Forex Market Offers Opportunity and Information

The forex market is what is called an international exchange currency market, where currencies are exchanged on a daily basis. There are five forex market centers around the world — New York, London, Tokyo, Frankfurt and Zurich. One does not need to be on the trading floor, so to speak to be involved in the forex market. Today, forex trading can be done from home on a computer. 

The forex market itself is basically a worldwide connection of traders, who make investment moves based on the price of currencies, or their values relative to other currencies. These traders constantly negotiate prices with other traders resulting in the fluctuation or movement of a currency's value. The value of a currency on the forex market also corresponds with supply. If there is greater demand for the Euro, let's say, then there will be less supply of it on the forex market, which means, in time, it will make a Euro more valuable compared to let's say the dollar. In short, in this forex market situation, one Euro would yield more dollars, subsequently weakening the dollar as well. Analyzing the forex market's fluctuations allows investors to make predictions on how a currency will move in relation to another currency. They then can make predictions and buy and sell currency accordingly. 

While some people view the forex market as a place to see what their exchange rate will be when they travel abroad, others view it as an opportunity to make great gains in their financial planning and future. 

 

What Forex Traders Need To Know About The Yen

Despite many attractive characteristics of forex trading, the foreign exchange market is vast, complicated and ruthlessly competitive. Major banks, trading houses and funds dominate the market and quickly incorporate any new information into the prices.

Foreign exchange is not a market for the unprepared or ignorant. To effectively trade foreign currencies on a fundamental basis, traders must be knowledgeable when it comes to the major currencies. This knowledge should include not only the current economic stats for a country, but also the underpinnings of the respective economies and the special factors that can influence the currencies.

Introduction to the Yen
Just seven currencies account for 80% of the forex market, and the Japanese yen is one of the largest currencies, in terms of international trade and forex trading. That is only fitting, as Japan is one of the largest economies in the world, with one of the highest GDP among nations and is one of the largest exporters, in dollar terms.

All of the major currencies in the forex market have central banks behind them. In the case of the Japanese yen, it is the Bank of Japan. Like most developed country central banks, the Bank of Japan has a mandate to act in a fashion that encourages growth and minimizes inflation. In the case of Japan, however, deflation has been a persistent threat for many years, and the BOJ has pursued a policy of very low rates in the hopes of stimulating demand and economic growth; at various points in the 2000s, real rates in Japan were actually slightly negative.

The Economy Behind the Yen
The Japanese economy has some particular and peculiar attributes that yen traders need to understand. Firstly, despite its size, Japan has been notably lacking in growth since the collapse of its real estate bubble. Writers often refer to a "lost decade" in Japan because of this reason. Although that may not be entirely accurate, growth has rarely exceeded 2% in Japan between 2001 and 2011, and has contracted to zero or negative rates multiple times. Japan is also notable for inflation, or rather its almost near-absence of it; Japan has actually experienced deflation for much of the last decade.

Second, Japan is also the oldest major economy in the world and has one of the lowest fertility rates. That suggests an increasingly aging workforce with fewer and fewer younger workers to support the economy through taxation and consumption. Japan is also quite closed to immigration and that establishes difficult demographics.

Lastly, Japan is also an advanced economy with a well-educated workforce. Although industries like shipbuilding have migrated to countries like South Korea and China, Japan is still a leading manufacturer of consumer electronics, autos and technological components. This has left Japan with significant exposure to the global economy, but increasing reliance on China as a trade partner.

Drivers of the Yen
There are several theories that attempt to explain foreign exchange rates. Purchasing power parity, interest rate parity, the Fisher effect and balance of payments models all offer explanations of the "right" exchange rate, based on factors like relative interest rates, price levels and so forth. In practice, these models do not work especially well in the real market – real market exchange rates are determined by supply and demand, which includes a variety of market psychology factors.

Major economic data includes the release of GDP, retail sales, industrial production, inflation and trade balances. These come out at regular intervals, and many brokers, as well as many financial information sources like the Wall Street Journal and Bloomberg, make this information freely available. Investors should also take note of information on employment, interest rates (including scheduled meetings of the central bank) and the daily news flow; natural disasters, elections and new government policies can all have significant impacts on exchange rates.

In the case of Japan and yen traders, the Tankan survey is particularly noteworthy. Many countries report information on business confidence, and the Tankan is a quarterly reported published by the Bank of Japan. The Tankan is seen as a very important report, and often moves trading in Japanese stock and currency; trade flow data is also uncommonly important for the yen.

Carry Trade
In many respects, BOJ policy drives carry trades across the world. Carry trading refers to borrowing money in a low-interest-rate environment, and then investing that money in higher-yielding assets from other countries. With a stated policy of near-zero interest rates, Japan has long been a major source of capital for that trade. That also means, though, that talk of higher rates in Japan can send ripples throughout the currency markets.

