY exchange rate specifies how many USdollars are required to buy a Japanese yen, orconversely, how many Japanese yen are needed topurchase a US dollar.

In a pair of currencies, the first currency is known as thebase (dominant) currency, and the second one isreferred to as the counter or quoted (subordinate)currency. In the USD/JPY example, the US dollar is thebase currency that we wish to trade, while the Japane-seyen is the counter currency that the exchange rate isquoted in. In simple and practical terms, the currencypair is a structure that can be bought or sold. The basecurrency acts as the basis for all transactions,regardless if it is buying or selling. When you buy acurrency pair, it is implied that you are buying the first(base) currency and selling the second (counter or

quoted) currency. Alternatively, a trader sells thecurrency pair when he/she anticipates that the basecurrency will depreciate relative to the quoted currency.

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How to Calculate which Currency is

Increasing or Decreasing in Value

Always remember that the simplest way to rememberwhich currency is increasing or decreasing in value is to

view rate changes from the perspective of the basecurrency. If we look at a chart and see an exchangerate increasing, it means that the value of the basecurrency is appreciating (getting stronger). Conversely,if we look at a chart and see an exchange ratedecreasing, it represents that the value of the basecurrency is depreciating (getting weaker). The diagrambelow may help you to have a more lucid understandingof this relationship.

The following is a couple of examples to help you graspthese key concepts:

EUR/USD:

In the EUR/USD pair, the euro acts as the basecurrency while the US dollar acts as the quotedcurrency. Therefore, the euro (base currency) is thebasis for buying and selling in trading. If you anticipatethat the stock market will fall and cause the USD todepreciate, you will buy the currency pair. By buying theEUR/USD pair, you are buying euros in anticipation that

the euro will appreciate against the USD. If you chooseto sell the pair, you are then buying the US dollars,expecting it to climb against the euro.

USD/JPY:

In the USD/JPY pair, the US dollar acts as the basecurrency while the Japanese yen acts as the quotedcurrency. Therefore, the dollar (base currency) is the

basis for buying and selling in trading. If you think thatthe Japanese government is going to weaken the yen inorder to strengthen their export industry, you would buythe currency pair. By buying the pair, you are buyingdollars in anticipation that they will increase in valueagainst the yen. On the other hand, if you believe thatJapanese investors are pulling money out of USfinancial markets and repatriating funds back to Japan,you would sell the pair. By selling the pair, you expectthe yen to strengthen against the dollar.

Hard & Soft Currencies

Alongside the US dollar, four major currencies dominatetrading in the Forex market by nature of their popularityand activity. According to a recent survey on 300 majortraders by Greenwich Associates, the trading volume onthe euro, Japanese yen, British pound, and Swiss francaccounts for over 70% of North American activity.

According to currency market expert, Cornelius Luca, inhis book Trading in the Global Currency Markets,second edition, market share for the five majorcurrencies after the introduction of the euro is estimatedat:

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Other tradable currencies include the Canadian,Australian, and New Zealand dollars. Each of theseaccounts for 3-7% of the total market volume and theyare often referred to as minor currencies. Together,

the majors and minors constitute all hard currenciesthat are currently traded in Forex. Soft currencies arecurrencies such as the Argentine peso, the Russianruble, the Hong Kong dollar, and the Polish zloty.These are not tradable or recognized outside theircountry of origin.

In the spot FX market, currency pairs can be dividedinto two categories: dollar-based currency pairs andcross-currency pairs. Dollar-based currency pairs arethose that consist of the US dollar and anothercurrency, while cross-currency pairs are those with

neither of its currencies being the US dollar. The mostactively traded dollar-based currency pairs are theEUR/USD, USD/JPY, GBP/USD, and the USD/CHF.The most actively traded cross-currency pair is theEUR/JPY. Normal daily movement on just these fivepairs can be anywhere from 50 pips on a slow day toover 100, 200, even 300 pips on a very active day. (Seedefinition of pips below.)

As mentioned before, currencies are often referred toby their nicknames. Similar to currencies, it is importantto familiarize yourself with the common names of thecurrency pairs. There is a specific trading terminology

that is used frequently to describe each currency pair.

