Forex Currency Trading Systems

Interest rate risk is pertinent to currency swaps, forward out rights, futures, and options. It refers to the profit and loss generated by both the fluctuations in the forward spreads and by forward amount mismatches and maturity gaps among transactions in the foreign exchange market. An amount mismatch is the difference between the spot and the forward amounts. For an active forward desk the complete elimination of maturity gaps is virtually impossible. However, this may not be a serious problem if the amounts involved in these mismatches are small. On a daily basis, traders balance the net payments and receipts for each currency through a special type of swap,called tomorrow/next or rollover.

To minimize interest rate risk, management sets limits on the total size of mismatches. The policies differ among banks, but a common approach is to separate the mismatches, based on their maturity dates, into up to six months and past six months. All the transactions are entered in computerized systems in order to calculate the positions for all the delivery dates and the profit and loss. Continuous analysis of the interest rate environment is necessary to forecast any changes that may impact on the outstanding gaps.

Credit Risk
Credit risk is connected with the possibility that an outstanding currency position may not be repaid as agreed, due to a voluntary or involuntary action by a counter party. In these cases, trading occurs on regulated exchanges, where all trades are settled by the clearing house. On such exchanges, traders of all sizes can deal without any credit concern.
The following forms of credit risk are known:
1. Replacement risk which occurs when counter parties of the failed ank find their books unbalanced to the extent of their exposure to the insolvent party. To rebalance their books, these banks enter new transactions.

2. Settlement risk which occurs because of different time zones on different continents. Such a way, currencies may be credited at different times during the day. Australian and New Zealand dollars are credited first, then Japanese yen, followed by the European currencies and ending with the U.S. dollar. Therefore, payment may be made to a party that will declare insolvency (or be declared insolvent) immediately after, but prior to executing its own payments. The credit risk for instruments traded off regulated exchanges is to be minimized through the customers’ creditworthiness. Commercial and investment banks, trading companies, and banks’ customers must have credit lines with each other to be able to trade. Even after the credit lines are extended, the counter parties financial soundness should be continuously monitored. Along with the market value of their currency portfolios, end users, in assessing the credit risk, must consider also the potential portfolios exposure. The latter may be determined through probability analysis over the time to maturity of the outstanding position. For the same purposes netting is used. Netting is a process that enables institutions to settle only their net positions with one another not trade by trade but at the end of the day, in a single transaction. If signs of payment difficulty of a bank are shown, a group of large banks may provide short-term backing from a common reserve pool.

In terms of volume, currencies from around the world are traded mostly against the U.S. dollar, because the U.S. dollar is the currency of basis and reference.

The other major currencies are the euro, followed by the Japanese yen, the British pound, and the Swiss franc. Other currencies with significant spot market shares are the Canadian dollar and the Australian dollar.

In addition, a significant share of trading takes place in the currencies crosses, a non-dollar instrument whereby foreign currencies are quoted against other foreign currencies, such as euro against Japanese yen.

There are several reasons for the popularity of currency spot trading. Profits (or losses) are realized quickly in the spot market, due to market volatility. In addition, since spot deals mature in only two business days, the time exposure to credit risk is limited. Turnover in the spot market has been increasing dramatically, thanks to the combination of inherent profitability and reduced credit risk. The spot market is characterized by high liquidity and high volatility. Volatility is the degree to which the price of currency tends to fluctuate within a certain period of time. Free-floating currencies, such as the euro or the Japanese yen, tend to be volatile against the U.S. dollar.

In an active global trading day (24 hours), the euro/dollar exchange rate may change its value 18,000 times. An exchange rate may “fly” 200 pips in a matter of seconds if the market gets wind of a significant event. On the other hand, the exchange rate may remain quite static for extended periods of time, even in excess of an hour, when one market is almost finished trading and waiting for the next market to take over. This is a common occurrence toward the end of the New York trading day. Since California failed in the late 1980s to provide the link between the New York and Tokyo markets, there is a technical trading gap between around 4:30 pm and 6 pm EDT. In the United States spot market, the majority of deals are executed between 8 am and noon, when the New York and European markets overlap. The activity drops sharply in the afternoon, over 50 percent in fact, when New York loses the international trading support. Overnight trading is limited, as very few banks have overnight desks.

Trading the Forex market offers 24 hour flexibility. You can trade at home, from anywhere in the world and catch market fluctuation whether it be the Japanese market, the European market or the United States market.

Currency trading has a long history and it can be traced back to the ancient Middle East and Middle Ages, centuries ago, when the foreign exchange started to take shape after the international merchant bankers devised bills of exchange, which were transferable third-party payments that allowed flexibility and growth in foreign exchange dealings.

The modern foreign exchange market characterized by the consequent periods of increased volatility and relative stability formed itself in the twentieth century. By the mid-1930s, London became the leading center for foreign exchange and the British pound served as the currency to trade and to keep as a reserve currency. Back then, the foreign exchange was traded primarily on the telex machine or cable, and thus, that is where the pound inherited it’s nickname “cable”.

In 1930, The Bank for International Settlements was established in Basel, Switzerland, to oversee the financial efforts of the newly independent countries that emerged after World War I. They also  provided monetary relief to countries experiencing temporary balance of payments difficulties.

