Risk Aversion in Forex

Risk Aversion in the Forex is a kind of trading behavior exhibited by the foreign exchange market when a potentially adverse event happens which may affect market conditions.
This behavior is caused when risk averse traders liquidate their positions in risky assets and shift the funds to less risky assets due to uncertainty.[21]
In the context of the forex market, traders liquidate their positions in various currencies to take up positions in safe haven currencies, such as the US Dollar.[22]
Sometimes the choice of a safe haven currency is more of a choice based on prevailing sentiments rather than one of economic statistics.
An example would be the Financial Crisis of 2008. The value of equities across world fell while the US Dollar strengthened.( See Fig.1 ) This happened despite the strong focus of the crisis in the USA.

Determinants of FX rates

The following theories explain the fluctuations in FX rates in a floating exchange rate regime (In a fixed exchange rate regime, FX rates are decided by its government):
(a) International parity conditions: Relative Purchasing Power Parity, interest rate parity, Domestic Fisher effect, International Fisher effect. Though to some extent the above theories provide logical explanation for the fluctuations in exchange rates, yet these theories falter as they are based on challengeable assumptions [e.g., free flow of goods, services and capital] which seldom hold true in the real world.
(b) Balance of payments model (see exchange rate): This model, however, focuses largely on tradable goods and services, ignoring the increasing role of global capital flows. It failed to provide any explanation for continuous appreciation of dollar during 1980s and most part of 1990s in face of soaring US current account deficit.
(c) Asset market model (see exchange rate): views currencies as an important asset class for constructing investment portfolios. Assets prices are influenced mostly by people’s willingness to hold the existing quantities of assets, which in turn depends on their expectations on the future worth of these assets. The asset market model of exchange rate determination states that “the exchange rate between two currencies represents the price that just balances the relative supplies of, and demand for, assets denominated in those currencies.”
None of the models developed so far succeed to explain FX rates levels and volatility in the longer time frames. For shorter time frames (less than a few days) algorithm can be devised to predict prices. Large and small institutions and professional individual traders have made consistent profits from it. It is understood from above models that many macroeconomic factors affect the exchange rates and in the end currency prices are a result of dual forces of demand and supply. The world's currency markets can be viewed as a huge melting pot: in a large and ever-changing mix of current events, supply and demand factors are constantly shifting, and the price of one currency in relation to another shifts accordingly. No other market encompasses (and distills) as much of what is going on in the world at any given time as foreign exchange.
Supply and demand for any given currency, and thus its value, are not influenced by any single element, but rather by several. These elements generally fall into three categories: economic factors, political conditions and market psychology.

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Archaeological and paleontological excavations at the site of Gran Dolina, in the Atapuerca Mountains of Spain, where fossils and stone tools of the earliest known hominians in Western Europe have been found. Two archaeological levels are visible in this shot: The first one is TD-10, and it is believed to be a Homo heidelbergensis camp, about 300,000 years old. The second is TD-6, located under the scaffolding (bottom centre). The first remains of the new species mentioned by the Atapuerca team, Homo antecessor, were found there, about 800,000 years old.

Featured content in Wikipedia

The 2006 Westchester County tornado was an F2 tornado that touched down in Rockland County, New York, on July 12, 2006. It traveled 13 miles (21 km) into southwestern Connecticut during a 33-minute span through two states. The tornado touched down at 3:30 p.m. EDT on the shore of the Hudson River before becoming a waterspout and traveling 3 mi (5 km) across the river. Coming ashore, the tornado entered Westchester County and struck the town of Sleepy Hollow at F1 intensity. After passing through the town, it intensified into an F2 tornado and grew to almost a quarter of a mile (400 m) in diameter, making it both the strongest and largest tornado in the county's history. The tornado continued through the county, causing damage to numerous structures, until it crossed into Connecticut at 4:01 p.m. EDT. Not long after entering the state, it dissipated in the town of Greenwich at 4:03 p.m. EDT. The tornado left significant damage in its wake. Two barns and a warehouse were destroyed, and a large stained-glass window was shattered. Numerous homes and businesses were damaged and thousands of trees were uprooted. There were no fatalities and only six minor injuries were associated with the storm. Damages from the tornado totaled $12.1 million.