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Chart Reading Basics

Charts are used to show the correlation between thevalue of the base and quoted currencies. The followingcharts are in the format in which you would see them on

an actual computer screen. In these charts, thechanging currency is the quoted currency.

Trends

Trend is a term used to describe the persistence ofprice movements in one direction over a period of time.Trends move in three directions: up, down andsideways. An uptrend signifies the strengthening of thebase currency, while a downtrend represents theweakening of the base currency. A sideways trendoccurs when markets bounce back and forth betweensupport and resistance levels, the lowest and highest

points within a given period, resulting in less significantprice movements. It is estimated that 70% of the time,markets will fluctuate randomly or move betweensupport and resistance levels. The rest of the time,market behavior is characterized by persistent pricemovements trends that break through support andresistance levels. It is highly possible to increase yourability to capitalize on trends by locating trend signals,identifying specific entry points within the trend, andusing risk management techniques to limit losses. Moreinformation on trends and strategies is discussed insection 4: technical analysis.

Lot Sizes and Margin

The FX market attracts many new traders becausecurrency trading can be conducted on a highlyleveraged basis. Every trader should have a thorough

understanding of lot sizes and margin requirementsbefore trading in order to employ proper riskmanagement.

Lot SizesIn Forex, one million dollars worth of a currency isgenerally accepted as a minimum round lot and is oftenreferred to as one dollar or one buck. Single orders,in excess of a million dollars, are regularly traded bylarge institutions and corporations. However, smallersize orders are available to individual FX traders. Forexample, some dealers offer sizes in half-dollar (.5) andquarter-dollar increments (.25), while others offer sizesof approximately $200,000 USD (.2), $100,000 USD(.1), $50,000 USD (.05), and even $10,000 USD (.01).

An advantage of currency trading is that most brokerswill allow you to trade 100 times the value of yourdeposit. Therefore, if you deposit $2,000 into youraccount, you would be able to trade $200,000 worth ofcurrency units. This is referred to as trading on margin,which is also common with stockbrokers; however,stockbrokers leverage is typically 50% greater thanyour investment. Hence, if you invest $2,000 with astockbroker, you would be able to trade with a marketvalue of only $3,000.

Margin

Margin is a monetary deposit that you provide ascollateral to cover any losses. All dealers establish theirown margin policy based on a percentage of the lotsize. Normal margins range from 1% to 5%. Forexample, if the margin for day trading is 1% (100:1) witha dealer that offers lot sizes of $200,000, you may opena one-lot position with $2,000 in your account. Therequirements for margin vary with account size, andmay be changed from time to time at the sole discretionof the dealing desk, based on volume traded andmarket conditions. As the account size and the ability totrade more lots increase, the margin percentage may

also increase.

Risk Management

For the purpose of risk management, traders must haveposition limits. This number is set relative to the money

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in a traders account. Risk is minimized in the spot FXmarket because the online capabilities of the tradingplatform will automatically generate a margin call if therequired margin amount exceeds the dollar value of the

account as a result of trading losses. All open positionswill be closed immediately regardless of the size or thenature of positions held within the account. Thisadvanced feature is very beneficial for traders. In thefutures market, on the other hand, if the price movesagainst your position, it may be liquidated at a largeloss, making you liable for any resulting deficit in theaccount.

Determining Position Size

Prior to starting up your trade station, an assessmentshould be made of the maximum account loss that is

likely to occur overtime, per lot. For example, assumeyou have determined that the worst case scenario is tolose 20 pips on any trade. This translates intoapproximately $200 per $100,000 position size. Furtherassume that the $100,000 position size is equal to onelot. Six consecutive losing trades would result in a lossof $1,200 (6 x $200); a difficult period but not anunrealistic one over the long run. This scenario wouldtranslate to a 12% loss for an account that has a tradingcapital of $10,000. Therefore, even though it may bepossible to trade 5 lots or more with a $10,000 account,this analysis suggests that the resulting drawdown

would be too great - 60% or more of the capital wouldbe wiped out. Traders should have a sense of thismaximum loss per lot and determine the amount he/shewishes to trade for a given account size that will yieldtolerable drawdown.