After World War II, when the British economy was virtually destroyed and the United States was at that time, the only country unscathed by the ravages of war, the U.S. dollar then became the prominent currency of choice for the entire globe. To this day, currencies from around the world are generally quoted against the U.S. dollar.

The U.S. Dollar
The United States dollar is the world’s main currency. All currencies are generally quoted in U.S. dollar terms. Under conditions of international economic and political unrest, the U.S. dollar is the main safe-haven currency which was proven particularly well during the Southeast Asian crisis of 1997-1998. The U.S. dollar became the leading currency toward the end of the Second World War and was at the center of the Bretton Woods Accord, as the other currencies were virtually pegged against it. The introduction of the euro in 1999 reduced the dollar’s importance only marginally.
The major currencies traded against the U.S. dollar are the Euro, The Japanese Yen, The British Pound, The Swiss franc and most recently The Canadian Dollar.

The Euro
The euro was designed to become the premier currency in trading by simply being quoted in American terms. Like the U.S. dollar, the euro has a strong international presence stemming from members of the European Monetary Union. The currency remains plagued by unequal growth, high unemployment, and government resistance to structural changes. The pair was also weighed in 1999 and 2000 by outflows from foreign investors, particularly Japanese, who were forced to liquidate their losing investments in euro denominated assets. Moreover, European money managers rebalanced their portfolios and reduced their euro exposure as their needs for hedging currency risk in Europe declined.

The Japanese Yen
The Japanese yen is the third most traded currency in the world; it has a much smaller international presence than the U.S. dollar or the euro. The yen is very liquid around the world, practically around the clock. The natural demand to trade the yen concentrated mostly among the Japanese keiretsu, the economic and financial conglomerates. The yen is much more sensitive to the fortunes of the Nikkei index, the Japanese stock market, and the real estate market. The attempt of the Bank of Japan to deflate the double bubble in these two markets had a negative effect on the Japanese yen, although the impact was short-lived

The British Pound
Until the end of World War II, the pound was the currency of reference. Its nickname, cable, is derived from the telex machine, which was used to trade it in its heyday. The currency is heavily traded against the euro and the U.S. dollar, but has a spotty presence against other currencies. The two-year bout with the Exchange Rate Mechanism, between 1990 and 1992, had a soothing effect on the British pound, as it generally had to follow the deutsche mark’s fluctuations, but the crisis conditions that precipitated the pound’s withdrawal from the ERM had a psychological effect on the currency. Prior to the introduction of the euro, both the pound benefited from any doubts about the currency convergence. After the introduction of the euro, Bank of England is attempting to bring the high U.K. rates closer to the lower rates in the euro zone. The pound could join the euro in the early 2000s, provided that the U.K. referendum is positive.

The Swiss Franc
The Swiss franc is the only currency of a major European country that belongs neither to the European Monetary Union nor to the G-7 countries. Although the Swiss economy is relatively small, the Swiss franc is one of the four major currencies, closely resembling the strength and quality of the Swiss economy and finance. Switzerland has a very close economic relationship with Germany, and thus to the euro zone. Therefore, in terms of political uncertainty in the East, the Swiss franc is favored generally over the euro. Typically, it is believed that the Swiss franc is a stable currency. Actually, from a foreign exchange point of view, the Swiss franc closely resembles the patterns of the euro, but lacks its liquidity. As the demand for it exceeds supply, the Swiss franc can be more volatile than the euro.

The Canadian Dollar
The Canadian Dollar and its recent rise and prominence has proven to be a worthy spot market trading currency against the U.S Dollar. The Canadian Dollar has gained from a weak sister to almost par status with the U.S Dollar in the past few years. The rise amongst other factors can be associated with the rising worldwide oil and energy prices.

The following are the top 3 primary fundamental indicators causing currencies to fluctuate.
The “Journal of Commerce” Industrial Price Index (JoC)
The “Journal of Commerce” Industrial price index consists of the prices of 18 industrial materials and supplies processed in the initial stages of manufacturing, building, and energy production. It is more sensitive than other indexes, as it was designed to signal changes in inflation prior to the other price indexes.

Merchandise Trade Balance
The merchandise trade balance is one of the most important economic indicators. Its value may trigger long-lasting changes in monetary and foreign policies. The trade balance consists of the net difference between the exports and imports of a certain economy.

The data includes six categories:

1. Food;
2. Raw materials and industrial supplies;
3. Consumer goods;
4. Automobiles;
5. Capital goods;
6. Other merchandise.

Employment Indicators
The employment rate is an economic indicator with significance in multiple areas. The rate of employment, naturally, measures the health of an economy. The unemployment rate is a lagging economic indicator. It is an important feature to remember, especially in times of economic recession. Whereas people focus on the health and recovery of the job sector, employment is the last economic indicator to rebound. When economic contraction causes jobs to be cut, it takes time to generate psychological confidence in economic recovery at the managerial level before new job positions are added. At individual levels, the improvement of the job outlook may be clouded when new positions are added in small companies and thus not fully reflected in the data. The employment reports are significant to the financial markets in general and to foreign exchange in particular. In foreign exchange, the data is truly affective in periods of economic transition—recovery and contraction. The reason for the indicators’ importance in extreme economic situations lies in the picture they paint of the health of the economy and in the degree of maturity of a business cycle. A decreasing unemployment figure signals a maturing cycle, whereas the opposite is true for an increasing unemployment indicator.