FOREIGN EXCHANGE MARKET

INDEX

1
 Sr.no. Topic Page no.
1 INTRODUCTION 7-30
FOREIGN EXCHANGE MARKET
1.1 Introduction 7-9
1.2 History 10-12
1.3 Definition 13-14
1.4 Trading characteristics 14-18
1.5 Trading types 18-26
1.6 Advantages and 26-28
Disadvantages
1.7 Basic terminology related to 28-30
foreign exchange

2 RESEARCH AND 31-39

METHODOLOGY

2.1 Introduction 31-31

2.2 Research and methodology 31-32
2.3 Statement of problem 32-33
2.4 Objective of study 33-34
  2.5 Significance of study 34-34
2.6 Sample design 34-34
2.7 Sample size 34-35
2.8 Sample selection techniques 35-35
2.9 Data collection tools 35-35
2.10 Source of data 36-36
2.11 Statistics tool applied 36-38
2.12 Hypotheses for the test 38-39
2.13 Limitations of study 39-39
2.14 Future scope 39-39
3 REVIEW LITRATURE 40-52

4 DATA ANALYSIS 53-76

4.1 Forex market analysis 53-53

4.2 Fundamental analysis 53-53
4.3 Technical analysis 53-53
4.4 Weekend analysis 53-54
4.5 Applying Forex Market 54-55
Analysis
2

4.6 Charts in forex 56-66

4.7 Qualitative vs Quantitative 67-67
analysis
 FOREIGN EXCHANGE MARKET

1.1 INTRODUCTION

The foreign exchange market (Forex, FX, or currency market) is a global decentralized or over-the-

counter (OTC) market for the trading of currencies. This market determines foreign exchange rates for
every currency. It includes all aspects of buying, selling and exchanging currencies at current or
determined prices. In terms of trading volume, it is by far the largest market in the world, followed by
the credit market.

The main participants in this market are the larger international banks. Financial centers around the world
function as anchors of trading between a wide range of multiple types of buyers and sellers around the
clock, with the exception of weekends. Since currencies are always traded in pairs, the foreign exchange
market does not set a currency's absolute value but rather determines its relative value by setting the
market price of one currency if paid for with another. Ex: US$1 is worth X CAD, or CHF, or JPY, etc.

The foreign exchange market works through financial institutions and operates on several levels. Behind
the scenes, banks turn to a smaller number of financial firms known as "dealers", who are involved in
large quantities of foreign exchange trading. Most foreign exchange dealers are banks, so this behind-the-
scenes market is sometimes called the "interbank market" (although a few insurance companies and other
kinds of financial firms are involved). Trades between foreign exchange dealers can be very large,
involving hundreds of millions of dollars. Because of the sovereignty issue when involving two
currencies, Forex has little (if any) supervisory entity regulating its actions.

The foreign exchange market assists international trade and investments by enabling currency conversion.
For example, it permits a business in the United States to import goods from European Union member
states, especially Eurozone members, and pay Euros, even though its income is in United States dollars. It
also supports direct speculation and evaluation relative to the value of currencies and the carry
trade speculation, based on the differential interest rate between two currencies.

In a typical foreign exchange transaction, a party purchases some quantity of one currency by paying with
some quantity of another currency.

The modern foreign exchange market began forming during the 1970s. This followed three decades of
government restrictions on foreign exchange transactions under the Bretton Woods

system

3
 FOREIGN EXCHANGE MARKET

system of monetary management, which set out the rules for commercial and financial relations among
the world's major industrial states after World War II. Countries gradually switched to floating exchange
rates from the previous exchange rate regime, which remained fixed per the Bretton Woods system.

The foreign exchange market is unique because of the following characteristics:

 its huge trading volume, representing the largest asset class in the world leading to high liquidity;

4
 FOREIGN EXCHANGE MARKET

 its geographical dispersion;

 its continuous operation: 24 hours a day except for weekends, i.e., trading from 22:00 GMT on
Sunday (Sydney) until 22:00 GMT Friday (New York);
 the variety of factors that affect exchange rates;
 the low margins of relative profit compared with other markets of fixed income; and
 the use of leverage to enhance profit and loss margins and with respect to account size.
As such, it has been referred to as the market closest to the ideal of perfect competition,
notwithstanding currency intervention by central banks.

According to the Bank for International Settlements, the preliminary global results from the 2019
Triennial Central Bank Survey of Foreign Exchange and OTC Derivatives Markets Activity show that
trading in foreign exchange markets averaged $6.6 trillion per day in April 2019. This is up from $5.1
trillion in April 2016. Measured by value, foreign exchange swaps were traded more than any other
instrument in April 2019, at $3.2 trillion per day, followed by spot trading at $2 trillion

5
 FOREIGN EXCHANGE MARKET

1.2 History
Ancient
Currency trading and exchange first occurred in ancient times. Money-changers (people helping others to
change money and also taking a commission or charging a fee) were living in the Holy Land in the times
of the Talmudic writings (Biblical times). These people (sometimes called "kollybistẻs") used city stalls,
and at feast times the Temple's Court of the Gentiles instead. Money-changers were also the silversmiths
and/or goldsmiths of more recent ancient times.

During the 4th century AD, the Byzantine government kept a monopoly on the exchange of currency.

Papyri PCZ I 59021 (c.259/8 BC), shows the occurrences of exchange of coinage in Ancient Egypt.

Currency and exchange were important elements of trade in the ancient world, enabling people to buy and
sell items like food, pottery, and raw materials. If a Greek coin held more gold than an Egyptian coin due
to its size or content, then a merchant could barter fewer Greek gold coins for more Egyptian ones, or for
more

material goods. This is why, at some point in their history, most world currencies in circulation today had
a value fixed to a specific quantity of a recognized standard like silver and gold.

Medieval and later

During the 15th century, the Medici family were required to open banks at foreign locations in order to
exchange currencies to act on behalf of textile merchants. To facilitate trade, the bank created
the nostro (from Italian, this translates to "ours") account book which contained two columned entries
showing amounts of foreign and local currencies; information pertaining to the keeping of an account
with a foreign bank. During the 17th (or 18th) century, Amsterdam maintained an active Forex market. In
1704, foreign exchange took place between agents acting in the interests of the Kingdom of England and
the County of Holland.

Early modern

6
 FOREIGN EXCHANGE MARKET

Alex. Brown & Sons traded foreign currencies around 1850 and was a leading currency trader in the
USA. In 1880, J.M. do Espírito Santo de Silva (Banco Espírito Santo) applied for and was given
permission to engage in a foreign exchange trading business.

The year 1880 is considered by at least one source to be the beginning of modern foreign exchange:
the gold standard began in that year.

Prior to the First World War, there was a much more limited control of international trade. Motivated by
the onset of war, countries abandoned the gold standard monetary system.

Modern to post-modern
From 1899 to 1913, holdings of countries' foreign exchange increased at an annual rate of 10.8%, while
holdings of gold increased at an annual rate of 6.3% between 1903 and 1913.

At the end of 1913, nearly half of the world's foreign exchange was conducted using the pound
sterling. The number of foreign banks operating within the boundaries of London increased from 3 in
1860, to 71 in 1913. In 1902, there were just two London foreign exchange brokers. At the start of the
20th century, trades in currencies was most active in Paris, New York City and Berlin; Britain remained
largely uninvolved until 1914. Between 1919 and 1922, the number of foreign exchange brokers in
London increased to 17; and in 1924, there were 40 firms operating for the purposes of exchange.

During the 1920s, the Kleinwort family were known as the leaders of the foreign exchange market, while
Japheth, Montagu & Co. and Seligman still warrant recognition as significant FX traders. The trade in
London began to resemble its modern manifestation. By 1928, Forex trade was integral to the financial
functioning of the city. Continental exchange controls, plus other factors in Europe and Latin America,
hampered any attempt at wholesale prosperity from trade[clarification needed] for those of 1930s London.

After World War II

In 1944, the Bretton Woods Accord was signed, allowing currencies to fluctuate within a range of ±1%
from the currency's par exchange rate. In Japan, the Foreign Exchange Bank Law was introduced in 1954.
As a result, the Bank of Tokyo became the center of foreign exchange by September 1954. Between 1954
and 1959, Japanese law was changed to allow foreign exchange dealings in many more Western
currencies.

U.S. President, Richard Nixon is credited with ending the Bretton Woods Accord and fixed rates of
exchange, eventually resulting in a free-floating currency system. After the Accord ended in
1971, the Smithsonian Agreement allowed rates to fluctuate by up to ±2%. In 1961–62, the volume of
foreign operations by the U.S. Federal Reserve was relatively low. Those involved in controlling
7
 FOREIGN EXCHANGE MARKET

exchange rates found the boundaries of the Agreement were not realistic and so ceased this[in March
1973, when sometime afterward[none of the major currencies were maintained with a capacity for
conversion to gold, organizations relied instead on reserves of currency. From 1970 to 1973, the volume
of trading in the market increased three-fold. At some time (according to Gandolfo during February–
March 1973) some of the markets were "split", and a two-tier currency market[was subsequently
introduced, with dual currency rates. This was abolished in March 1974.

Reuters introduced computer monitors during June 1973, replacing the telephones and telex used
previously for trading quotes.

Markets close
Due to the ultimate ineffectiveness of the Bretton Woods Accord and the European Joint Float, the forex
markets were forced to close[sometime during 1972 and March 1973. The largest purchase of US dollars
in the history of 1976[was when the West German government achieved an almost 3 billion dollar
acquisition (a figure is given as 2.75 billion in total by The Statesman: Volume 18 1974). This event
indicated the impossibility of balancing of exchange rates by the measures of control used at the time, and
the monetary system and the foreign exchange markets in West Germany and other countries within
Europe closed for two weeks (during February and, or, March 1973. Giersch, Paqué, & Schmieding state
closed after purchase of "7.5 million Dmarks" Brawley states "... Exchange markets had to be closed.
When they re-opened ... March 1 " that is a large purchase occurred after the close).

After 1973
In developed nations, the state control of the foreign exchange trading ended in 1973 when complete
floating and relatively free market conditions of modern times began. Other sources claim that the first
time a currency pair was traded by U.S. retail customers was during 1982, with additional currency pairs
becoming available by the next year.

On 1 January 1981, as part of changes beginning during 1978, the People's Bank of China allowed certain
domestic "enterprises" to participate in foreign exchange trading. Sometime during 1981, the South
Korean government ended Forex controls and allowed free trade to occur for the first time. During 1988,
the country's government accepted the IMF quota for international trade.