What is a PIP?

A pip (price interest percentage) is the smallestincrement a price moves and it determines the profit orloss of a trade. It is simply a base point value to theright of the decimal point of the quoted currency thatis used to measure changes in exchange rates (the

difference between the rates of the currency).

A few examples of where the pip is located within theexchange rate are listed below. The one-digit for pip

values is underlined and highlighted in red for eachexample.

For instance, the US dollar moves from 1.6000 to1.6004 in the cable/dollar pair, it has moved 4 pips.When you have an open position, each upward ordownward pip movement in the market price can be

either a profit or a loss, depending on which currency(base or quoted) you bought and which one you sold.

Calculating Profit/Loss

Many Forex retail brokers assign a fixed dollar valueper pip that varies according to the lot size and themakeup of each currency pair. For example, the pipvalue may be $10 per pip on each $100,000 lot of ca-ble/dollar, while only $6.50 per pip on each $100,000 lotof dollar/franc. Other dealers offer a floating pip valuethat is calculated according to the lot size of each cur-rency pair and the fluctuating exchange rate. For exam-

ple, notice how the pip value on a 15,000,000 lot ofdollar/yen is calculated based on a one-pip movementfrom 120.00 to 120.01:

The value of a pip is determined by the currency pairand the rate at which the pair is trading. For currencypairs where the dollar is not the base currency(EUR/USD, AUD/USD, NZD/USD, GBP/USD), each piphas a fixed value of $10. For example, if you are tradingEUR/USD and the market moves 10 pips in your favor,

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then your profit would be exactly $100. On the otherhand, when a currency other the dollar is the countercurrency (USD/JPY, USD/CHF USD/CAD) the pip valuein dollar terms fluctuates based on prevailing market

rates.

Although most online trading platforms with reputablebrokers offer live Profit/Loss tracking whereby profitsand losses are calculated and re-calculated every timethe exchange rate changes, it is fundamental for atrader to have an understanding of the value of a pip.The table below gives you an idea of the dollar valueattached to each pip:

Calculating pip values when the

dollar is the counter currency

If the current exchange rate for EUR/USD is 1.1460,then one euro is worth 1.1460 US dollars.Consequently, 100,000 euros are worth 114,600 USdollars. If the market price moves one pip to 1.1470,then one euro is now worth 1.1470 US dollars. This is a

pretty small change in the value of the euro (onethousandth of a dollar to be exact) but this can besubstantial when we are talking about a lot of euros,100,000 Euros are now worth 114,700 dollars.

If a trader had bought 100,000 euros by selling114,600 dollars when the market price was 1.1460,

then those 100,000 Euros would be worth 114,700dollars (10 US dollars more) when the market pricemoves to 1.1470. The trader could choose to closethe position out and take this $100 profit.

Conversely, lets say the trader initially sold 100,000euros by buying 114,600 dollars when EUR/USDwas trading at 1.1460. If the market price moves to1.1470 and the traders chooses to close the position,he/she would have to buy back the 100,000 Euroswith 114,700 dollars. The loss on the trade would be$100.

Calculating pip values when the

dollar is the base currency

When the USD is the base currency, the value of a

pip will fluctuate according to the exchange rate ofthe currency pair.

For example, if the current exchange rate forUSD/CAD is 1.3300, then one dollar is worth 1.33Canadian Dollar; hence, 100,000 dollars are worth133,000 CAD. If the market price of USD/CADmoves up by one pip to 1.3301, then I dollar will beworth 1.3301 CAD; hence, one lot of 100,000 dollarsequal 133,010 CAD.

In this particular case, a one pip fluctuation is valued

at $10 Canadian Dollar or $7.52 USD when theUSD/CAD price is 1.3301. The calculation is simple,since at this time I USD=1.3301, then 10 CAD= 7.52USD. Simply divide 10 by 1.3301.

If a trader closes out a position at a one pip profitwhen the USD/CAD market price is 1.3301, he/sheautomatically locks in a 10 CAD profit which isequivalent to $7.52 at that time. At a different marketprice, however, such as 1.3200, those 10 CAD willhave a value of $7.58.

