The Forex Nitty Gritty

If a beginning trader wishes to profit from fluctuations in the US Dollar, Swiss franc or Euro versus other currencies he will need to develop a Forex trading system. Although it is possible to let a team of traders and programmers develop a Forex trading system for you it is important that any foreign currency trader understands the ins and outs of the system. Even if you plan to purchase a trading system it is an excellent exercise to think through the various aspects of foreign currency trading in order to put things in perspective. So, if you are going to develop a Forex trading system or purchase one “off the shelf” what are the important parts?

Which Currency Pair and When

People trade foreign currencies for two basic reasons. Companies doing business internationally need to exchange currencies in order to make and receive payment for goods and services. These folks follow fundamentals and use Forex technical strategies in order to hedge the risk of currency fluctuation between the signing of a contract and final payment. Currency speculators simply seek to profit from price changes between any given pair of currencies. To a degree it is easier to develop a Forex trading system for hedging currency risk because the trader is only interested in one pair of currencies and one specific time frame. On the other hand a currency speculator will commonly keep his eye on a number of currency pairs in order to trade the most profitable pair at the most profitable time. Thus a speculator will need to allot time to seeking the most profitable pairs to trade and may subscribe to an alert service in order to trade when price action is potentially most profitable.

Which Market to Trade and What Time of Day

The major Forex exchanges are London, New York, and Tokyo. The sum total of their business hours allows a trader, in theory, to trade around the clock. However, humans need sleep. Traders also need prep time to scout out trading opportunities, learn more about trading strategies, review results, and modify their trading system. In order to develop a Forex trading system that works for people, time of day, available hours and organization of work flow are crucial. Folks wishing to trade the post tsunami Yen versus other currencies may wish to work during Tokyo business hours while those trading the British Pound may wish to work London business hours. For a trader living in Miami, Chicago, Denver, or San Francisco this will require other arrangements in order for the trader to have a personal, social, or family life.

How Much Do You Want To Risk and How Do You Protect Your Money?

Success is never guaranteed in Forex trading. Traders typically trade using a margin account. Then they leverage their trades which can greatly magnify profits but can also magnify losses. Smart traders also use trailing stops in order to lock in gains and avoid disastrous losses. Smart day traders get out of all of their trades at the end of the trading session to avoid getting caught in a big gap when the market opens the next day. Smart traders never put all of their money into one trade and smart traders never look upon what they are doing as gambling. And good traders review their results whether they are trading the Euro and the Greek debt crisis or are knowledgeable about commodities and trading the AUD, and if their system does not work they develop a Forex trading system that does.

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An interesting new problem may have arisen for currency traders, how to trade a declining Yuan. The assertion regarding the Chinese currency for many years has been that the People’s Bank of China buys dollars in order to reduce the value of the Yuan and keep Chinese exports flowing. The continuing balance of payments deficits that the US, especially, runs with China, has led US and other lawmakers to demand that China allow its currency to float without any intervention. The theory is that by allowing the Yuan to float Chinese exports will become more expensive and less competitive. Now it appears that the Yuan is falling in value, and not because of currency manipulation. Today’s currency traders trade a declining Yuan as the global economic recovery weakens and the twin financial crises in North America and Europe threaten a second dip to the recession and substantially reduced imports from China. In addition an increase in Chinese imports may well erase the Chinese trade surplus, according to Chinese sources.

Those who currently trade a declining Yuan, have watched as Yuan forwards declined. Forwards are derivative contracts used to hedge currency risk or engage in currency speculation for profit. Unlike trading options on currencies no money changes hands when a forward contract is agreed upon. Also, unlike options contracts, both the seller and the buyer are obligated to fulfill their portion of the forward contract on the delivery date. As currency traders anticipate a falling Yuan, forwards decline. The early result of the debt crisis in Europe and the USA has been the appreciation of other currencies, including the Yuan. However, the threat of a substantial economic downturn in both economies threatens Chinese exports and threatens to drive down the Yuan. Chinese exports did, in fact, fall last month. While talk of internationalization of the Yuan persists its value seems to be driving today by the market and much less so by currency manipulation.