Intervention by European banks (especially the Bundesbank) influenced the Forex market on 27 February
1985.The greatest proportion of all trades worldwide during 1987 were within the United Kingdom
(slightly over one quarter). The United States had the second highest involvement in trading.

8
 FOREIGN EXCHANGE MARKET

During 1991, Iran changed international agreements with some countries from oil-barter to foreign
exchange.

1.3 Definition

What is the Forex Market ?

The forex market is the market in which participants can buy, sell, exchange, and speculate on currencies.
The forex market is made up of banks, commercial companies, central banks, investment
management firms, hedge funds, and retail forex brokers and investors. The currency market is
considered to be the largest financial market with over $5 trillion in daily transactions, which is more than
the futures and equity markets combined.

Basics of Forex Market

The foreign exchange market is not dominated by a single market exchange, but a global network of
computers and brokers from around the world. Forex brokers act as market makers as well, and may post
bid and ask prices for a currency pair that differs from the most competitive bid in the market.

The forex market is made up of two levels; the interbank market and the over-the-counter (OTC) market.
The interbank market is where large banks trade currencies for purposes such as hedging, balance sheet
adjustments, and on behalf of clients. The OTC market is where individuals trade through online
platforms and brokers. 

Operating hours
From Monday morning in Asia to Friday afternoon in New York, the forex market is a 24-hour market,
meaning it does not close overnight. This differs from markets such as equities, bonds, and commodities,
9
 FOREIGN EXCHANGE MARKET

which all close for a period of time, generally in the New York late afternoon. However, as with most
things there are exceptions. Some emerging market currencies closing for a period of time during the
trading day. 

The Big Players

The US dollar is by far the most traded currency, making up close to 85 percent of all trades. Second is
the euro, which is part of 39 percent of all currency trades, and third is the Japanese yen at 19 percent.
(Note: these figures do not total 100 percent because there are two sides to every FX transaction). 

According to the 2018 Greenwich Associates study, Citigroup and JPMorgan Chase & Co. were the two
biggest banks in the forex market, combining for more than 30 percent of the global market share. UBS,
Deutsche Bank, and Goldman Sachs made up the remaining places in the top five. According to CLS, a
settlement and processing group, the average daily trading volume in January 2018 was $1.805 trillion.

Origins of Forex Market

Up until World War I, currencies were pegged to precious metals, such as gold and silver. But the system
collapsed and was replaced by the Bretton Woods agreement after the second world war. That agreement
resulted in the creation of three international organizations to facilitate economic activity across the globe.
They were the International Monetary Fund (IMF), General Agreement on Tariffs and Trade (GATT),
and the International Bank for Reconstruction and Development (IBRD). The new system also replaced
gold with the US dollar as peg for international currencies. The US government promised to back up
dollar supplies with equivalent gold reserves.

But the Bretton Woods system became redundant in 1971, when US president Richard Nixon announced
“temporary” suspension of the dollar’s convertibility into gold. Currencies are now free to choose their
own peg and their value is determined by supply and demand in international markets.

KEY TAKEAWAYS

10
 FOREIGN EXCHANGE MARKET

 Forex market is a market in which participants can buy, sell, exchange, and speculate on
currencies.
 It operates 24X7, five days a way and is responsible for approximately $5 trillion in trading
turnover activity.

1.4 Trading characteristics

There is no unified or centrally cleared market for the majority of 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 quite close due to arbitrage. Due
to London's dominance in the market, a particular currency's quoted price is usually the London market
price. Major trading exchanges include Electronic Broking Services (EBS) and Thomson Reuters
Dealing, while major banks also offer trading systems. 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 centers are London and New York City, though 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.

Fluctuations in exchange rates are usually caused by actual monetary flows as well as by expectations of
changes in monetary flows. These are 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, large banks have an important
advantage; they can see their customers' order flow.

Currencies are traded against one another in pairs. 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

11
 FOREIGN EXCHANGE MARKET

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. The market convention is to quote most exchange rates
against the USD with the US dollar as the base currency (e.g. USDJPY, USDCAD, USDCHF). The
exceptions are the British pound (GBP), Australian dollar (AUD), the New Zealand dollar (NZD) and the
euro (EUR) where the USD is the counter currency (e.g. GBPUSD, AUDUSD, NZDUSD, EURUSD).

The factors affecting XXX will affect both XXXYYY and XXXZZZ. This causes a positive
currency correlation between XXXYYY and XXXZZZ.

On the spot market, according to the 2019 Triennial Survey, the most heavily traded bilateral currency
pairs were:

 EURUSD: 24.0%
 USDJPY: 13.2%
 GBPUSD (also called cable): 9.6%
The U.S. currency was involved in 88.3% of transactions, followed by the euro (32.3%), the yen (16.8%),
and sterling (12.8%) (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.

12
 FOREIGN EXCHANGE MARKET

Most traded currencies by value

Currency distribution of global foreign exchange market turnover

% of daily trades
ISO 4217 code
Rank Currency (bought or sold)
(symbol)
(April 2019)

1  United States dollar USD (US$) 88.3%

2  Euro EUR (€) 32.3%

3  Japanese yen JPY (¥) 16.8%

4  Pound sterling GBP (£) 12.8%

5  Australian dollar AUD (A$) 6.8%

6  Canadian dollar CAD (C$) 5.0%

7  Swiss franc CHF (CHF) 5.0%

8  Renminbi CNY (元) 4.3%

9  Hong Kong dollar HKD (HK$) 3.5%

10  New Zealand dollar NZD (NZ$) 2.1%

11  Swedish krona SEK (kr) 2.0%

12  South Korean won KRW (₩) 2.0%

13  Singapore dollar SGD (S$) 1.8%

14  Norwegian krone NOK (kr) 1.8%

15  Mexican peso MXN ($) 1.7%

16  Indian rupee INR (₹) 1.7%

17  Russian ruble RUB (₽) 1.1%

18  South African rand ZAR (R) 1.1%

19  Turkish lira TRY (₺) 1.1%

20  Brazilian real BRL (R$) 1.1%

21  New Taiwan dollar TWD (NT$) 0.9%

13
 FOREIGN EXCHANGE MARKET

22  Danish krone DKK (kr) 0.6%

23  Polish zloty PLN (zł) 0.6%

24  Thai baht THB (฿) 0.5%

25  Indonesian rupiah IDR (Rp) 0.4%

26  Hungarian forint HUF (Ft) 0.4%

27  Czech koruna CZK (Kč) 0.4%

28  Israeli new shekel ILS (₪) 0.3%

29  Chilean peso CLP (CLP$) 0.3%

30  Philippine peso PHP (₱) 0.3%

31  UAE dirham AED (‫إ‬.‫)د‬ 0.2%

32  Colombian peso COP (COL$) 0.2%

33  Saudi riyal SAR (‫)﷼‬ 0.2%

34  Malaysian ringgit MYR (RM) 0.1%

35  Romanian leu RON (L) 0.1%

Other 2.2%

Total 200.0%

14
 FOREIGN EXCHANGE MARKET

1.5 Types of trading

Fundamental trading is a method where a trader focuses on company-specific events to determine

which stock to buy and when to buy it. Trading on fundamentals is more closely associated with a buy-
and-hold strategy rather than short-term trading. There are, however, specific instances where trading on
fundamentals can generate substantial profits in a short period.

Different Types of Traders

Before we focus on fundamental trading, here's a review of the main types of equity trading:

 Scalping: A scalper is an individual who makes dozens or hundreds of trades per day in an

attempt to "scalp" a small profit from each trade by exploiting the bid-ask spread.
 Momentum Trading: Momentum traders seek stocks that are moving significantly in one
direction in high volume. These traders attempt to ride the momentum to the desired profit.
 Technical Trading: Technical traders focus on charts and graphs. They analyze lines on stock or
index graphs for signs of convergence or divergence that might indicate buy or sell signals.
 Fundamental Trading: Fundamentalists trade companies based on fundamental analysis, which
examines corporate events, particularly actual or anticipated earnings reports, stock splits,
reorganizations, or acquisitions.
 Swing Trading: Swing traders are fundamental traders who hold their positions longer than a
single day. Most fundamentalists are really swing trading since changes in corporate fundamentals
typically require several days or even weeks to produce a price movement sufficient for the trader
to claim a reasonable profit.

Scalping (trading)
Scalping is a very short-term trading style and despite its odd name, it's quite popular among professional
traders.

Scalping represents the shortest-term style of trading, even shorter than day trading, and got its name
because it attempts to skim many small profits off of a large number of trades throughout the trading day.
Scalpers believe that it's easier to catch and profit from small moves in stock prices rather than from large
moves. 

15
 FOREIGN EXCHANGE MARKET

Scalping is Technical Analysis

Scalpers are usually technical analysis traders, as opposed to fundamentals traders. Technical analysis

focuses on a security's past price movements, usually with the help of charts and other data analysis tools.
Traders use the historical price information to predict the security's future movements and set up their
trades. 

Fundamental analysis usually involves using a company's financial statements, discounted cash flow
modeling and other tools to assess a company's intrinsic value. Scalpers may trade on news or events that
drastically affect a company’s value immediately after its release. In some cases, they may also use short
term changes in fundamental ratios to scalp trades but typically they focus mostly on the technical charts.

Scalpers use technical analysis but within this style, can be either discretionary or system traders.
Discretionary scalpers will make each trading decision in real time (albeit very quickly), whereas system
scalpers follow a scalping system without making any individual trading decisions. Scalpers primarily use
the market's prices to make their trading decisions, but some scalpers also use one or more technical
indicators, such as moving averages, channel bands, and other chart patterns.

Trading Timeframes

Scalping chart timeframes and the amount of time that each trade is active are the shortest of all of the
trading styles. For example, a day trader might use a five-minute chart, and make four or five trades per
trading day, with each trade being active for thirty minutes.

In contrast, a scalper might use a five-second chart, where each price bar represents only five seconds of
trading, and make anywhere from 20 to 100 or more trades per day, with each trade being active for a few
seconds to a few minutes.

Styles and Techniques

As with any other style of trading, many different methods of scalping exist. The most well-known
scalping technique is using the market's time and sales to determine when and where to make trades.
Scalping using the time and sales is sometimes referred to as tape reading because the time and sales used
to be displayed on the old-fashioned ticker tape, known as the tape.