समीक्षा

मुद्रा बाजार में वित्तीय संस्थान और मनी या क्रेडिट डीलर शामिल हैं जो या तो उधार लेने अथवा उधार देने का कार्य करते हैं. प्रतिभागी अल्प अवधि के लिए उधार लेते या देते हैं जो आमतौर पर तेरह महीने तक का होता है. अल्पकालिक वित्तीय साधनों के मुद्रा बाज़ार व्यापार को सामान्यतः "पेपर" कहा जाता है. यह अपेक्षाकृत लम्बी अवधि के कैपिटल पूंजी बाजार के विपरीत है जहाँ बांडों और शेयरों द्वारा आपूर्ति होती है.
मुद्रा बाजार के मूल में बैंक होते हैं जो वाणिज्यिक पत्र, दोबारा खरीदे जा सकने वाले एग्रीमेंट और इसी प्रकार के साधनों का प्रयोग करके एक दूसरे को उधार लेते और देते हैं. ये साधन अक्सर उपयुक्त शर्तों और मुद्रा के लिए (अर्थात् जिस संदर्भ द्वारा कीमत तय होती है) लंदन इंटरबैंक द्वारा प्रस्तुत दर (LIBOR) द्वारा निर्धारित होते हैं.
वित्त कम्पनियां जैसे कि GMAC आमतौर पर बड़ी मात्रा में अपनी परिसंपत्ति के वाणिज्यिक पत्र (ABCP) जारी कर के धन एकत्र करती हैं जो कि ABCP माध्यम में योग्य परिसंपत्ति पात्रों की प्रतिज्ञा के द्वारा सुरक्षित है. योग्य पात्रों के उदाहरण में ऑटो ऋण, क्रेडिट कार्ड प्राप्तियाँ, आवासीय/व्यावसायिक वित्त ऋण, वित्त प्रतिभूतियाँ और इसी तरह वित्तीय पात्र शामिल हैं. मजबूत क्रेडिट रेटिंग के साथ कुछ बड़े निगमों जैसे कि जनरल इलेक्ट्रिक, अपने क्रेडिट पर वाणिज्यिक पत्र ज़ारी करते हैं. अन्य बड़ी कंपनियाँ वाणिज्यिक पत्र लाइनों के जरिए अपनी तरफ से बैंकों द्वारा वाणिज्यिक पत्र जारी करती हैं.
संयुक्त राज्य अमेरिका में, संघीय, राज्य और स्थानीय सरकारें धन की जरूरत को पूरा करने के लिए पेपर ज़ारी करती हैं. राज्य और स्थानीय सरकारें नगर निगम पत्र ज़ारी करती हैं जबकि यू.एस. ट्रेजरी अमरीकी सार्वजनिक ऋणों को धन देने के लिए ट्रेजरी बिल ज़ारी करती है.
व्यापार कंपनियाँ अक्सर बैंकरों की स्वीकृतियों की खरीद विदेशी आपूर्तिकर्ताओं को भुगतान के लिए करती हैं.
खुदरा और संस्थागत मुद्रा बाजार धन
बैंक
सेंट्रल बैंक
नकद प्रबंधन प्रोग्राम
अनियमित ABCP माध्यम, जो उच्च लाभ वाले पेपर खरीदने की तलाश करते हुए खुद सस्ता पेपर बेचते हैं.
मर्चेंट बैंक

Money market

The money market is a component of the financial markets for assets involved in short-term borrowing and lending with original maturities of one year or shorter time frames. Trading in the money markets involves Treasury bills, commercial paper, bankers' acceptances, certificates of deposit, federal funds, and short-lived mortgage-backed and asset-backed securities.[1] It provides liquidity funding for the global financial system