Bid/Ask SpreadAll FX quotes include a two-way price, the bid and ask.The bid price is always lower than the ask price. Thebid is the price at which a market maker is willing to buy(and traders can sell) the base currency in exchange for

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the counter currency. The ask is the price at which amarket maker will sell (and a trader can buy) the basecurrency in exchange for the counter currency. Thedifference between the bid and the ask price is referred

to as the spread, which can be recovered with afavorable currency movement.

In the above example, the bid price for EUR/USD is1.1797, which indicates the price at which a trader cansell the currency pair. The ask price is 1.1801,indicating the price at which a trader can buy thecurrency pair. The difference between the bid and theask price gives us a 4-pip spread in this example. The4-pip spread represents the cost of the transaction. It is

important to note that since the FX market is adecentralized market, the spreads that a trader receivesfor a given currency pair will vary according to themarket maker one trades with. Generally, there is anaverage of 4-5 pips on the major currency pairs and 5-20 pips on the cross currency pairs.

Position Trading

The objective of currency trading is to exchange onecurrency for another in the anticipation that the marketrate or price will change, thus, increasing the value ofthe currency bought relative to the one sold. In tradinglanguage, a long position is one in which a trader buysa new currency at one price and aims to sell it later at ahigher price. When a trader buys a currency and theprice appreciates in value, the trader must sell thecurrency back in order to secure the profit. A shortposition is one in which the trader sells a currency inanticipation that it will depreciate. If a trader sells acurrency and the price depreciates in value, the tradermust buy the currency back in order to secure the profit.While a long position is to buy and a short position is tosell, an open trade or position is one in which a trader

has either bought or sold a currency pair and has notsold or bought back the equivalent amount to effectivelyclose the position.

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Part III. Types of Transactions

There are several types of transactions that take placein the FX market. These transactions are Spot, OutrightForward, Futures, Swap, and Option. According to theBank for International Settlements, market share forthese five transactions are estimated at: Spot = 48%,Swap = 39%, Forwards = 7%, Options = 5%, Futures =1%

Spot TransactionsThis type of transaction accounts for almost half of allFX market transactions. The exchange of two curren-cies at a rate agreed on the date of the contract for de-livery in two business days (except for USD/CAD, whichis the next business day).

Outright Forward TransactionsOne way to deal with the foreign exchange risk is

to engage in forward transaction. In this transaction,money does not actually change hands until an agreedupon future date. A buyer and seller agree on anexchange rate for any date in the future and the

l00K Account vs. Mini-Account

You may choose to open a regular (l00K) account or a mini account. As a novice trader, we recommend that youbegin trading with a mini-account once you are ready to trade live. As you have developed a disciplined tradingsystem, you may choose to proceed to a regular account. Below is a chart that illustrates the differences between

the two accounts.

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transaction occurs on that date, regardless of what themarket rates are then. The date can be a few days,months, or years in the future.

Futures TransactionsForeign currency futures are forward transactions withstandard contract sizes and maturity dates forexample, 500,000 British pounds for next November atan agreed rate. These contracts are traded on aseparate exchange set up for that purpose.

Swap Transactions

The most common type of forward transaction is thecurrency swap. In a swap, two parties exchangecurrencies for a certain length of time and agree toreverse the transaction at a later date. The purpose of a

swap transaction is to manage liquidity and currencyrisk, by executing foreign exchange transactions at themost appropriate moment.

For example: selling US dollars for euros value spotand agreeing to reverse the deal at a later date com-monly I day, 1 week, I month, or 3 months. Effectively,the underlying amount in each currency is simultane-ously borrowed or lent the long lent and the shortborrowed.

Since currency risk is replaced by interest rate risk,

such transactions are conceptually different from spottransactions. They are, however, closely linked becauseforeign exchange swaps are often initiated to move thedelivery date of a foreign currency originating from spot,or outright forward transactions to a more optimalmoment in time. It is by using swaps that traders canhold a position without ever being delivered. This

enables customers to trade on a margin basis, and paymargin on a daily basis when the position is marked tothe market.

Option TransactionTo address the lack of flexibility in forward transactions,the foreign currency option was developed. An option issimilar to a forward transaction. It gives its owner theright to buy or sell a specified amount of foreigncurrency at a specified price at any time up to aspecified expiration date.