16
 FOREIGN EXCHANGE MARKET

Some scalping techniques are similar to other trading styles in that they use bar or candlestick charts, and
traders determine when and where to make trades using price patterns, support and resistance, and
technical indicator signals

The Trading Psychology

Scalping is most suitable for a specific type of trading personality. Scalpers must be very disciplined,
especially in the case of system scalpers, as they must be capable of following their trading system
precisely no matter what.

Scalpers must be able to make decisions without any hesitation, and without questioning their decisions
once they have been made. However, scalpers must also be flexible enough to recognize when a trade is
not proceeding as expected or hoped and take action to rectify the situation by exiting the trade.

To Be or Not To Be a Scalper?

If you are a position trader that uses daily charts and makes your trading decisions over the course of an
entire evening, you probably won't make a good scalper. However, if the thought of waiting several days
for your next trade drives you insane and you prefer quick trades, then perhaps scalping would be suitable
for you.

Scalping can appear easy because a scalper might make an entire day's profit within a few minutes.
However, in reality, scalping can be quite challenging because there is very little room for error. If you do
decide to try scalping, make sure that you do so by using a trading simulator, until you are consistently
profitable and no longer make any beginning mistakes, such as not exiting your trades when they move
against you.

 Momentum Trading
On paper, momentum investing seems less like an investing strategy and more like a knee-jerk reaction to
market information. The idea of selling losers and buying winners is seductive, but it flies in the face of
the tried and true Wall Street adage, "buy low, sell high."

The Father of Momentum Investing

Though not the first momentum investor, Richard Driehaus took the practice and made it into the strategy
he used to run his funds. His philosophy was that more money could be made by "buying high and selling
higher" than by buying underpriced stocks and waiting for the market to re-evaluate them.

17
 FOREIGN EXCHANGE MARKET

Driehaus believed in selling the losers and letting the winners ride while re-investing the money from the
losers in other stocks that were beginning to boil. Many of the techniques he used became the basics of
what is now called momentum investing.

Elements of Momentum Investing

Trading momentum markets require sophisticated risk management rules to address volatility,
overcrowding, and hidden traps that reduce profits. Market players routinely ignore these rules, blinded
by an overwhelming fear they’ll miss the rally or sell off while everyone else books windfall profits. The
rules can be broken down into five elements:

1. Selection, or what equities you choose

2. Risk revolve around timing in opening and closing the trades
3. Entry timing means getting into the trade early
4. Position management couples wide spreads and your holding period
5. Exit points require consistent charting

Tight Risk Control

The risk side of the equation must be addressed in detail, or the momentum strategy will fail. The pitfalls
of momentum trading include:

 Jumping into a position too soon, before a momentum move is confirmed.

 Closing the position too late, after saturation has been reached.
 Failing to keep eyes on the screen, missing changing trends, reversals or signs of news that take
the market by surprise.
 Keeping a position open overnight. Stocks are particularly susceptible to external factors
occurring after the close of that day's trading – these factors could cause radically different prices
and patterns the next day.
 Failing to act quickly to close a bad position, thereby riding the momentum train the wrong way
down the tracks.

Benefits of Momentum Investing

18
 FOREIGN EXCHANGE MARKET

Momentum investing can turn into large profits for the trader who has the right personality, can handle
the risks involved, and can dedicate themselves to sticking to the strategy.

Potential for High Profits Over a Short Period

There are lucrative profits to be made from momentum investing. For example, say you buy a stock that
grows from $50 to $75 based upon an overly positive analyst report. You then sell at a profit of 50%
before the stock price corrects itself. You've made a 50% return over the course of a few weeks or months
(not an annualized return). Over time, the profit potential increase using momentum investing can be
staggeringly large.

Leveraging the Market's Volatility to Your Advantage

The key to momentum investing is being able to capitalize on volatile market trends. Momentum
investors look for stocks to invest in that are on their way up and then sell them before the prices start to
go back down. For such investors, being ahead of the pack is a way to maximize return on
investment (ROI).

Leveraging the Emotional Decisions of Other Investors

According to Ben Carlson of the blog A Wealth of Common Sense, the entire idea of momentum
investing is built around chasing performance. However, momentum investors do this in a systematic way
that includes a specific buying point and selling point. Rather than be controlled by emotional responses
to stock prices like many investors are, momentum investors seek to take advantage of the changes in
stock prices caused by emotional investors.

Market Sensitive

19
 FOREIGN EXCHANGE MARKET

Momentum investing works best in a bull market because investors tend to herd a lot more. In a bear
market, the margin for profit on momentum investing shrinks in accordance with increased investor
caution.

Will It Work for You?

Momentum investing can work, but it may not be practical for all investors. As an individual
investor, practicing momentum investing will most likely lead to overall portfolio losses. When you
purchase a rising stock or sell a falling stock, you will be reacting to older news than the professionals at
the head of the momentum investing funds.

They will get out and leave you and other unlucky folks holding the bag. If you do manage to time it
right, you will still have to be more conscious of the fees from turnover and how much they will eat up
your returns. 

The Bottom Line

Momentum trading is not for everyone, but it can often lead to impressive returns if done properly. It
takes severe discipline to trade in this type of style because trades must be closed at the first sign of
weakness and the funds must be immediately placed into a different trade that is exhibiting strength.

Factors, such as commissions, have made this type of trading impractical for many traders, but this story
is slowly changing as low-cost brokers take on a more influential role in the trading careers of short-term
active traders. Buying high and selling higher is momentum traders' enviable goal, but this goal does not
come without its fair share of challenges.

Technical Trading
Technical trading is a broader style that is not necessarily limited to trading. Generally, a technician uses
historical patterns of trading data to predict what might happen to stocks in the future. This is the same
method practiced by economists and meteorologists: looking to the past for insight into the future.
However, we all know how poor forecasts can be.

The challenge of technical analysis is that there are literally hundreds of technical indicators available,
and there is no single indicator that is considered universally better as each particular indicator or group
of indicators, may be applicable only to specific circumstances. Some technical indicators may be useful
for certain industries, others only for stocks of a certain classification (for example, stocks within a
20
 FOREIGN EXCHANGE MARKET

certain range of liquidity or market capitalization). Because of the unique patterns that highly traded
stocks might exhibit throughout history, some indicators may be relevant only to certain individual
stocks.

Technical indicators, like momentum indicators, are not a silver bullet for deciding when to buy or sell.
They are poor predictors of precise timing, but they are good at indicating which stocks are candidates for
further analysis with such detailed data as the Level 2 screen. As such, technical analysis can be viewed
as a starting point—the historical patterns do not necessarily translate into an exact picture of future
performance.

Instead of trying to provide an exhaustive study of all of the indicators available to the technical trader,
we discuss the most common groupings and provide a general introduction to each. This discussion is
limited to indicators applicable to individual stocks—there are many indicators that might be useful to
predict an index or industry group.

Common Groups of Technical Indicators:

 Relative Strength Index (RSI): This measures a stock's recent performance in relation to its
historical strength by comparing the number and magnitude of recent and historical up and down
closes. If the RSI rises above 80, this may indicate an overbought condition, which is a sell signal.
Below 20, the RSI may indicate an oversold stock, which is a buy signal.
 Range Trading:  A series of high, low, and closing prices are plotted on a graph for a certain
period of time, and support and resistance lines are drawn across the bottom and top of the range.
A breakout occurs when the price sustains a movement, even for a period or two, above or below
the range.
 Pattern Analysis: This may be the form of technical analysis that is easiest to understand. The
same price charts discussed above are analyzed for specific patterns that have historically
appeared in the same stock or for common patterns that have been seen in many stocks over time.
The most commonly observed patterns are head-and-shoulders patterns, triangle-up or triangle-
down patterns, rounded tops or rounded bottoms, cup-and-handle formation, and so on.
 Trend Analysis: Highly complex and mathematical trend analysis looks at short and long-term
trends and tries to identify crossovers, where prices cross over their long-term averages. The long-
term averages are referred to as moving averages, where a price range is smoothed for a period of
time by averaging a series of data points and plotting the smoothed line against the actual price

21
 FOREIGN EXCHANGE MARKET

line of the stock. The moving average convergence divergence (MACD) is used to identify
crossovers, divergence, and convergence, and overbought and oversold conditions.
 Gap Analysis: A gap occurs when the opening price of a stock is significantly higher or lower
than its closing price the previous day, possibly because of company news released overnight or
some other factor. The gap trader is concerned with the performance of the stock above or below
its open, which may indicate further movement in either direction. In this sense, the trader's
decisions may be closer in style to that of the momentum trader than the technical analyst.

Fundamental Trading
Most equity investors are aware of the most common financial data used in the fundamental analysis
including earnings per share (EPS), revenue, and cash flow. These quantitative factors include any figures
found on a company's earnings report, cash flow statement, or balance sheet. They can also include the
results of financial ratios such as return-on-equity (ROE) and debt to equity (D/E). Fundamental traders
may use such quantitative data to identify trading opportunities if, for example, a company issues
earnings results that catch the market by surprise.

Swing trading

Swing trading has been described as a kind of fundamental trading in which positions are held for longer
than a single day. Most fundamentalists are swing traders since changes in corporate fundamentals
generally require several days or even a week to cause sufficient price movement to render a reasonable
profit.

But this description of swing trading is a simplification. In reality, swing trading sits in the middle of the
continuum between day trading to trend trading. A day trader will hold a stock anywhere from a few
seconds to a few hours but never more than a day; a trend trader examines the long-term fundamental
trends of a stock or index and may hold the stock for a few weeks or months. Swing traders hold a
particular stock for a period of time, generally a few days to two or three weeks, which is between those
extremes, and they will trade the stock on the basis of its intra-week or intra-month oscillations between
optimism and pessimism.

22
 FOREIGN EXCHANGE MARKET

KEY TAKEAWAYS
 Most fundamentalists are swing traders since changes in corporate fundamentals generally require
several days or even a week to cause sufficient price movement to render a reasonable profit.
 Swing trading sits in the middle of the continuum between day trading to trend trading.
 The first key to successful swing trading is picking the right stocks.

1.6 Advantages and disadvantages of a forex trading

Advantages

One of the major advantages of forex trading is that it has low costs, so the trader eliminates the potential
overheads associated with equity or other securities. In forex trading, traders do not have to pay
commission or brokerage fees. Any trader who has learned how to trade CFDs will know that CFD
brokers, along with those who give forex advice, make their money from spreads between currency pairs.