Speculators Pile Up Against Euro

The Wall Street Journal’s coverage of the Greek dent crisis has focused less on the crisis itself, and more on the markets’ reaction to it. With headlines like “Hedge Funds Try ‘Career Trade’ Against Euro” and “Speculators Bet Record Amount Against Euro For 4th Week” and “Europe Trouble, U.S. Opportunity” – among others – the WSJ has identified a collapse in the Euro (mainly against the Dollar) as one of the most prominent (and profitable!) strategies for exploiting the crisis.As I mentioned in the last post (”Understanding the Greece Situation“), the debt crisis has become self-fulfilling, not only for Greece, but also for the Euro. In other words, as perceptions abound that Greece is insolvent and the Euro is doomed, Greek bonds and the Euro have lost value, which only makes the crisis worse. It seems that speculators are taking advantage of this phenomenon by making large bets against the Euro. In fact, large is an understatement, as the net short positions against the Euro now total a record $12 Billion, according to the closely watched Commitment of Traders report.
Some analysts have taken such information at face value, noting that “The fact that the shorts got even shorter when they were already at extreme levels highlights just how negative the sentiment is toward euro.” On the other hand, there is evidence (and some degree of admission) that large speculators are now acting in concert to bring down the value of the Euro. The WSJ reports mention private meeting between hedge funds managers and investment banks helping their clients bet against the Euro using derivatives. For those that are skeptical that speculators could really influence currency markets, consider that one man – George Soros – single-handedly forced a devaluation of the Pound in 1992, and made $1 Billion in the process. While the Euro is certainly bigger than the Pound ever was, there are more people watching it than ever, and when there is money to be made - hundreds of billions of dollars in this case – it isn’t inconceivable that the Euro could suffer a similar fate.
Already, there is evidence that this strategy is working, as the Euro has fallen 10% in less than three months, which is unbelievable for a currency whose daily trading volume is estimated at $1.2 Trillion. In fact, one popular options trade is based on the the Euro falling to parity against the Dollar. Once unthinkable, such a possibility now faces odds of “only” 1 in 14 (based on options premiums), compared to 1 in 33 in November. On the one hand, it’s frustrating to accept the market power that these speculators have. But emotion has no place in (forex) trading, and standing in the way of momentum would be costly.
On the other hand, Euro fundamentals remain strong. To be sure, a currency is only as strong as its constituent parts, and the fact that a handful of EU member states have shaky finances certainly cannot be dismissed. At the same time, the fact that such currencies have no direct control over the Euro is just as important. Before the inception of the Euro, currency traders would be justifiably concerned that a country in a similar position to Greece would deliberately devalue its currency (by printing money) in order to devalue its debt and make it more manageable.
Now, this would be impossible, since the Euro is controlled by the European Central Bank, over which Greece has no power. The current crisis in Greece notwithstanding, “The European Central Bank’s (ECB) resolve to maintain sound money is…important. This is especially true for the ECB, which has a single mandate—price stability—unrelated to fiscal problems.” While there is legitimate concern that the ECB will be forced (or voluntarily) print more money to fund bailouts of bankrupt EU member states, this doesn’t seem very likely, given the history of the ECB. Its monetary policy has always been quite conservative, and it’s no wonder that the Euro has come to be seen as a viable alternative to the Dollar.
In my opinion, the decline in the Euro is mostly baseless, and if it were to continue, it wouldn’t represent the prevailing of logic. Then again, logic is not exactly a word that I would apply to the forex markets, now or ever.

Emerging Market Currencies Continue their Run

Since most emerging market economies and financial markets are fairly small, their currencies are subject to the whims of international investors, moreso than is the case with major currencies. For that reason, when I research emerging market currencies as a whole, I often like to focus on what investors are saying are saying about their stocks and bonds.
According to one columnist, “For an asset class once considered a snake pit of risk, emerging market sovereign bonds have become remarkably popular among investors. So popular, in fact, that even the most cautious of institutions have developed an appetite. Indeed, US pension funds are poised to pour almost $100bn (£65m, €74m) into emerging market debt in the next five years…potentially helping push yields relative to US Treasuries to a record low.” The popularity of emerging market debt is pretty incredible in the context of the Greek debt crisis and the consequent spike in risk aversion. At the same time, emerging market countries have been lauded for their sound finances and low debt-to-GDP ratios, so perhaps it’s no surprise that investors remain willing to continue lending them money. “More and more investors are looking to emerging market local bonds as an alternative to standard global bond allocations, as the problems in Greece and the European periphery highlight the credit risks of that market that have been long underpriced.”

Historical Data

The following exchange rates are certified by the Federal Reserve Bank of New York for customs purposes as required by section 522 of the amended Tariff Act of 1930. These rates are also those required by the SEC for the integrated disclosure system for foreign private issuers. The information is based on data collected by the Federal Reserve Bank of New York from a sample of market participants.
The data are noon buying rates in New York for cable transfers payable in foreign currencies.
Please note: Based on information we received from the Federal Reserve Bank of New York, revisions were applied in October 2004 to the exchange rate of the dollar against both the Hong Kong Dollar and the Chinese Yuan for several days between 1999 and 2003. Please refer to the following link for a list of these days and for the size of the revisions: http://www.newyorkfed.org/markets/fxrates/revisions.html.

foreign exchange rate

Effective January 1, 2009, the Federal Reserve Board is discontinuing publication of the H.10 Daily Update, which provides U.S. dollar exchange rates against other currencies certified for customs purposes by the Federal Reserve Bank of New York and summary measures of the foreign exchange value of the dollar. The Federal Reserve Bank of New York also has issued notification that it will discontinue publication of these foreign exchange rates on its web site. The Federal Reserve Board will still make the certified exchange rates available. Effective January 5, 2009, the Board will publish the daily exchange rate data in a weekly version of the H.10 release, reinstituting the weekly publication, which had been discontinued in May 2006. The webpage that links to historical data from the H.10 release will also be updated once per week to pick up the daily data from the previous week.