For a price, a market participant can buy the right, butnot the obligation, to buy or sell a currency at a fixedprice on or before an agreed upon future date. Theagreed upon price is called the strike price.

Depending on whichthe option rate or the currentmarket rateis more favorable, the owner may exer-cise the option or let the option lapse, choosing insteadto buy/sell currency in the market. This type of transac-tion allows the owner more flexibility than a swap orfutures contract.

In all of these transactions, market rates might change.However, the buyer and seller are locked into a contractat a fixed price that cannot be affected by any changesin the market rates. These tools allow the market

participants to plan more safely, since they know inadvance what their FX will cost. It also allows them toavoid an immediate outlay of cash.

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Settlement and Delivery

The Spot market is traded on a two-business day valuedate. It requires a two-day settlement between thebanks as they may be in different time zones (the only

exception is the Canadian dollar, where 24 hours is therequirement). For instance, for trades executed onMonday, the value day (day of delivery) is Wednesday.

Volume & Open Interest

Volume consists of the total amount of currency tradedwithin a specific period, usually one day. Of course,traders are more interested in the volume for a specificcurrency. A high trading volume suggests that there ishigh interest and liquidity in a market. Also, some chartpatterns require heavy volume for successfuldevelopment. A low trading volume is a warning sign to

traders to be extra careful. In a low-volume market,rates can be all over the map and make it harder to getthe price one wants.

Open interest is the net outstanding position in aspecific instrument. It normally represents the differencebetween the outstanding long (buy) positions and theoutstanding short (sell) positions.

Volume and open interest are difficult to quantify inmost of the foreign exchange markets because about97% of the markets are decentralized. Volume figures

can be calculated in the foreign exchange futuresmarkets because these transactions take place oncentralized trading floors, and all trades go throughclearinghouses. However, futures transactions (purefutures and options on futures) only account for about3% of the worlds foreign exchange activity. The other97% of currency trading takes place in the spot, swap,forwards, and cash options markets, where trading iscompletely decentralized. Hence, volume is impossibleto measure with any precision and can only be roughlyextrapolated from futures market data.

Interest RolloverInterest rollover fees are a function of the interest ratesestablished by the various central banks and federalauthorities used to regulate the official policy of thecurrency. Economies that are growing rapidly may

encounter inflation, in which prices of goods andservices are rising rapidly. Along with rapid economicgrowth and inflation, interest rates may often rise as aresult. In turn, raised interest rates increase the cost of

the currency and thus, decrease the overall demand forgoods and services. The decreased demand will inhibitprices from continuing to rise at an excessive, rapidpace. Conversely, economies facing recessionaryperiods may require economic stimuli to encourageconsumer spending, which in turn expedites economicgrowth. A cut in interest rates may make money moreaccessible and cheaper to borrow. The decreasedinterest rate would enable entrepreneurs to borrowcapital with less financial stress. Therefore, a cut ininterest rates would ideally revitalize the economy andcease the economic recession or, to a greater extent,

depression.

Rollover charges are determined by the differencebetween the interest rates of the two correspondingcountries. The greater the interest rate differentialbetween the currency pair, the greater the rollovercharge will be. It takes place when the settlement of atrade is rolled forward to the next value date. Asmentioned above, trades must be settled in twobusiness days in the FX market. If a trader sells100,000 euros on Tuesday, the trader must deliver100,000 euros on Thursday, unless the position is rolled

over. Traders that hold a position overnight pay intereston the currency they borrow, and earn interest on thecurrency they purchase. Typically, interest rollovercharges are applied at 5pm (17:00) New York time(9pm GMT; 10pm GMT when New York is operating ondaylight savings time from late March to late October) incoordination with the international trading day.

For the FX trader, interest rollover charges can have asmall impact on their overall profit and loss fromexchange rate speculation. To illustrate how interestrollover charges work, consider the following example:

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Trader A buying GBP/USD at 1.5755.