Forex trading is also advantageous for part-time and full-time traders in subtly different ways. Part-time
traders can log into any live trading market and start their dealings whenever they find a few minutes or
hours to spare. It does not matter what time it is – there will always be a live market to trade.

Likewise, full-time traders can take advantage of the 24-hour trading window and use it to their benefit.
When it’s daytime in one part of the world, it will be night in another area, allowing traders to engage at
all hours simply by switching to the live markets that will be open at the time.

Thanks to the large numbers of people now involved in forex trading, forex markets are highly liquid,
which means forex traders do not need to worry about closing trades. At any time, they can always trade

23
 FOREIGN EXCHANGE MARKET

different currencies without much hassle. The liquidity of the forex market also means that traders benefit
from efficient pricing as the lack of high price deviations eliminates price anomalies and price
manipulation.

The forex market is also devoid of regulators. Rarely do central governments interfere in forex trading,
which helps reduce unexpected market developments. It also allows traders to take advantage of short
positions, which is banned in certain security classes of other markets, and diminish costs. In addition,
there aren’t any insiders in forex trading, so traders do not need to worry about losing large sums of
money owing to insider trading, as is the case with equity markets.

Disadvantages

In some ways, lacking a central market benefits forex markets advantageously, but it can also work
against them. The deregulated nature of forex markets means that traders operate in partnership with
brokers. On some occasions, traders may not be furnished with all the details by the broker, especially in
the cases of strained relationships. This means there is a possibility that the trader will lose money from
unfulfilled trade orders. Forex markets are based on global economics and global politics, two factors that
are very difficult to predict and analyze. Therefore, it is difficult for the forex trader to come up with
reliable information on what to trade on and what to avoid. The fact that forex markets are based on
global politics also leads to high volatility as any major developments can have a strong impact on forex
markets.

Forex trading comes with high leverage, hence high risk. On average, the leverage for the forex market is
50-1. This means that for every $1 that you trade, you stand to gain as much as $50. This is a good thing
if you happen to gain the money, but if the opposite happens and you lose $50, the whole forex trading
adventure could turn into a loss-making nightmare.

24
 FOREIGN EXCHANGE MARKET

Different concept in foreign exchange market

oreign exchange market is one of the important components of any economy today. It involves currency
exchange, remittances, import & export, investments etc. This article gives an idea about what is foreign
exchange & foreign exchange market. It also throws light on basic terminology involved in foreign
exchange transactions. In this era of globalization and highly interconnected economies, foreign exchange
market has become very prominent. In fact, it has a huge role to play in a developing economy like India.
Financial institutions like banks are constantly looking for professionals well-versed in foreign exchange
market as the volume of transactions & the participation is increasing at a rapid rate. In this article we will
try to get the basics of foreign exchange.

Forex participants
We mentioned the word participants in the definition of forex market. Who are the participants actually?
The participants are the entities who seek foreign exchange for their needs. They can be banks, investors,
or any individual etc. Let's go through the different types of participants in the forex market.
Central & commercial banks – A central Bank, like RBI, make use of forex market to manage their
reserves and take corrective steps whenever home currency (say Rupee) faces abrupt devaluation.
Commercial banks, on the other hand, need forex market for the exchange of currencies for their clients.
They also use it for the purpose of investments.
Investment Banks – As their name implies, investment banks primarily use forex market for the purpose
of investment.
Broker – A broker, like the one in the stock market, works as a middleman between two participants of
forex market.
Individuals – Normal people who seek forex market for different purposes like investment, business,
travel etc.

1.7 Basic terminology related to foreign exchange

Exchange Rate

An exchange rate refers to the rate at which one currency can be exchanged with another. So if someone
says that exchange rate between USD and Rupee is 64 that means one USD can be exchanged for INR 64.
We understand the exchange rate by looking at the quotes.

25
 FOREIGN EXCHANGE MARKET

Direct & Indirect Quotes

A quote is a way of expressing one currency in certain units of the other currency. So 1 USD = Rs. 64
would mean 1 unit of USD is equivalent to 64 units of Indian Rupee. The quotes can be given in two
ways – direct and indirect. Under direct method, local currency or the home currency is variable. For
instance, the quote we mentioned above is a direct quote as we can get the value of home currency against
USD directly. Direct quote is also known as Home currency.

In indirect quote, the foreign currency is variable while home currency is fixed. For instance, Rs. 128 = 2
USD is an indirect quote. Generally direct quotes are used across the globe with few notable exceptions

Cross Rate Mechanism

Sometimes, in a particular market, we might not get a quote between two currencies and we need to
exchange them. In such a case we make use of cross rate mechanism. Under this, we make use of a
currency having quotes with both of the above currencies. The most common example is that of USD. So
we will obtain direct quotes involving USD for both the currencies and by simply crossing them out using
plain mathematics, we can get the desired quote.

Spot Rate
Most of the forex transactions are not necessarily settled on the same day. They may be settled in future
also. So, depending on the settlement time, the exchange also varies. Generally, the settlement of forex
transactions takes place on the second working day. The rate then applied is called Spot rate. Even though
the word 'spot' indicates a quick settlement, the actual transaction is completed only on the second
working day.

Forward Rate
If settlement of funds takes place after second working day i.e. spot date, then the rate applied is called
forward rate. This rate is derived from the spot rate.

Ready/Cash
When the settlement takes place on the same day of the deal, it is called Ready or Cash.

Tom

26
 FOREIGN EXCHANGE MARKET

If settlement takes place on next working day of the deal, it is referred to as Tom.
Premium & Discount
If the forward rate is more than spot rate of a currency, then that currency is said to be at premium. On the
other hand, if the forward rate is less than spot rate, the currency is said to be at discount. This
relationship can be expressed as
Forward Rate = Spot rate +Premium ( or – discount)
Bid & Offered rate
They are nothing but buying & selling rates of currencies. So a bid rate refers to the rate at which a
financial institution is ready to buy currency while offer rate is the rate at which it is ready to sell
currency.
Authorized Dealers
The authorized dealers are the entities who are authorized to deal in foreign exchange. They are basically
financial institutions who have been allowed to undertake transactions pertaining to forex by RBI. There
was a change in the definition of the authorized dealers in the year 2005. As per new definition, these
entities are called Authorized Persons. Moreover, they have been divided into three different categories.
Authorised Person – Category I refer to financial institutions that are authorized to handle all types of
forex transactions.
Authorised Person – Category II refers to entities who can deal with buying/selling of foreign currency,
remittances, travellers cheques etc.
Authorised Person – Category III refers to entities who are authorized for purchasing of foreign
currency and traveller’s cheques only.

World’s Major Currencies

COUNTRY SYMBOL COUNTRY SYMBOL

United States USD Switzerland CHF

Eurozone EUR Canada CAD

Japan JPY Australia AUD

27
 FOREIGN EXCHANGE MARKET

COUNTRY SYMBOL COUNTRY SYMBOL

Great Britain GBP New Zealand NZD

28
 FOREIGN EXCHANGE MARKET

Chapter 2 – Research Methodology

2.1 Introduction

2.2 Research Methodology

2.3 Statement of the Problem

2.4 Objectives of Study

2.5 Significance of Study

2.6 Sample Design

2.7 Sample Size

2.8 Sample Selection Techniques

2.9 Data Collection Tools

29
 FOREIGN EXCHANGE MARKET

2.10 Sources of Data and Form of Data

L

2.11 Statistical Tools Applied

2.12 Hypothesis for the Test

2.13 Limitation of Study

2.14 Future Scope

30
 FOREIGN EXCHANGE MARKET

 With the help of this research, researcher can find out other variable factors (political, economic,
internal war and any specific events) through which exchange rate fluctuated.

31
 FOREIGN EXCHANGE MARKET

CHAPTER 3- LITERATURE REVIEW

3.1 Introduction
Currency exposure management being important in the context of global trade and investments,
voluminous literature on the subject is available worldwide. Developed economies account for a big
chunk of empirical
literature on currency exposure management for obvious reasons. Some literature is available relating to
emerging and developing economies also, which may be of greater help to the present research. To
facilitate a better review of literature, studies conducted abroad are presented first followed by studies
conducted in India. The following is an exhaustive list of investigations conducted in foreign countries.

Empirical Studies Conducted Abroad

Belk and Glaum (1990) report the results of an empirical study undertaken during 1988 on how UK
multinational corporations try to manage their foreign exchange exposure. The study was based upon
research conducted in 17 major UK industrial companies. Majority of the respondents feels transaction
exposure management was seen a centerpiece of their foreign exchange risk management. Despite the
financial literature demonstrating that accounting exposure is not a useful concept for foreign exchange
risk management, the study found that a majority of companies were inclined to manage their accounting
exposure actively. Further surveyed MNC’s showed a lower degree of centralization and the majority of
respondents described their companies as ‘totally risk averse’.

Wai (1993) conducted a survey of 61 listed companies in Singapore with an objective to investigate the
general practice adopted in foreign exchange risk management. Investigation revealed that foreign
exchange risk management is an integral part of the operations of many companies in Singapore. The
results of his survey show that a majority of the companies, accounting for 75 percent,adopt a centralized
foreign exchange management system; 85 percent of the respondents feel that they operate their treasuries
as a cost centre; the survey results show that some of these companies are prepared to take risks by
leaving
some of their exposure un-hedged or by taking position in currencies. He reports that 92 percent of
Singapore companies hedge their foreign exchange exposure on a case-by-case basis; only a negligible
proportion goes for cent percent exposure cover. Survey finds that short-dated forward contracts are the
most

32
 FOREIGN EXCHANGE MARKET

widely used hedging techniques of Singapore companies; other derivative instruments like futures,
options and swaps are not popular amongst the said companies.

Batten, Mellor and Wan (1993) conducted industry-wide, cross-sectional study on foreign exchange
risk management practice and product usage of large Australian-based firms. Results are discussed from
an empirical field study of seventy-two firms operating in Australia. Study finds that all firms hedge
foreign
exchange exposure. Survey finds that 61 percent of the Australian firms manage transaction exposure
only, 8 percent manage transaction and translation and 17 percent manage all three exposures (other 14%
have not given their response). They found that Australian firms were using both physical and synthetic
products
to offset the cash flows generated by the firm's foreign operations and trade. The synthetic products used
by these sample firms included futures, options, swaps and option products. The physical products
included spot, forwards, forwardforwards and short and long-term physical swaps. The survey suggested
extensive use of synthetics by the corporate sector with 35 firms (49 percent) using both physical and
synthetic products, four firms (6 percent) using only synthetic products and the remaining 33 (46 percent)
using physical products exclusively.