Daily Update

Effective January 1, 2009, the Federal Reserve Board is discontinuing publication of the H.10 Daily Update, which provides U.S. dollar exchange rates against other currencies certified for customs purposes by the Federal Reserve Bank of New York and summary measures of the foreign exchange value of the dollar. The Federal Reserve Bank of New York also has issued notification that it will discontinue publication of these foreign exchange rates on its web site. The Federal Reserve Board will still make the certified exchange rates available. Effective January 5, 2009, the Board will publish the daily exchange rate data in a weekly version of the H.10 release, reinstituting the weekly publication, which had been discontinued in May 2006. The webpage that links to historical data from the H.10 release will also be updated once per week to pick up the daily data from the previous week. H.10 DAILY UPDATE: WEB RELEASE ONLY For immediate release FOREIGN EXCHANGE RATES December 31, 2008 The Board of Governors of the Federal Reserve System is advised that the Federal Reserve Bank of New York has certified for customs purposes the following noon buying rates in New York City for cable transfers payable in foreign currencies: (Rates in currency units per U.S. dollar except as noted) MONETARY COUNTRY UNIT Dec. 29 Dec. 30 Dec. 31 Jan. 1 Jan. 2 *AUSTRALIA DOLLAR 0.6950 0.6906 0.6983 BRAZIL REAL 2.3975 2.3291 2.3180 CANADA DOLLAR 1.2162 1.2215 1.2240 CHINA, P.R. YUAN 6.8447 6.8295 6.8225 DENMARK KRONE 5.2335 5.2895 5.3497 *EMU MEMBERS EURO 1.4232 1.4085 1.3919 HONG KONG DOLLAR 7.7500 7.7498 7.7499 INDIA RUPEE 48.2500 48.0500 48.5800 JAPAN YEN 90.2000 90.3700 90.7900 MALAYSIA RINGGIT 3.4780 3.4770 3.4500 MEXICO PESO 13.5225 13.7600 13.8320 *NEW ZEALAND DOLLAR 0.5825 0.5770 0.5815 NORWAY KRONE 7.0047 7.0030 6.9756 SINGAPORE DOLLAR 1.4370 1.4372 1.4377 SOUTH AFRICA RAND 9.4600 9.3500 9.3000 SOUTH KOREA WON 1262.0000 1257.4000 1262.0000 SRI LANKA RUPEE 113.6200 113.3000 112.9000 SWEDEN KRONA 7.7354 7.7875 7.8770 SWITZERLAND FRANC 1.0414 1.0567 1.0673 TAIWAN DOLLAR 32.9900 32.7600 32.7600 THAILAND BAHT 34.9700 34.7100 34.7200 *UNITED KINGDOM POUND 1.4591 1.4395 1.4619 VENEZUELA BOLIVAR 2.1446 2.1446 2.1446 MEMO: UNITED STATES DOLLAR1)BROAD JAN97=100 106.6383 107.0459 107.35742)MAJOR CURRENCY MAR73=100 78.4987 79.0638 79.41423)OITP JAN97=100 137.5822 137.6436 137.8345 For more information on exchange rate indexes for the U.S. dollar, see "Indexes of the Foreign Exchange Value of the Dollar," Federal Reserve Bulletin, 91:1 (Winter 2005), pp. 1-8 (http://www.federalreserve.gov/pubs/bulletin/2005/winter05_index.pdf). Weights for the broad index can be found at http://www.federalreserve.gov/releases/H10/Weights; weights for the major currencies index and the other important trading partners (OITP) index are derived from the broad index weights. The most recent annual revision of the currency weights and dollar indexes took effect with the January 2, 2007 release of this report. The source for exchange rates not listed in the table above but used in the calculation of the broad and OITP indexes is Bloomberg L.P. * U.S. dollars per currency unit. 1) A weighted average of the foreign exchange value of the U.S. dollar against the currencies of a broad group of major U.S. trading partners. 2) A weighted average of the foreign exchange value of the U.S. dollar against a subset of the broad index currencies that circulate widely outside the country of issue. 3) A weighted average of the foreign exchange value of the U.S. dollar against a subset of the broad index currencies that do not circulate widely outside the country of issue. The euro is reported in place of the individual euro-area currencies. These currency rates can be derived from the dollar/euro rate by using the fixed conversion rates (in currencies per euro) given below: 1 EURO = 13.7603 AUSTRIAN SCHILLINGS = 40.3399 BELGIAN FRANCS = 5.94573 FINNISH MARKKAS = 6.55957 FRENCH FRANCS = 1.95583 GERMAN MARKS = .787564 IRISH POUNDS = 1936.27 ITALIAN LIRE = 40.3399 LUXEMBOURG FRANCS = 2.20371 NETHERLANDS GUILDERS = 200.482 PORTUGUESE ESCUDOS = 166.386 SPANISH PESETAS = 340.750 GREEK DRACHMAS = 239.640 SLOVENIAN TOLAR