In this case, Trader A is borrowing US dollars, andhence will pay interest on the borrowed funds. Trader Ais, however, earning interest on the British pounds that

have been purchased. If the Bank of England whichregulates the pound offers a higher interest rate thanthe Federal Reserve which regulates the US dollarthe client has an opportunity to earn interest.

Alternatively, if the Federal Reserve issues a higherinterest rate on the US dollar than the Bank of Englandoffers on the British pound, then the client willexperience a net interest payment.

Because banks can lend to each other at rates differentfrom what the central bank lends to them, the rollovercalculations can never be reduced to an exact science.

Like the currency exchange rate, the rollover interestrates are subject to market conditions, and hence canfluctuate as well.

How to Estimate Interest Rollover

Since interest rates raise the cost of the currency it ismore expensive to borrow currencies with a highinterest rate a central banks interest rate policy canbe used to adjust the economy to its respective needs.However, since the interest rollover charge is generallyquite small, it should not serve as the core of a tradingstrategy. The following is a sample calculation of

interest rollover:

Suppose the Bank of England has an official interestrate of 3.5%, while the Federal Reserve has an officialinterest rate of 1%. Consequently, a client who is buy-ingGBP/USD will earn interest, since he/she is only paying1% while earning 3.5%. Because interest rates arequoted on a yearly basis, it is divided down to a dailybasis that can be applied for daily interest rollovercharges. Although there are 365 days in a year,financial transactions in a year are rounded off to 360

days. For instance, in the United States, 1% of theprincipal balance for the whole year is divided by 360.

The following is the equation to calculate the amount forinterest rollover:

(No. of Lots) x (No. of Units per Lot) x (Annual InterestRate Differential / 360) x (No. of Days)

GBP/USD

Trader A buys 2 contracts of GBP/USD on Thursday

and closes them on the next dayContract Value: GBP 100,000Opening Price: 1.6770Yearly Interest Rate Differential: GBP 3.5% - USD 1% =2.5%Calculation: GBP 100,000 x 2 x (2.5%/360) x 1 = 13.88

USD/JPY

Trader A sells 3 lots of USD/JPY on Monday and closesthem on the next dayLot Value: USD 100,000 or JPY 12,200,000Opening Price: 110.00

Yearly Interest Rate Differential: USD 1% - JPY 0% =1%Calculation: USD 100,000 x 3 (-1%/360) x I = -8.31

Triple Rollover on Wednesday

Since there is a two-day settlement period in foreignexchange, the transactions that are opened onWednesday at 5 pm which is the Thursday tradingday should not get settled until Saturday. Of course,banks are closed during the weekend, so thetransaction cannot effectively be settled until Monday(which begins on Sunday at 5 pm New York time).

Therefore, for positions opened and held overnight onWednesday, rollover fee is charged for the followingMonday as well, meaning an extra two days of fees forthe weekend. As a result, rollover fees are tripled in theFX market on Wednesday. It is important to understandthat every transaction has a value day. If the deal is not

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closed on the same day, the trade is subject to rollovercharges.

Part IV. Types of OrdersWhen placing an order in the FX market, you canchoose from the 4 different options available. Thisincludes: market, limit, stop-loss, and entry orders.

Market Order

A market order is an order to buy or sell a currency pairat the current market price. One of the key advantagesof trading in a spot market is that market orders areguaranteed when dealing with a reputable broker, asthe vast liquidity of the market ensures that there arealways buyers and sellers.

Limit Order (Take Profit Order)

A limit order allows a client to specify the rate at whichhe will take profits and exit the market. Essentially, itdefines the amount of profit that the trader is looking tocapture on this particular trade. Lets assume a traderhas an open position where he is long (meaning he hasbought) GBP/USD, he would place a limit order at1.5900; if the market reached that rate, he would betaken out of the market, and his profit from the tradewould immediately be reflected in his balance.

Alternatively, a trader could place a limit order to an

existing sell position.

Stop-Loss Order

A stop-loss order works like a limit order, but in anopposite fashion: it specifies the maximum loss that atrader is willing to accept on a given position. Forexample, if a trader is long USD/JPY at 121.50 with alimit at 121.70, he may wish to maximize the loss he iswilling to accept by placing a stop-loss order at 121.30.In such a case, if the market reached 121.30, he wouldbe stopped out of the position and would have suffereda loss no greater than 20 pips.