Bodnar, Hayt and Marston (1995) conducted a survey of derivatives usage by US non-financial firms.
Out of 350 firms took part in the survey, 176 from the manufacturing sector, 77 from the primary
products sector which includes agriculture, mining, and energy as well as utilities, and 97 from the service
sector. The study found that 76 percent of all derivatives users in their survey manage foreign exchange
risk using some foreign currency derivative or the other. This percentage makes foreign currency
derivatives the most commonly used class of derivatives among the surveyed respondents. Among the
types of foreign currency derivatives the firms use, the forward contract is the most popular choice. More
than 75 percent of firms rank the forward contract as one of their top three choices among foreign
currency derivative instruments with over 50 percent ranking it as their first choice. OTC options are also
a popular foreign currency derivative instrument, with about 50 percent of the firms choosing this as one
of their top choices. Among the remaining instruments, swaps and futures are the most popular.

Jesswein, Kwok and Floks (1995) analyses and documents the extent of awareness and use of currency
risk managements products by US Corporations. Based on the survey of Fortune 500 Companies, they
concludes

33
 FOREIGN EXCHANGE MARKET

that traditional forward contract is the most popular derivative product with 93% using the same followed
by currency swaps (53%) and OTC Options (49%). Many recent hybrid products were least preferred by
respondents.

Milan (1996) provides empirical evidence on the determinants of corporate hedging decisions. In his
paper he examines the evidence in the light of mandated financial reporting requirements in general and
constraints placed on anticipatory hedging in particular. Data on hedging is obtained from the 1992
annual reports for a sample of 3022 US firms. Out of 771 firms classified as hedgers, 543 firms disclose
information in their annual reports on their hedging activities; the remaining 228 firms report use of
derivates but no information on hedging activities is provided. Study finds robust evidence that larger
firms are more likely to hedge.

Grant and Marshall (1997) conducted a survey of large UK companies to ascertain their usage of
derivatives. They examined the extent of derivatives usage, the reasons behind their usage, the perceived
risk associated with derivatives, the control mechanism to monitor the derivatives used and the reporting
practices which governed the usage of derivatives. The results of the survey indicated widespread usage
of derivatives like swaps, forwards and options. The primary reason for their use was to manage interest
rate and currency risks. There was a rather limited but growing use of derivatives to manage commodity
and equity risks. Treasurers of the sampling firms reported that they were somewhat cautious about more
exotic types of derivatives, primarily because of concern over the illiquidity of the underlying market for
these
derivatives. Interestingly, they revealed that they viewed control and the nature of their counterparty as
the main risk in using derivatives. Finally, the use of derivatives was accompanied by significant control
mechanism within the companies and treasurers were using sophisticated methods to quantify their
exposure to derivatives before they were reported at board level.

Berkman, Bradbury and Magan (1997) presents the result of survey of derivatives use by 79 New
Zealand firms and compare the use of derivatives between non-financial firms in New Zealand and the
United States. Although New Zealand is a small open economy with an under-developed financial market
compared to US, across all firm sizes, relatively more NZ firms use derivatives. This greater use of
derivatives despite higher transaction costs reflects the relatively high exposure of NZ firms. The study
finds that 68.6% derivative users felt that USD was the main currency to which the firm was exposed and
29% felt it was Australian Dollar. 62% of respondents mentioned reducing the fluctuations in earnings is

34
 FOREIGN EXCHANGE MARKET

the major objective behind the usage of derivatives. Study also find that NZ firms report more frequently
on their derivative positions to their boards of directors than US firms. However, the types of transactions
that derivatives are being used to hedge and the objectives of risk management are very similar between
NZ and US firms.

Makar and Huffman (1997) examined how foreign exchange derivatives (FXDs) were used by 64 U.S.
multinationals facing potentially significant economic exposure, to manage currency risk. The results
indicated that FXD use was positively associated with foreign currency exposure. Moreover, there was
evidence that these results were not sensitive to industry membership or other differences across firms
and reporting years. Evidence of the use of multiple hedging techniques was also provided.

Bodnar, Martson and Hayt’s (1998) conducted a Wharton survey of financial risk management by 399
US non-financial firms. The results show that foreign currency derivatives are the most commonly used
class of derivatives with 83 percent of derivatives-using firms utilizing them. They asked firms to indicate
their percentage of total revenues and costs in foreign currency. A reasonable percentage of firms
reported neither foreign currency revenue nor foreign currency costs. On the other hand, 40 percent of the
firms reported foreign currency revenues of 20 percent or more of total revenues, while 36 percent of the
firms reported foreign currency expenses of 20 percent or more of total expenses. So, many firms in the
survey had significant foreign currency exposure. The survey showed that the most frequently cited
motivation for
transacting in foreign currency derivatives markets was for hedging near-term, directly observable
exposures. The most commonly hedged exposures were onbalance- sheet commitments (89 percent
hedged frequently or sometimes), transactions anticipated within one year (85 percent hedged frequently
or sometimes), and foreign repatriations (78 percent hedged frequently or sometimes). Partial hedging
appeared to be a normal practice of these firms. Results reveal that the majority of firms hedge less than
25 percent of their perceived exposure. This suggests that reducing the exposure is preferred over
completely eliminating them. Study reveals that options are less frequently used than forwards.
Furthermore they find that options are mainly used in long-term exposures. Firms avoid using options
either because of the cost they incur in
order to get the options or because they find another instrument that is better suited for the given
exposure.

35
 FOREIGN EXCHANGE MARKET

Howton and Perfect (1998) examined use of derivatives in samples of 451 Fortune 500 / S&P 500 (FSP)
firms and 461 randomly selected firms operating in USA. The study was based purely on the secondary
data available in the company’s annual report. They found that over 61 percent of the FSP firms and 36
percent of the random firms used derivatives. In the two samples, forwards and futures were the most-
often used currency contracts. The results are consistent with the argument that fewer firms in the random
sample are using currency derivatives as compared to FSP firms and for those random sample firms, the
main consideration is exposure to currency movements. For the FSP sample derivatives use is directly
related to financial distress and external financing costs, tax considerations, and currency-risk exposure,
and inversely
related to hedging substitutes. The results for the random sample differed considerably from previous
studies. Derivatives use in the random sample is unrelated to most of the proxies for the theoretical
hedging determinants.

Marshall (1999) conducted a simultaneously survey of the foreign exchange risk management practices
of large UK, USA and Asia Pacific multinational companies (MNCs). He investigated whether foreign
exchange risk management practices vary internationally. From 179 (30%) usable responses it
is shown that there are statistically significant regional differences in the importance and objectives of
foreign exchange risk management, the emphasis on translation and economic exposures, the
internal/external techniques used in managing foreign exchange risk and the policies in dealing with
economic exposures. In general, UK and USA MNCs have similar policies, with a few notable
exceptions; however, Asia Pacific MNCs display significant differences. To control for regional
variations in the characteristics of respondents the results are also compared by size, percentage of
overseas business and industry sector. It was found that either the size of the respondent or the industry
sector could also explain the emphasis on translation and economic exposure and use of external hedging
instruments.

Kedia and Mozumdar (1999) examine the role of foreign currency denominated debt in firms' risk
management activities. In a sample of large US firms, they found a strong relationship between the
aggregate foreign exchange exposure and foreign currency denominated debt. This relationship between
exposure and foreign currency denominated debt also holds at the individual currency level. Firms' choice
of denominating debt in Australian Dollar, Canadian Dollar, French Franc, German Mark, Italian Lira and
British Pound is related to their exposure in these currencies. However, firms' choice of denominating
debt in Swiss Franc and Japanese Yen is influenced not by exposure in these currencies, but by the high

36
 FOREIGN EXCHANGE MARKET

liquidity offered by the debt markets in these currencies. The evidence also suggests that creditors’ rights
and information asymmetries influence the choice of the currency of debt. However, the authors find no
evidence in favour of tax arbitrage-induced currency preferences in the denomination of debt.

Lodder and Pichler (2000) conducted a survey of risk management practices of Swiss Industrial
corporations. Study analysed whether Swiss firms are conscious of their currency exposure. They found
that less than 40 percent of the firms are able to quantify their risk. They are able to come out with two
major reasons to explain why firms do not measure their foreign currency exposure - it is difficult to
measure the risk and firms believe their exposure is small. Study reveals that guaranteeing cash flows,
reducing financing cost, simplifying planning, preventing losses and reducing taxes are the main reasons
for managing currency risk. They found that most often transaction exposure is hedged by Swiss
companies. Translation and economic exposures appear to be less important from their perspective. It is
observed that firms often manage economic exposure by lending and borrowing in foreign currencies.
They cite the following
reason for not hedging economic exposure: firms are unable to anticipate the size and the currency of
future cash flows with confidence; the firms already hedge transaction exposure and hence believe that in
the long term currency fluctuations offset each other. Surprisingly, the cost of hedging economic
exposure is not regarded as an obstacle.

Glaum (2000) conducted a survey of foreign exchange risk management by 74 large German non-
financial corporations. The study concludes that the majority of the firms are concerned about managing
their transaction exposure. Most firms adopted a selective hedging strategy based on exchange rate
forecasts.
Only a small minority of firms did not hedge foreign exchange risk at all, and only few companies hedge
their transaction exposure completely. Looking in more detail at the management of the firms' exposure to
the US-dollar, the survey found that only 16% of the firms were fully edged. The majority of firms had
realized hedge ratios between 50 and 99%. There were numerous German non financial firms which were
concerned about managing their accounting exposure and some firms are actively managing it. This is in
contrast to the exposure concept supported by academic literature which holds that economic exposure is
of little importance in practice. The most interesting finding from an academic point of view, however, is
the widespread use of exchange rate forecasts and of exchange risk management strategies based on
forecasts (selective hedging). By adopting such strategies, the managers indicate that they do not believe
that the foreign exchange markets are information efficient and they are able to beat the market with their

37
 FOREIGN EXCHANGE MARKET

own forecasts. The academic literature, on the other hand, emphasizes that it is very difficult indeed to
make systematically successful exchange rate forecasts.