Market size and liquidity

The foreign exchange market is the largest and most liquid financial market in the world. Traders include large banks, central banks, currency speculators, corporations, governments, and other financial institutions. The average daily volume in the global foreign exchange and related markets is continuously growing. Daily turnover was reported to be over US$3.2 trillion in April 2007 by the Bank for International Settlements. [2] Since then, the market has continued to grow. According to Euromoney's annual FX Poll, volumes grew a further 41% between 2007 and 2008.[3]
Of the $3.98 trillion daily global turnover, trading in London accounted for around $1.36 trillion, or 34.1% of the total, making London by far the global center for foreign exchange. In second and third places respectively, trading in New York accounted for 16.6%, and Tokyo accounted for 6.0%.[4] In addition to "traditional" turnover, $2.1 trillion was traded in derivatives.
Exchange-traded FX futures contracts were introduced in 1972 at the Chicago Mercantile Exchange and are actively traded relative to most other futures contracts.
Several other developed countries also permit the trading of FX derivative products (like currency futures and options on currency futures) on their exchanges. All these developed countries already have fully convertible capital accounts. Most emerging countries do not permit FX derivative products on their exchanges in view of prevalent controls on the capital accounts. However, a few select emerging countries (e.g., Korea, South Africa, India—[1]; [2]) have already successfully experimented with the currency futures exchanges, despite having some controls on the capital account.
FX futures volume has grown rapidly in recent years, and accounts for about 7% of the total foreign exchange market volume, according to The Wall Street Journal Europe (5/5/06, p. 20).

Foreign exchange market

The foreign exchange market (forex, FX, or currency market) is a worldwide decentralized over-the-counter financial market for the trading of currencies. Financial centers around the world function as anchors of trading between a wide range of different types of buyers and sellers around the clock, with the exception of weekends.
The purpose of the foreign exchange market 'Forex' is to assist international trade and investment. The foreign exchange market allows businesses to convert one currency to another foreign currency. For example, it permits a U.S. business to import European goods and pay Euros, even though the business's income is in U.S. dollars. Some experts, however, believe that the unchecked speculative movement of currencies by large financial institutions such as hedge funds impedes the markets from correcting global current account imbalances. This carry trade may also lead to loss of competitiveness in some countries. [1]
In a typical foreign exchange transaction a party purchases a quantity of one currency by paying a quantity of another currency. The modern foreign exchange market started forming during the 1970s when countries gradually switched to floating exchange rates from the previous exchange rate regime, which remained fixed as per the Bretton Woods system.
The foreign exchange market is unique because of
trading volume results in market liquidity
geographical dispersion
continuous operation: 24 hours a day except weekends, i.e. trading from 20:15 UTC on Sunday until 22:00 UTC Friday
the variety of factors that affect exchange rates
the low margins of relative profit compared with other markets of fixed income
the use of leverage to enhance profit margins with respect to account size
As such, it has been referred to as the market closest to the ideal perfect competition, notwithstanding market manipulation by central banks.[citation needed] According to the Bank for International Settlements,[2] average daily turnover in global foreign exchange markets is estimated at $3.98 trillion as of April 2007. Trading in the world's main financial markets accounted for $3.21 trillion of this. This approximately $3.21 trillion in main foreign exchange market turnover was broken down as follows:
$1.005 trillion in spot transactions
$362 billion in outright forwards
$1.714 trillion in foreign exchange swaps
$129 billion estimated gaps in reporting

The use of high leverage

By offering high leverage, the market maker encourages traders to trade extremely large positions. This increases the trading volume cleared by the market maker and increases his profits, but increases the risk that the trader will receive a margin call. While professional currency dealers (banks, hedge funds) seldom use more than 10:1 leverage, retail clients are generally offered leverage between 50:1 and 200:1[2].
A self-regulating body for the foreign exchange market, the National Futures Association, warns traders in a forex training presentation of the risk in trading currency. “As stated at the beginning of this program, off-exchange foreign currency trading carries a high level of risk and may not be suitable for all customers. The only funds that should ever be used to speculate in foreign currency trading, or any type of highly speculative investment, are funds that represent risk capital; in other words, funds you can afford to lose without affecting your financial situation.“ [17]