To trade a declining Yuan will require a change of mindset for many traders. The Yuan rose to a seventeen year high against the dollar in mid-November, after a nearly four percent run up this year. Some may merely view this as a correction. However, the debt issues in Europe and North America are terribly real. Thus the Asian exporters who have profited from keeping their currencies weak and have built up huge dollar and Euro currency reserves are likely to pay a price in terms of reduced exports. A silver lining to the clouds may be that as the Yuan depreciates the value of China’s reserves will go up. For those set to trade a declining Yuan two general issues come to mind. One is that the continued appreciation of the Yuan is not guaranteed, especially if China ceases to manipulate its currency. The other is that China has its own set of internal issues and problems. The nation has had steady economic growth for years and many Chinese would consider it political suicide to drastically reduce exports and cash flow into the country. China states that it intends to increase development of internal infrastructure projects in order to maintain high employment and its internal economy. With time, to trade a declining Yuan or a rising Yuan traders may spend less time concerning themselves with currency manipulation and will watch the same sorts of employment numbers and statistics as they watch in the USA when trading the US dollar. With time the Yuan could join the dollar as a safe haven currency.

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The China current account surplus is down roughly forty percent from last year. The US would like to see this shrink even further as America constantly runs a deficit due to more imports from China than exports to China. The US argument is that the China current account surplus is because of an artificially low exchange rate on the Chinese currency, the Yuan. The US and the EU would both like to see the Chinese allow their currency to float freely versus other currencies in order to make US and EU exports more competitive in the Chinese market and elsewhere. The Chinese, however, are merely following the example set years ago by Japan and Taiwan. By constantly purchasing US dollars to use as foreign currency reserves these nations are able to force the dollar higher and their own currency lower in currency pair trading. As the specter of a Greek debt default occupies the attention of the Forex world Western leaders are looking to the future and one of the reasons for the degree of debt in Europe, the China current account surplus.

In recent discussions as well as in pronouncements in the media, Chinese leaders cite the reduced China current account surplus as evidence that China is investing more heavily on infrastructure as a means of driving its currently export driven economy. They state that China is moving at a reasonable speed in increasing the value of its currency and that moving any faster is not necessary. On the other hand world leaders like US president Obama make the argument that China needs to let its currency float and do it more rapidly. With the US and EU debt burdens on the front burner for the West it is understandable that these economies look for relief in the form of more nearly balanced foreign trade with China and other Asian nations. Meanwhile China states its intention for internationization of the Yuan. The goal of China is, by the end of the decade, to add the Yuan to the small of group of currencies that nations hold as foreign currency reserves.

Currently the dollar as a safe haven currency is rising due to the EU debt crisis and pronouncements out of Europe that nations can voluntarily leave the European Union. This could well mean the entire southern tier of nations, Greece, Italy, Spain, and Portugal whose sovereign debt issues have occupied currency traders for over a year. If the Chinese are successful in internationalizing the Yuan it could become a so called safe haven currency along with the Yen, Swiss franc, US dollar, and, in better times, the Euro. Much of this will depend upon continuing a China current account surplus but not to the degree that the US and EU engage in a trade war as a means of last resort in order to deal with their own debt crises. The bottom line for China is to move to a more balanced economy in which their citizens buy products from around the world as well as being the new workshop of the world and only being an export driven economy. Many experts feel that the planned economy approach that China is using to create jobs in the interior does not solve the balanced economy issue and simply continues an eventually unsustainable China current account surplus.

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The recently announced French austerity plan reminds us that it is not only the so called PIIGS nations in the European Union that need to cut expenses. In announcing the French austerity plan Prime Minister Francois Fillon forecasted that the French austerity plan needs to save 100 billion euros. President Nicolas Sarkozy and his government would like to avoid a downgrade of their credit rating (as seen in the USA) and is thus cutting budgets and looking to raise taxes. With the Greek debt crisis ever so painfully in the news Italy is seen as the next, and worse, problem confronting the EU. The news the other day carried a telling item. The very Catholic nation of Ireland will no longer have an ambassador to the Vatican. It appears that everyone is cutting something in their budget.