Baba and Fukao (2000) explore a new aspect of currency exposure of Japanese firms with overseas
operations. For the purpose of the study authors chose the firms classified in electric and precision
machinery listed on the Tokyo Stock Exchange. This was because they are generally highly dependent on
international operations such as exports, imports of primary materials, and overseas production. The
number of the sample firms turned out to be 84, of which 74 firms belong to the electric machinery
industry and the remaining 10 firms belong to the precision machinery industry. Empirical results show
that in response to JPY’s depreciation (appreciation), the values of the firms that are dependent on
overseas production declined (rose) after controlling for the effects via the dependency on exports and
imported primary materials. The result is consistent with the prediction of the static version of currency
risk exposure model.

Christie and Marshall (2001) explore the impact of the introduction of Euro on foreign exchange risk
management of UK’s multinational companies. The study was based on primary and secondary data of 49
large UK Multinational companies. The study has shown that Euro will undoubtedly affects the foreign
exchange risk management in many UK MNCs, despite the U K governments’ decision not participate in
EMU. The survey reveals that 55 percent of respondents believe that Euro has decreased their exposure to
foreign exchange risk. Theoretically, it could be expected that the reduction in the currency risk results in
reduced hedging, but survey indicates that majority of respondent’s hedging remains unchanged. Only 39
percent of the respondents replied that they would alter their foreign exchange risk management policy
and hedge less as a result of the Euro. It was found that the methods of internal and external hedging
unchanged by Euro.

Carter, Pantzalis and Simkins (2001) investigates the impact of firm wide risk management practices
on the currency exposure of 208 U.S. multinational corporations (MNC) based on various source of
secondary data over the period 1994 to 1998. Firm wide risk management is referred to as the coordinated
use of both financial hedges, such as currency derivatives, and operational hedges, described by the
structure of a firm’s MNC foreign subsidiary network. Study found that the use of currency derivatives,
particularly forward contracts, is associated with reduced levels of foreign-exchange exposure. To
conclude, the survey results strongly support the view that MNCs hedging in a coordinated manner can

38
 FOREIGN EXCHANGE MARKET

significantly reduce exposure to currency risk. These results strongly suggest that operational and
financial hedges are complementary risk
management strategies.
Popov and Stutzmann (2003) investigate how two Swiss companies, Kudulski and Logitech manage
their foreign exchange risk. They find that transaction exposure is the most managed foreign exchange
exposure, but translation and economic exposures are not well identified and managed mainly because
firms believe it is unnecessary or too complex. Study also reports that whenever possible netting is used
by both the companies as it has no cost. Forward is the main external hedging instrument, as options are
expensive tool to manage foreign exchange risk, both Kudulski and Logitech use it rarely. Finally, firms
hedge their exposure but never fully due to the high cost of hedging.

Jonuska and Samenaite (2003) based on the response of 18 companies, studies the state of currency
exposure management in Lithuanian companies. The study focuses on the characteristics of currency
exposure management in exporting companies and the problem encountered while using currency
derivatives. Most of the companies in Lithuanian are aware of the currency exposure they face especially
after pegging their home currency Litas to Euro. Most of the companies try to manage currency exposure
by employing internal methods of hedging. Study show that currency derivatives are not popular with
Lithuanian companies. The hindrance in usage of derivatives is the relatively high cost, lack of managers’
knowledge, mistrust in bank and complicated accounting procedure. Those respondent companies who
use derivatives, mostly dependent on forward contract. Majority of derivative user felt that they are not
willing to pay option premium, since they consider this derivative to be more complex to apply in risk
management. Dairy, oil and chemical industries are among the most highly exposed to US dollar
fluctuations, yet the specifics of those industries and financial markets make hedging non-beneficial.
Survey results reveal that the cost of hedging indeed exceeds the benefit.

Alkeback, Pramborg and Hagelin (2003) analyse Swedish non-financial firms' use of derivatives in
2003 and compare the results with results from an earlier study which investigated Swedish firms in 1996.
The results show, among other things, that: 59 percent of the Swedish firms used derivatives in 2003
compared

39
 FOREIGN EXCHANGE MARKET

to 52 percent in 1996; the use of derivatives for hedging the balance sheet among Swedish firms in 2003
is higher than that for other countries but lower than that for Swedish firms in 1996 suggesting that
Swedish firms conform to international practice; and the issue of greatest concern to Swedish firms in
1996, viz., lack of knowledge about derivatives within the firm, no longer exists in 2003.

Pramborg (2004) compares the hedging practices of Swedish and Korean nonfinancial firms. Analysis is
based upon the response from 163 companies which includes 60 from Korea and 103 from Sweden. The
findings suggest similarities between firms in the two countries, with notable exceptions. The aim of
hedging
activity differed between the countries, Korean firms being more likely to focus on minimizing
fluctuations of cash flows, while Swedish firms favored minimizing fluctuations of earnings or protecting
the appearance of the balance sheet. The proportion of firms that used derivatives was significantly lower
in the Korean
than in the Swedish sample. This could not be captured by firm characteristics such as foreign exchange
exposure, size, liquidity, or leverage. This may be due to the higher fixed costs incurred by Korean firms
initiating derivatives programs. These higher costs could result from the relative immaturity of Korean
derivatives markets, and, perhaps more importantly, from Korean authorities’ heavy regulation of OTC
derivatives use. Korean firms relied to a larger extent on alternative hedging methods, suggesting that the
decision to hedge was not country specific but rather driven by firm-specific variables, such as the level
of
foreign exchange exposure and firm size. It was further argued that Korean firms were less rigorous in
monitoring their risk positions than Swedish firms. Finally, a large proportion of firms in both countries
used a profit-based approach to evaluate the risk management function

Hegelin and Pramborg (2005) investigate Swedish firms' use of financial hedges against foreign
exchange exposure. Their survey data lets them distinguish between hedging translation exposure and
transaction exposure. Survey responses indicate that over 50 percent of the sample firms employ financial
hedges and that transaction exposure is more frequently hedged than translation exposure. The likelihood
of using financial hedges increases with firm size and exposure. Importantly, the existence of loan
covenants accounts for translation exposure hedging, suggesting that firms hedge translation exposure to
avoid violating loan covenants.

40
 FOREIGN EXCHANGE MARKET

Schena (2005) explores the sensitivity of firm-level Chinese stock returns to changes in a trade-weighted
index of the RMB, as well as against the currencies of China’s major trading partners, over the five-year
period from 1999 to 2003. In assessing the exposure and management of foreign exchange risk by
Chineselisted companies, the analysis suggests that despite the currency peg, internationally oriented
Chinese firms have experienced significant foreign exchange exposure. Study finds that approximately
34% of sample displays a significant exposure to changes in the value of one or more of the currencies of
China’s major trading partners against which the RMB is not pegged. Indeed, the exposure is particularly
acute against the yen. Furthermore, there was no empirical evidence to suggest that Chinese firms are
engaged in hedging activities.

Chan-Lau (2005) assesses foreign exchange exposure in the corporate sector in Chile and opines that
foreign exchange exposure in Chile is lower than other countries in the region and similar to that observed
in small industrialized countries. The most exposed sector is the financial sector. However, this is not a
major source of systemic risk since a recent assessment of financial sector in Chile suggests that banks
can withstand severe exchange and interest rate shocks successfully. Managing currency exchange risk
has been facilitated by a well-functioning forward market in Chile

Abor (2005) reports on the foreign exchange risk management practices among Ghanaian firms involved
in international trade. The results indicate that close to one-half of the firms do not have any well-
functioning risk-management system. The study found that among Ghanaian firms foreign exchange risk
is mainly
managed by adjusting prices to reflect changes in import prices resulting from currency fluctuation and
also by buying and saving foreign currency in advance. The main problems the firms face are the frequent
appreciation of foreign currencies against the local currency and the difficulty in retaining local customers
because of the high cost of imported inputs, which tend to affect the prices of the final products sold
locally. The results also show that Ghana’s firms involved in international trade exhibit a low level use of
hedging techniques.

Yazid and Muda (2006) examines the extent of foreign exchange risk management among Malaysian
multinationals and investigates the purpose of managing foreign exchange risks, the types of risks
managed and the extent of management control and documentation of the foreign exchange risk

41
 FOREIGN EXCHANGE MARKET

management. The study which was based on response from 54 MNCs, indicate that Malaysian
multinationals are involved in foreign exchange risk management primarily because they sought to
minimize the losses on operational cash flows which are affected by currency volatility. Another finding
of the study is that the majority of multinationals centralized their risk management activities and at the
same time imposed greater control by frequent reporting on derivative activities. It is likely that huge
financial losses related to derivative trading in the past led to top management being extra cautious.
Similarly study proves that Malaysian multinationals focused on managing short term transactions
exposure rather than other exposures.

Davies, Eckberg and Marshall (2006) examines foreign exchange hedging by Norwegian exporting
firms to provide empirical evidence on the determinants of the hedging decision. The paper contributes to
prior studies by, first, focusing on exporters to ensure that the companies in the sample have foreign
exchange
exposure, thereby allowing a more rigorous test of the theoretical determinants of hedging, and, secondly,
in contrast to most previous studies that have focused on foreign exchange external hedging instruments,
the use of both internal and external instruments is examined. The firm size, extent of internationalization
and
liquidity--are found to be related to the decision to hedge foreign exchange risk. Unlike empirical studies
for other countries the evidence for Norwegian firms does not support the hypothesis that the avoidance
of financial distress and the need to resort to external capital markets is a significant determinant of the
hedging decision. Whilst the evidence suggests that country-specific factors may play a role in
determining the use of foreign exchange hedging, it does not imply that the different policies adopted are
necessarily inconsistent with the firm value maximization hypothesis.

Salifu, Osei and Adjasi (2007) examined the foreign exchange exposure of listed companies on the
Ghana Stock Exchange over the period January 1999 to December 2004. The study was based on the
secondary data of 20 listed companies. The study found that, all the major currencies of international
transaction of the country are sources of foreign exchange risk to listed firms on the GSE. The US dollar
turned out to be the most dominant source of exchange rate risk at both the firm and sector levels. Most
firms had negative exposure coefficients and this suggests that, the majority of the listed firms could
experience an adverse valuation effect when the local currency (cedi) depreciates substantially against
other foreign currencies and benefit when the cedi strengthens in value relative to these currencies. About
55 per cent of firms in the sample have a statistically significant exposure to the US dollar while 35

42
 FOREIGN EXCHANGE MARKET

percent are statistically exposed to the UK pound sterling. Sector specific exposure results show that the
manufacturing and retail sectors are significantly exposed to the US dollar exchange rate risk. The
financial sector did not show any risk exposure to any of the international currencies. The most dominant
source of exchange rate risk exposure is the US dollar. Study revealed that, though there are a number of
techniques such as balance sheet hedging, use of derivatives, leading and lagging amongst others
available to manage foreign exchange risk in most developed countries, these measures tend to be rather
too sophisticated and difficult to implement in developing countries like Ghana with undeveloped
financial systems. Study concludes that, given the degree of exposure revealed, corporate managers and
investors in Ghana should endeavor to apply a combination of
simple tools such as the use of forward contracts and swaps to supplement price adjustments and
investment in foreign currency in order to minimize their exposure to exchange risk. Despite the short-
comings of the financial system in terms of availability of tools for managing foreign exchange risk
exposure, instruments are still available to manage the risk exposure.