Not beating the market

The foreign exchange market is a zero sum game[7] in which there are many experienced well-capitalized professional traders (e.g. working for banks) who can devote their attention full time to trading. An inexperienced retail trader will have a significant information disadvantage compared to these traders.
Although it is possible for a few experts to successfully arbitrage the market for an unusually large return, this does not mean that a larger number could earn the same returns even given the same tools, techniques and data sources. This is because the arbitrages are essentially drawn from a pool of finite size; although information about how to capture arbitrages is a nonrival good, the arbritrages themselves are a rival good. (To draw an analogy, the total amount of buried treasure on an island is the same, regardless of how many treasure hunters have bought copies of the treasure map.)
Retail traders are - almost by definition - undercapitalized. Thus they are subject to the problem of gambler's ruin. In a fair game (one with no information advantages) between two players that continues until one trader goes bankrupt, the player with the lower amount of capital has a higher probability of going bankrupt first. Since the retail speculator is effectively playing against the market as a whole - which has nearly infinite capital - he will almost certainly go bankrupt.
The retail trader always pays the bid/ask spread which makes his odds of winning less than those of a fair game. Additional costs may include margin interest, or if a spot position is kept open for more than one day the trade may be "resettled" each day, each time costing the full bid/ask spread.
According to the Wall Street Journal (Currency Markets Draw Speculation, Fraud July 26, 2005) "Even people running the trading shops warn clients against trying to time the market. 'If 15% of day traders are profitable,' says Drew Niv, chief executive of FXCM, 'I'd be surprised.' "[15]
Paul Belogour, the Managing Director of a Boston based retail forex trader, was quoted by the Financial Times as saying, "Trading foreign exchange is an excellent way for investors to find out how tough the markets really are. But I say to customers: if this is money you have worked hard for – that you cannot afford to lose – never, never invest in foreign exchange." [16]

Forex scam

A forex (or foreign exchange) scam is any trading scheme used to defraud traders by convincing them that they can expect to gain a high profit by trading in the foreign exchange market. Currency trading "has become the fraud du jour" as of early 2008, according to Michael Dunn of the U.S. Commodity Futures Trading Commission.[1] But "the market has long been plagued by swindlers preying on the gullible," according to the New York Times.[2] "The average individual foreign-exchange-trading victim loses about $15,000, according to CFTC records" according to The Wall Street Journal.[3] The North American Securities Administrators Association says that "off-exchange forex trading by retail investors is at best extremely risky, and at worst, outright fraud."[4]
"In a typical case, investors may be promised tens of thousands of dollars in profits in just a few weeks or months, with an initial investment of only $5,000. Often, the investor’s money is never actually placed in the market through a legitimate dealer, but simply diverted – stolen – for the personal benefit of the con artists."[5]
In August, 2008 the CFTC set up a special task force to deal with growing foreign exchange fraud.”[6]
The forex market is a zero-sum game,[7] meaning that whatever one trader gains, another loses, except that brokerage commissions and other transaction costs are subtracted from the results of all traders, technically making forex a "negative-sum" game.
These scams might include churning of customer accounts for the purpose of generating commissions, selling software that is supposed to guide the customer to large profits,[8] improperly managed "managed accounts",[9] false advertising,[10] Ponzi schemes and outright fraud.[4][11] It also refers to any retail forex broker who indicates that trading foreign exchange is a low risk, high profit investment.[12]
The U.S. Commodity Futures Trading Commission (CFTC), which loosely regulates the foreign exchange market in the United States, has noted an increase in the amount of unscrupulous activity in the non-bank foreign exchange industry.[13]
An official of the National Futures Association was quoted as saying, "Retail forex trading has increased dramatically over the past few years. Unfortunately, the amount of forex fraud has also increased dramatically."[14] Between 2001 and 2006 the U.S. Commodity Futures Trading Commission has prosecuted more than 80 cases involving the defrauding of more than 23,000 customers who lost $350 million. From 2001 to 2007, about 26,000 people lost $460 million in forex frauds.[1] CNN quoted Godfried De Vidts, President of the Financial Markets Association, a European body, as saying, "Banks have a duty to protect their customers and they should make sure customers understand what they are doing. Now if people go online, on non-bank portals, how is this control being done?"

Forward

One way to deal with the foreign exchange risk is to engage in a forward transaction. In this transaction, money does not actually change hands until some agreed upon future date. A buyer and seller agree on an exchange rate for any date in the future, and the transaction occurs on that date, regardless of what the market rates are then. The duration of the trade can be a one day, a few days, months or years. Usually the date is decided by both parties.