French growth forecasts have been cut in half. Analysts say the French austerity plan will certainly reduce debts but may not be sufficient to avoid a cut in the nation’s credit rating. This issue is a little like looking at Illinois or California within the USA. It has to do with a member of the EU and not the EU itself. But, maybe not. In order for the bailout plans of the various nations in the EU to work the two largest economies must grow. Italy, the third largest EU economy is in trouble. France is looking to reduce debt which will likely reduce economic growth. That leaves Germany whose economy is recovering from the recession more slowly than desired. How does all of this affect the seemingly continuous downward direction of the Euro? Europe, for all of its current problems, is either the first or second largest economy in the world, depending upon whether they or the USA are in the lead for the year. However, the value of the Euro versus other currencies will adjust based upon the economic strength of the EU in relation to other economies.

French officials are cautioning the nation that sacrifices may be required as the idea of a European nation going bankrupt is no longer an abstraction. With Greece, Spain, and now Italy in danger of debt default it is altogether possible that one or more nations might leave the EU. How this new reality will affect the Euro versus the dollar is uncertain. A national bankruptcy could cause a cascade of defaults in weaker European economies. This could lead to nations leaving the EU. On the other hand it could end up with a stronger and more economically viable union. As with all Forex trading the issue of the French austerity plan requires continual fundamental and technical analysis of the currency involved, the Euro. Obviously a true global economic recovery would speed the recovery of the major nations of Europe and help stave off the wave of defaults that trouble world markets. As always traders need to watch two economies and two sets of data at once in Forex trading as traders trade one currency against the other.

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New headlines about a government collapse indicate that a Greek debt default is very possible despite herculean efforts by the European Community at large to prevent this very scenario. This story goes back a couple of years to the 2008 stock market crash and onset of the worst recession in three quarters of a century. Nations throughout the world borrowed heavily, or simply printed money, to avoid a banking collapse and a much dreaded freeze in credit worldwide. This strategy has been criticized by some as likely bankrupt many nations and lauded by some as having avoided a second Great Depression. The result in a number of nations in the European Union is that banks stayed open and governments engaged in various economic stimulus plans in efforts to jump start their economies. However, the end result for several nations was that they simply ran out of money and credit. The looming Greek debt is not the only sovereign debt issue plaguing Europe. Five nations have been in the spotlight for the last years. Portugal, Ireland, Italy, Greece, and Spain have become known as the PIIGS group in financial circles. As things worsen Forex risk aversion has driven the Euro down.

News reports tell us that austerity measures demanded by lenders in return for writing of large portions of Greek national debt and securing the rest have evoked street demonstrations and riots in Greece. The Prime Minister recently called for a popular referendum on the painfully cobbled together debt deal offer to Greece. The reaction of many lawmakers is that they will call for a no confidence vote. If this vote passes there will have to be new elections in Greece and all of nearly two years of work putting together a rescue package may indeed go down the drain. A possible result of a Greek debt default would be Greece leaving the European Union and more pressure on other members of the PIIGS group, starting with Italy. The Yen and Swiss franc will likely be under pressure rise farther and the dollar as a safe haven currency will likely go up as well.

What effect will a Greek debt default have on the Euro? What effect will a Greek debt default have on the situation in Italy, Ireland, Portugal, and Spain? How about stock markets throughout the world and other currencies? Many fear a domino effect of debt defaults if the Greek situation is not contained. Certainly markets throughout the world are concerned as every time there is bad news about European debt, stocks go down. Experts are especially concerned that Italy will be next if Greece defaults, with other PIIGS nations to follow. The Euro will likely fall in this case and traders buying puts in Forex trading the Euro will likely prosper. Many choose to buy options in such a situation and avoid trading currencies directly. By doing so the trader limits his risk to the cost of the options contract and enjoys the leverage of trading options as well. Using a strategy known as a long straddle a trader buys calls and puts on the same currency with the same expiration date. He will profit if the currency rises or falls and if the currency rate does not change he will lose only the prices of the options contracts whether there is a Greek debt default or not.

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