Faseruk and Mishra (2008) examine the impact of US dollar exchange rate risk on the value of
Canadian non-financial firms. The sample includes all nonfinancial Canadian firms with sales over $100
million. The study segregates firms into hedging and non-hedging groups and applies statistical
techniques to test if
hedging enhances value. A total of 194 firms were selected for the study which was carried on the basis
of secondary data in the form of annual reports. The paper has two major contributions. First, this is the
first study that examines the US dollar risk management by Canadian firms. Second, it documents that it
is
important to hedge US dollar risk for the firms that have US exports. Firms are better off by
implementing both operational and financial hedging of US dollar risk. As expected, Canadian firms that
have higher levels of US sales tend to use derivatives more often and tend to have higher levels of US$
exposure. However, firms with both US sales and US assets tend not to use financial hedging as often.
The US assets provide some sort of natural operational hedging for US sales of Canadian firms. Firms
that have at least one US subsidiary (or reported assets) and that use financial instruments to hedge US
dollar risk tend to have

43
 FOREIGN EXCHANGE MARKET

higher values than other firms. Hence, the use of operational hedging in conjunction with financial
hedging of US$ risk by Canadian firms is value enhancing. Based on the study of currency exposure
management 100 Malaysian manufacturers

Yazid, Hussain and Razai (2008) reports that majority of Malaysian manufacturers (55%) are not
involved in management of foreign exchange exposure. The study shows that considerable number of
manufacturers totaling to 46% are not involved in managing currency exposure due to insignificant
exposure. On analysis of annual reports of the respondents, it was found that total of 20% of
manufacturers who were not involved in hedging the risk by using derivative products used natural hedge
by borrowing in foreign currency. This study which was based on annual reports of the companies shows
that manufacturers with large asset base and more employees are more likely to involve in currency
exposure management. Majority of respondents who are managing the currency exposure are making use
of Forward contract as it is simple and easy to understand. They use foreign currency derivatives only for
hedging purpose.

Al-Momani and Gharaibeh (2009) studied the foreign exchange risk management practices of Jordanian
firms. The results of the study indicate that the use of foreign exchange risk management techniques such
as financial derivatives is not a common practice by Jordanian firms. The most common methods used by
Jordanian firms to manage foreign exchange risks are matching, netting, using local currency, and price
policy. In addition, this study concludes that there are no relationships between firm size and legal
structure
and the management practices toward transaction exposure.

Gonzalez, Bua, Lopez and Santomil (2010) analyzes the factors that determine the use of foreign
currency debt to manage currency exposure for a sample of 96 Spanish non-financial companies. Study
found that on one hand the decision to hedge with foreign debt is positively related to the level of foreign
currency
exposure, size. On the other hand, the extent of hedging is related positively to the foreign currency
exposure, size, managerial risk aversion and negatively to the costs of financial distress.

Aabo, Hog and Kuhn (2010) applies an integrated foreign exchange risk management approach with a
particular focus on the role of import in mediumsized manufacturing firms in Denmark Study found that a
strong, negative relation between import and the use of foreign exchange derivatives on the aggregate

44
 FOREIGN EXCHANGE MARKET

level. Their findings are consistent with the notion that firms use import to match the foreign exchange
exposure created by foreign sales activities.

Kang and Lee (2011) conducted an empirical analysis of the exchange rate exposure of 392 Korean
firms by employing not only changes in the exchange rate but also the standard deviation of exchange
rate. The empirical results in the case of using the standard deviation of exchange rates suggest that: the
number
of firms showing significant exchange rate exposure has been relatively increasing; exchange rate
exposure is more likely for export-oriented manufacturing industries than for nonmanufacturing
industries; and large firms using hedging methods are likely to show a low degree of exchange rate
exposure.

CHAPTER 4 - .DATA ANALYSIS INTERPRETATION AND PRESENTATION

4.1 Forex Market Analysis

45
 FOREIGN EXCHANGE MARKET

Forex analysis is used by retail forex day traders to determine to buy or sell decisions on currency pairs. It
can be technical in nature, using resources such as charting tools. It can also be fundamental in nature,
using economic indicators and/or news-based events. Analysis can seem like an ambiguous concept to a
new forex trader. But it actually falls into three basic types.

4.2 Fundamental Analysis

Fundamental analysis is often used to analyze changes in the forex market by monitoring figures, such as
interest rates, unemployment rates, gross domestic product (GDP), and other types of economic data that
come out of countries. For example, a trader conducting a fundamental analysis of the EUR/USD
currency pair would find information on the interest rates in the Eurozone more useful than those in the
U.S. Those traders would also want to be on top of any significant news releases coming out of each
Eurozone country to gauge the relation to the health of their economies.

4.3 Technical Analysis

The technical analysis comes in the form of both manual and automated systems. A manual system
typically means a trader is analyzing technical indicators and interpreting that data into a buy or sell
decision. An automated trading analysis means that the trader is "teaching" the software to look for
certain signals and interpret them into executing buy or sell decisions. Where automated analysis could
have an advantage over its manual counterpart is that it is intended to take the behavioral economics out
of trading decisions. Forex systems use past price movements to determine where a given currency may
be headed.

4.4 Weekend Analysis

There are two basic reasons for doing a weekend analysis. The first reason is that you want to establish a
"big picture" view of a particular market in which you are interested. Since the markets are closed and not
in dynamic flux over the weekend, you don't need to react to situations as they are unfolding, but can
survey the landscape, so to speak.

46
 FOREIGN EXCHANGE MARKET

Secondly, the weekend analysis will help you to set up your trading plans for the coming week, and
establish the necessary mindset. A weekend analysis is akin to an architect preparing a blueprint to
construct a building to ensure a smoother execution. Tempted to trade without a plan? Bad idea: Shooting
from the hip can leave a hole in your pocket.

4.5 Applying Forex Market Analysis

It's important to think critically about the tenets of forex market analysis. Here is a four-step outline.

1. Understand the Drivers

The art of successful trading is partly due to an understanding of the current relationships between
markets and the reasons that these relationships exist. It is important to get a sense of causation,
remembering that these relationships can and do change over time.

For example, a stock market recovery could be explained by investors who are anticipating an economic
recovery. These investors believe that companies will have improved earnings and, therefore, greater
valuations in the future—and so it is a good time to buy. However, speculation, based on a flood
of liquidity, could be fueling momentum and good old greed is pushing prices higher until larger players
are on board so that the selling can begin.

Therefore the first questions to ask are: Why are these things happening? What are the drivers behind the
market actions?

2. Chart the Indexes

It is helpful for a trader to chart the important indexes for each market for a longer time frame. This
exercise can help a trader to determine relationships between markets and whether a movement in one
market is inverse or in concert with the other.

For example, in 2009, gold was being driven to record highs. Was this move in response to the perception
that paper money was decreasing in value so rapidly that there was a need to return to the hard metal or
was this the result of cheap dollars fueling a commodities boom? The answer is that it could have been
both, or as we discussed above, market movements driven by speculation.

3. Look for a Consensus in Other Markets

We can gain a perspective of whether or not the markets are reaching a turning point consensus by
charting other instruments on the same weekly or monthly basis. From there, we can take advantage of
the consensus to enter a trade in an instrument that will be affected by the turn. For example, if the

47
 FOREIGN EXCHANGE MARKET

USD/JPY currency pair indicates an oversold position and that the Bank of Japan (BOJ) could intervene
to weaken the yen, Japanese exports could be affected. However, a Japanese recovery is likely to be
impaired without any weakening of the yen.

4. Time the Trades

There is a much higher chance of a successful trade if one can find turning points on the longer
timeframes, then switch down to a shorter time period to fine-tune an entry. The first trade can be at the
exact Fibonacci level or double bottom as indicated on the longer-term chart, and if this fails then a
second opportunity will often occur on a pullback or test of the support level.

Patience, discipline, and preparation will set you apart from traders who simply trade on the fly without
any preparation or analysis of multiple forex indicators.

Acquiring Forex Trading Systems and Strategies

A day trader's currency trading system may be manually applied, or the trader may make use of
automated forex trading strategies that incorporate technical and fundamental analysis. These are
available for free, for a fee or can be developed by more tech-savvy traders.

Both automated technical analysis and manual trading strategies are available for purchase through the
internet. However, it is important to note that there is no such thing as the "holy grail" of trading systems
in terms of success. If the system was a fail-proof money maker, then the seller would not want to share
it. This is evidenced in how big financial firms keep their "black box" trading programs under lock and
key.

The Bottom Line

There is no "best" method of analysis for forex trading between technical and fundamental analysis. The
most viable option for traders is dependent on their time frame and access to information. For a short-
term trader with only delayed information to economic data, but real-time access to quotes, technical
analysis may be the preferred method. Alternatively, traders that have access to up-to-the-minute news

48
 FOREIGN EXCHANGE MARKET

reports and economic data may prefer fundamental analysis. In either case, it does not hurt to conduct a
weekend analysis when the markets are not in a constant state of fluctuation.

4.6 CHARTS IN FOREX

1. The Price & Time Axis

All trading charts have 'time' along the horizontal x-axis and 'price' on the vertical y-axis. This means we
can view historical prices as we move to the left of the chart. The dates and times shown will vary
depending on how zoomed in or out you are on the chart. The more zoomed out you are, the more
historical price action you will see.

In forex trading charts, the vertical y-axis shows the 'exchange rate' pricing for the market you are
viewing. Based on this simple understanding of price and time we can deduce a few scenarios that help
traders make decisions on what to trade and when:

49
 FOREIGN EXCHANGE MARKET

1. If from the left side of the chart to the right side of the chart, the exchange rate has fallen we can
deduce that over that period of time the market is in a downtrend - or, that sellers are in control.