Spot

A spot transaction is a two-day delivery transaction (except in the case of trades between the US Dollar, Canadian Dollar, Turkish Lira and Russian Ruble, which settle the next business day), as opposed to the futures contracts, which are usually three months. This trade represents a “direct exchange” between two currencies, has the shortest time frame, involves cash rather than a contract; and interest is not included in the agreed-upon transaction. The data for this study come from the spot market. Spot transactions has the second largest turnover by volume after Swap transactions among all FX transactions in the Global FX market. NNM

Algorithmic trading in foreign exchange

Electronic trading is growing in the FX market, and algorithmic trading is becoming much more common. According to financial consultancy Celent estimates, by 2008 up to 25% of all trades by volume will be executed using algorithm, up from about 18% in 2005.[citation needed]

Algorithmic trading in foreign exchange

Electronic trading is growing in the FX market, and algorithmic trading is becoming much more common. According to financial consultancy Celent estimates, by 2008 up to 25% of all trades by volume will be executed using algorithm, up from about 18% in 2005.[citation needed]

Market psychology

Flights to quality: Unsettling international events can lead to a "flight to quality," with investors seeking a "safe haven." There will be a greater demand, thus a higher price, for currencies perceived as stronger over their relatively weaker counterparts. The Swiss franc and gold have been traditional safe havens during times of political or economic uncertainty.[12]
Long-term trends: Currency markets often move in visible long-term trends. Although currencies do not have an annual growing season like physical commodities, business cycles do make themselves felt. Cycle analysis looks at longer-term price trends that may rise from economic or political trends.[13]
"Buy the rumor, sell the fact": This market truism can apply to many currency situations. It is the tendency for the price of a currency to reflect the impact of a particular action before it occurs and, when the anticipated event comes to pass, react in exactly the opposite direction. This may also be referred to as a market being "oversold" or "overbought".[14] To buy the rumor or sell the fact can also be an example of the cognitive bias known as anchoring, when investors focus too much on the relevance of outside events to currency prices.
Economic numbers: While economic numbers can certainly reflect economic policy, some reports and numbers take on a talisman-like effect: the number itself becomes important to market psychology and may have an immediate impact on short-term market moves. "What to watch" can change over time. In recent years, for example, money supply, employment, trade balance figures and inflation numbers have all taken turns in the spotlight.
Technical trading considerations: As in other markets, the accumulated price movements in a currency pair such as EUR/USD can form apparent patterns that traders may attempt to use. Many traders study price charts in order to identify such patterns.[15]

Political conditions

Internal, regional, and international political conditions and events can have a profound effect on currency markets.
All exchange rates are susceptible to political instability and anticipations about the new ruling party. Political upheaval and instability can have a negative impact on a nation's economy. For example, destabilization of coalition governments in Pakistan and Thailand can negatively affect the value of their currencies. Similarly, in a country experiencing financial difficulties, the rise of a political faction that is perceived to be fiscally responsible can have the opposite effect. Also, events in one country in a region may spur positive/negative interest in a neighboring country and, in the process, affect its currency.

Economic factors

These include: (a)economic policy, disseminated by government agencies and central banks, (b)economic conditions, generally revealed through economic reports, and other economic indicators.
Economic policy comprises government fiscal policy (budget/spending practices) and monetary policy (the means by which a government's central bank influences the supply and "cost" of money, which is reflected by the level of interest rates).
Government budget deficits or surpluses: The market usually reacts negatively to widening government budget deficits, and positively to narrowing budget deficits. The impact is reflected in the value of a country's currency.
Balance of trade levels and trends: The trade flow between countries illustrates the demand for goods and services, which in turn indicates demand for a country's currency to conduct trade. Surpluses and deficits in trade of goods and services reflect the competitiveness of a nation's economy. For example, trade deficits may have a negative impact on a nation's currency.
Inflation levels and trends: Typically a currency will lose value if there is a high level of inflation in the country or if inflation levels are perceived to be rising. This is because inflation erodes purchasing power, thus demand, for that particular currency. However, a currency may sometimes strengthen when inflation rises because of expectations that the central bank will raise short-term interest rates to combat rising inflation.
Economic growth and health: Reports such as GDP, employment levels, retail sales, capacity utilization and others, detail the levels of a country's economic growth and health. Generally, the more healthy and robust a country's economy, the better its currency will perform, and the more demand for it there will be.
Productivity of an economy: Increasing productivity in an economy should positively influence the value of its currency. Its effects are more prominent if the increase is in the traded sector [3].