Entry Order

All entry orders are essentially contingent orders: theywill only be filled if the market reaches that rate. Forexample, suppose you are trading USD/JPY, and the

current quote is 120.50 120.55. You can place anentry order to buy at 120.15 so that your order will onlybe filled if the market reaches 120.15. Ultimately, thereare two types of entry orders: limit entry orders and stop

orders.

Limit Entry Order

Limit entry orders are classified as entry orderswhereby the rate specified is either below the currentmarket rate if it is a buy order, or alternatively, abovethe market rate if it is a sell order. Limit entry orders areoften conducive to strategies pertaining to range-boundmarkets, whereby clients can place orders to buy at thebottom of the range and sell at the top.

Suppose the current market rate to sell EUR/USD is at

1.0800, and to buy is at 1.0804. There are two types oflimit entry orders that a trader could place in such asituation:

1. A trader could place an order to sell at a price abovethe current market rate, for instance, sell at 1.0820. Ifthe sell rate in the spot market reaches 1.0820, the sellorder would be activated. In this case, the traderexpects that the market will reach 1.0820 and thenreverse its direction.

2. A trader can place a limit entry order to buy at a price

that is below the current market rate. For instance, atrader could place a limit entry order to buy at 1.0790.His order would only be activated meaning it wouldonly begin to affect his P/L if the buy rate reached1.0790. The trader is expecting a reversal of the trendafter the market reaches the rate he/she specified. Inother words, the trader will profit if the market bouncesoff the 1.0790 level.

Since both buy and sell limit entry orders assume thereversal of a trend, they are most commonly used bytraders who believe the market is trading within an

upper and lower range, and that it will not break out ofthis range.

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Stop Entry Order

Stop entry orders rely on rationale that is the oppositeof limit entry orders. If a trader wishes to buy at a priceabove the current market rate, or, alternatively, sell at a

price below current market price, then he is placing astop entry order. Stop entry orders are conducive tobreakout strategies, whereby the trader believes that ifthe specified rate is reached, the trends movement isconfirmed and thus will continue in that direction.

Suppose the current market rate for the USD/JPY is at117.04; in other words, traders can enter the market tosell at 117.04, and can buy at 117.09.

There are two types of stop entry orders that a tradercould place in such a situation:

1. The trader could place an order to sell at a pricebelow the current market rate. So, for instance, hecould place an order to sell at 116.75; if the sell rate inthe spot market reaches 116.75, the sell order would beactivated. In this case, the trader expects that themarket will reach this level; it will break out and con-tinue in this direction.

2. The trader can place a stop entry order to buy at aprice that is above the current market rate. For in-stance, if the trader placed an order to buy at 117.85,

his order would only be activated meaning it wouldonly begin to affect his PIL if the buy rate reached117.85. In this example, the trader is expecting a break-out if the market reaches the rate he/she specified. Inother words, the trade will break through the 117.09level.

Since both buy and sell stop entry orders assume abreakout, they are most commonly used by traders whobelieve the market will make a big move.

Part V. Proper Phone Etiquette

Although most trades are placed online, traders alwayshave the option of calling the dealing desk to place an

order. It is important for spot traders to get their pointacross quickly and accurately, leaving no room forinterpretation or error. Lets take a look at a typical spottrade:

Please give me a price on USD/JPY (or USD/CHF, orEUR/USD, or GBP/USD) for (the number of lots youwant to trade) lot(s).

Example:Trader says, Please give me a price on USD/JPY for 3lots.

The dealer will respond with a 2-way price quote. Forexample, he may quote USD/JPY at: 125.10-125.15(but he will probably just say 125.10-1 5).

Dealer replies, 125.10-15.So you can either buy USD/JPY at 125.15, or you maysell USD/JPY at 125.10.

To buy USD/JPY you can say any of the following: 15,I buy, I buy at 15, mine, or mine at 15.To sell USD/JPY, you can say any of the following: 10,I sell, I sell at 10, yours, or yours at 10.

Trader states, I buy at 15.You would normally have 3-5 seconds to respond(sometimes more, sometimes less)

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