2. If from the left side of the chart to the right side of the chart, the exchange rate has risen, we can
deduce that over that period of time the market is in an uptrend - or, that buyers are in control.
This may sound simple to some but is actually quite important. Why? Because once a trend is set in
motion, it could stay so for an extended period of time. To calculate how much a market moves up or
down, we need to look at exchange rate pricing and what 'pips' are.

2. Exchange Rate Pricing - Pips

The movement of a currency pair is often referred to in 'pips', which stands for percentage in points.
Essentially, it is just a unit of measurement of price movement. Most currencies are measured in four
decimal places. However, any Japanese yen (JPY) currency pairings are measured in two decimal places.

Nowadays, due to algorithmic trading, most platforms offer precision pricing for trading robots to execute
transactions within nanoseconds. This is why there is often another number in the exchange rate.
However, it can be ignored when calculating pip movements. Let's view an example:

50
 FOREIGN EXCHANGE MARKET

In the screenshot above of part of a forex trading chart, the highest price level on the chart is 1.13385. The
lowest price on this chart is 1.12893. This means the market declined, over time by 49 pips, as 1.1338
minus 1.1289 equals 0.0049.

This is important, as it can determine your monetary profit or loss. When you open a trading ticket to
place a trade you must fill out the volume, or position size, of your trade. This is measured in lots where
one lot is equal to $10 per pip. This could mean two things from a monetary perspective:

1. If you bought at 1.1338 and sold at 1.1289, you will have lost 49 pips. If one pip is worth $10,
then you have lost $490 (49 pips * $10).
2. If you sold at 1.1338 and bought back at 1.1289, you will have gained 49 pips. This means you
could have made a profit of $490.
This is a very simplified example and figures will vary according to the currency pairs you are trading
and the position size you are using. However, risk management is an essential component of long term
trading success. To make it more simpler for traders, Admiral Markets offers a free trading calculator,
which may prove to be very handy!

3. Chart Types - Line, Bars and Candles

When viewing the exchange rate in live forex charts, there are three different options available to traders
using the MetaTrader platform: line charts, bar charts or candlestick charts. When in the MetaTrader
platform you can toggle between these different chart types by selecting View -> Toolbars -> Standard
option. In the toolbar at the top of your screen, you will now be able to see the box below:

The first option is to view your chart using OHLC bars, the second option offers candlestick charts and
the third option offers line charts. Let's look at each of these in more detail.

51
 FOREIGN EXCHANGE MARKET

4. Line Charts

A line chart connects the closing prices of the timeframe you are viewing. So, when viewing a daily chart
the line connects the closing price of each trading day. This is the most basic type of chart used by
traders. It is mainly used to identify bigger picture trends but does not offer much else unlike some of the
other chart types.

52
 FOREIGN EXCHANGE MARKET

5. OHLC Bar Charts

An OHLC bar chart shows a bar for each time period the trader is viewing. So, when looking at a daily
chart, each vertical bar represents one day's worth of trading. The bar chart is unique as it offers much
more than the line chart such as the open, high, low and close (OHLC) values of the bar.

The dash on the left represents the opening price and the dash on the right represents the closing price.
The high of the bar is the highest price the market traded during the time period selected. The low of the
bar is the lowest price the market traded during the time period selected.

1. The green bars are known as buyer bars as the closing price is above the opening price.
2. The red bars are known as seller bars as the closing price is below the opening price.

53
 FOREIGN EXCHANGE MARKET

In either case, the OHLC bar charts help traders identify who is in control of the market - buyers or
sellers. These bars form the basis of the next chart type called candlestick charts which is the most
popular type of forex charting.

6. Candlestick Charts

Candlestick charts were first used by Japanese rice traders in the 18th century. They are similar to OHLC
bars in the fact they also give the open, high, low and close values of a specific time period. However,
candlestick charts have a box between the open and close price values. This is also known as the 'body' of
the candlestick.

54
 FOREIGN EXCHANGE MARKET

Many traders find candlestick charts the most visually appealing when viewing live forex charts. They are
also very popular as they provide a variety of price action patterns used by traders all over the world
which we discuss in more detail in the next section.

Timeframes

When viewing live forex charts, there are multiple timeframes you can use. Typically, the time frame
chosen by a trader will depend on their overall style, for example:

1. The monthly, weekly and daily forex charts, tend to suit traders who hold positions for long
periods of time or use swing trading or positional trading styles.
2. The four-hour, hourly and thirty-minute forex charts, tend to suit traders who like to trade intraday
and hold positions for a few hours to a few days.
3. The 15-minute, five-minute and one-minute forex charts, tend to suit traders who hold positions
for very short periods of time such as day traders and scalpers.
When in the MetaTrader platform you can toggle between these different timeframes by selecting View
-> Toolbars -> Timeframes. In the toolbar at the top of your screen, you will now be able to see the box
below:

When viewing OHLC bar charts or candlestick charts, a new bar, or candle, will form once the chosen
time period ends. For example, when on a 5-minute chart (M5), a new bar, or candle, will form every five
minutes. Within one hour's worth of trading, 12 M5 bars or candles will have formed.

Now you understand some of the details involved in how to read forex charts, let's look at some of the
ways traders use these charts to make trading decisions on when and what to trade.

55
 FOREIGN EXCHANGE MARKET

How to Read Candlestick Charts

Below is an example of the two most basic types of candlestick formations: the buyer candle and the
seller candle.

Both candles give useful information to a trader:

56
 FOREIGN EXCHANGE MARKET

 The high and low price levels tell us the highest price and lowest price made within the timeframe
selected.
 The seller candle, shown by a red, or sometimes black body tells us that sellers won the battle
during the selected time period. This is because the closing price level is lower than the opening price
level.
 The buyer candle, shown by a green, or sometimes white body tells us that buyers won the battle
during the selected time period. This is because the closing price level is higher than the opening price
level.
How would traders use this information? In two ways:

1. If after the seller candle, the next candle goes on to make a new low then it is a sign that sellers are
willing to keep on selling the market. This weakness will cause some traders to initiate short (sell)
positions, or hold on to the short positions they already have.
2. If after the buyer candle, the next candle goes on to make a new high then it is a sign that buyers
are willing to keep on buying the market. This strength will cause some traders to initiate long
(buy) positions, or hold on to the long positions they already have.
The usefulness of candlestick charts does not stop there. When learning how to read candlestick charts it
is also worthwhile looking at some of the major types of unique patterns they make, as they help traders
in their decision-making process.

Bullish Candlestick Chart Patterns

Here are just a few examples of bullish candlesticks:

57
 FOREIGN EXCHANGE MARKET

The hammer candle shows sellers pushing the market to a new low and then the buyers pushing it all the
way back up. With the open and close price levels in the upper half of the candle, it represents a rejection
of the downside and possible strength to the upside in the future.

The bullish harami is a red candle followed by a green candle pattern which represents indecision in the
market and the possibility of a breakout from it. These are also called 'inside candle' formations as one
candle forms inside the previous candle's high to low price range.

The bullish engulfing is a red candle followed by a green candle pattern which represents a strong shift in
sentiment in the market. Essentially, a candle totally engulfs the previous candle's high to low price range
suggesting a continuation to the upside is likely.

Bearish Candlestick Chart Patterns

Here are just a few examples of bearish candlesticks:

The inverted hammer, also known as a shooting star, candle shows buyers pushing the market to a new
high and then the sellers pushing it all the way back down. With the open and close price levels in the
lower half of the candle, it represents a rejection of the upside and a possible move to the downside next.

58
 FOREIGN EXCHANGE MARKET

The bearish harami is a green candle followed by a red candle pattern which represents indecision in the
market and the possibility of a breakout from it. These are also called 'inside candle' formations as one
candle forms inside the previous candle's high to low price range.

The bearish engulfing is a green candle followed by a red candle pattern which represents a strong shift in
sentiment in the market. Essentially, a candle totally engulfs the previous candle's high to low price range
suggesting a continuation to the downside is likely.

Identifying Forex Trading Patterns on Candlestick Charts

Now you know more on how to read candlestick charts, can you spot any candlestick patterns below?

59
 FOREIGN EXCHANGE MARKET

These are just some of the patterns you can typically find on candlestick charts. It doesn't highlight all of
them but is a great foundation to build upon. What you may notice is that sometimes these patterns start
the beginning of a prolonged directional move. In fact, looking back it is clear to see the market cycles of
the chart more clearly.

Identifying market cycles can be useful when analysing forex trading charts, as they can help determine
the overall trend or future directional bias of a market. Of course, it doesn't tell us how many pips the
market will move by but can certainly to help form part of the picture when reading forex charts.

4.7 Qualitative vs Quantitative Analysis

60
 FOREIGN EXCHANGE MARKET

1. A Qualitative Analysis seeks out the ‘why’, not the ‘how’ of its topic, seeking out the quality not
quantity. A Quantitative Analysis seeks out the ‘How’, not the ‘Why’ of its topic, seeking out the
quantity not quality.
 
2. In market analysis, fundamental is qualitative and technical is quantitative.
 
3. Technical analysis which is quantitative in nature can also become qualitative or 100%
quantitative.
 4. Qualitative analysis is predictive (biased) in nature and Quantitative analysis is reactive
(unbiased) in nature. 
5. Qualitative analysis is a kind of art while Quantitative analysis is pure scientific.
 
6. In general, discretionary trading is qualitative and mechanical trading is quantitative.
 
7. In technical analysis, qualitative method gains an understanding of underlying reasons and
motivations like why the trend is bullish or bearish and also to determine its quality. Quantitative
method does not focus on underlying reasons and motivations but reacts 100% to preprogrammed
parameters. It doesn’t care for quality but seeks out the “quality in quantity”.
 
8. Chart pattern analysis, Elliott wave analysis, support and resistance levels all are qualitative
examples. The signals generated from these are subjective and opinions may change. Relying
solely on one indicator or combination of indicators generating mechanical signals are quantitative
examples. There is no second opinion in quantitative analysis.
 
9. Emotions may influence entry & exit decisions for qualitative methods. There is no place for
emotions in quantitative decisions.
 
10. Experience is required for making entry & exit decisions every time for trade execution in
qualitative analysis and only experienced traders are able to make profitable decisions. In
Quantitative analysis, experience is only required for making preprogrammed logic or strategy.
Once a profitable methodology is set, no experience is required for application.

61
 FOREIGN EXCHANGE MARKET

62