Determinants of FX rates

(a) International parity conditions: Relative Purchasing Power Parity, interest rate parity, Domestic Fisher effect, International Fisher effect. Though to some extent the above theories provide logical explanation for the fluctuations in exchange rates, yet these theories falter as they are based on challengeable assumptions [e.g., free flow of goods, services and capital] which seldom hold true in the real world.
(b) Balance of payments model (see exchange rate): This model, however, focuses largely on tradable goods and services, ignoring the increasing role of global capital flows. It failed to provide any explanation for continuous appreciation of dollar during 1980s and most part of 1990s in face of soaring US current account deficit.
(c) Asset market model (see exchange rate): views currencies as an important asset class for constructing investment portfolios. Assets prices are influenced mostly by people’s willingness to hold the existing quantities of assets, which in turn depends on their expectations on the future worth of these assets. The asset market model of exchange rate determination states that “the exchange rate between two currencies represents the price that just balances the relative supplies of, and demand for, assets denominated in those currencies.”
None of the models developed so far succeed to explain FX rates levels and volatility in the longer time frames. For shorter time frames (less than a few days) algorithm can be devised to predict prices. Large and small institutions and professional individual traders have made consistent profits from it. It is understood from above models that many macroeconomic factors affect the exchange rates and in the end currency prices are a result of dual forces of demand and supply. The world's currency markets can be viewed as a huge melting pot: in a large and ever-changing mix of current events, supply and demand factors are constantly shifting, and the price of one currency in relation to another shifts accordingly. No other market encompasses (and distills) as much of what is going on in the world at any given time as foreign exchange.
Supply and demand for any given currency, and thus its value, are not influenced by any single element, but rather by several. These elements generally fall into three categories: economic factors, political conditions and market psychology.

Trading characteristics

There is no unified or centrally cleared market for the majority of FX trades, and there is very little cross-border regulation. Due to the over-the-counter (OTC) nature of currency markets, there are rather a number of interconnected marketplaces, where different currencies instruments are traded. This implies that there is not a single exchange rate but rather a number of different rates (prices), depending on what bank or market maker is trading, and where it is. In practice the rates are often very close, otherwise they could be exploited by arbitrageurs instantaneously. Due to London's dominance in the market, a particular currency's quoted price is usually the London market price. A joint venture of the Chicago Mercantile Exchange and Reuters, called Fxmarketspace opened in 2007 and aspired but failed to the role of a central market clearing mechanism.
The main trading center is London, but New York, Tokyo, Hong Kong and Singapore are all important centers as well. Banks throughout the world participate. Currency trading happens continuously throughout the day; as the Asian trading session ends, the European session begins, followed by the North American session and then back to the Asian session, excluding weekends.
Fluctuations in exchange rates are usually caused by actual monetary flows as well as by expectations of changes in monetary flows caused by changes in gross domestic product (GDP) growth, inflation (purchasing power parity theory), interest rates (interest rate parity, Domestic Fisher effect, International Fisher effect), budget and trade deficits or surpluses, large cross-border M&A deals and other macroeconomic conditions. Major news is released publicly, often on scheduled dates, so many people have access to the same news at the same time. However, the large banks have an important advantage; they can see their customers' order flow.
Currencies are traded against one another. Each currency pair thus constitutes an individual trading product and is traditionally noted XXXYYY or XXX/YYY, where XXX and YYY are the ISO 4217 international three-letter code of the currencies involved. The first currency (XXX) is the base currency that is quoted relative to the second currency (YYY), called the counter currency (or quote currency). For instance, the quotation EURUSD (EUR/USD) 1.5465 is the price of the euro expressed in US dollars, meaning 1 euro = 1.5465 dollars. Historically, the base currency was the stronger currency at the creation of the pair. However, when the euro was created, the European Central Bank mandated that it always be the base currency in any pairing.
The factors affecting XXX will affect both XXXYYY and XXXZZZ. This causes positive currency correlation between XXXYYY and XXXZZZ.
On the spot market, according to the BIS study, the most heavily traded products were:
EURUSD: 27%
USDJPY: 13%
GBPUSD (also called cable): 12%
and the US currency was involved in 86.3% of transactions, followed by the euro (37.0%), the yen (17.0%), and sterling (15.0%) (see table). Volume percentages for all individual currencies should add up to 200%, as each transaction involves two currencies.
Trading in the euro has grown considerably since the currency's creation in January 1999, and how long the foreign exchange market will remain dollar-centered is open to debate. Until recently, trading the euro versus a non-European currency ZZZ would have usually involved two trades: EURUSD and USDZZZ. The exception to this is EURJPY, which is an established traded currency pair in the interbank spot market. As the dollar's value has eroded during 2008, interest in using the euro as reference currency for prices in commodities (such as oil), as well as a larger component of foreign reserves by banks, has increased dramatically. Transactions in the currencies of commodity-producing countries, such as AUD, NZD, CAD, have also increased.