Unique Factors for the Japanese Yen
While the BOJ has maintained low rates since Japan's property bubble collapsed, the bank has also been involved in currency intervention – selling the yen to help keep Japanese exports more competitive. This intervention has carried political consequences in the past, though, so the BOJ is relatively hesitant to intervene in the forex markets relative to its past history.

Japan's trade balance also impacts BOJ policy and forex rates. Japan has large trade surpluses, but very large public debt and an aging population. A large percentage of that debt is held domestically, though, and Japanese investors seem willing to accept low rates of returns.

The yen is the signature currency for Asia; it is one of the top most frequently traded currencies in the world, and a significant reserve currency for many Asian countries. While the significance of the yen could be at risk if the Chinese yuan becomes more liquid, that would likely be a multi-year process.

That said, the relative stability of the yen has made it a backup reserve currency for many countries. While Japan has very high debt levels, traders tend to be more comfortable with Japan's debt balance, as so much of it is domestically owned. Moreover, traders often balance the high debt level of Japan with its high trade surplus, though the devaluation of the dollar and the "safe haven" status of the yen has led to a stronger yen that threatens the very trade surplus that makes the yen attractive.

The Bottom Line
Currency rates are notoriously difficult to predict, and most models seldom work for more than brief periods of time. While economics-based models are seldom useful to short-term traders, economic conditions do shape long-term trends. Japan's strong trade surplus will likely maintain the country's position as a relative safe haven for some time to come, but the aging workforce, persistently low consumer and business confidence, as well as the rising significance of China as an economic rival, do threaten that position.

Get To Know the Major Central Banks

The one factor that is sure to move the currency markets is interest rates. Interest rates give international investors a reason to shift money from one country to another in search of the highest and safest yields. For years now, growing interest rate spreads between countries have been the main focus of professional investors, but what most individual traders do not know is that the absolute value of interest rates is not what's important - what really matters are the expectations of where interest rates are headed in the future.

Familiarizing yourself with what makes the central banks tick will give you a leg up when it comes to predicting their next moves, as well as the future direction of a given currency pair. In this article, we look at the structure and primary focus of each of the major central banks, and give you the scoop on the major players within these banks. We also explain how to combine the relative monetary policies of each central bank to predict where the interest rate spread between a currency pair is headed.

Examples
Take the performance of the NZD/JPY currency pair between 2002 and 2005, for example. During that time, the central bank of New Zealand increased interest rates from 4.75% to 7.25%. Japan, on the other hand, kept its interest rates at 0%, which meant that the interest rate spread between the New Zealand dollar and the Japanese yen widened a full 250 basis points. This contributed to the NZD/JPY's 58% rally during the same period.

Figure 1

On the flip side, we see that throughout 2005, the British pound fell more than 8% against the U.S. dollar. Even though the United Kingdom had higher interest rates than the United States throughout those 12 months, the pound suffered as the interest rate spread narrowed from 250 basis points in the pound's favor to a premium of a mere 25 basis points. This confirms that it is the future direction of interest rates that matters most, not which country has a higher interest rate.

Figure 2

The Eight Major Central Banks

U.S. Federal Reserve System (The Fed)
Structure - The Federal Reserve is probably the most influential central bank in the world. With the U.S. dollar being on the other side of approximately 90% of all currency transactions, the Fed's sway has a sweeping effect on the valuation of many currencies. The group within the Fed that decides on interest rates is the Federal Open Market Committee (FOMC), which consists of seven governors of the Federal Reserve Board plus five presidents of the 12 district reserve banks.

Mandate - Long-term price stability and sustainable growth

Frequency of Meeting - Eight times a year

European Central Bank (ECB)
Structure - The European Central Bank was established in 1999. The governing council of the ECB is the group that decides on changes to monetary policy. The council consists of the six members of the executive board of the ECB, plus the governors of all the national central banks from the 12 euro area countries. As a central bank, the ECB does not like surprises. Therefore, whenever it plans on making a change to interest rates, it will generally give the market ample notice by warning of an impending move through comments to the press.

Mandate - Price stability and sustainable growth. However, unlike the Fed, the ECB strives to maintain the annual growth in consumer prices below 2%. As an export dependent economy, the ECB also has a vested interest in preventing against excess strength in its currency because this poses a risk to its export market.

Frequency of Meeting - Bi-weekly, but policy decisions are generally only made at meetings where there is an accompanying press conference, and those happen 11 times a year.

Bank of England (BoE)
Structure - The monetary policy committee of the Bank of England is a nine-member committee consisting of a governor, two deputy governors, two executive directors and four outside experts. The BoE, under the leadership of Mervyn King, is frequently touted as one of the most effective central banks.

Mandate - To maintain monetary and financial stability. The BoE's monetary policy mandate is to keep prices stable and to maintain confidence in the currency. To accomplish this, the central bank has an inflation target of 2%. If prices breach that level, the central bank will look to curb inflation, while a level far below 2% will prompt the central bank to take measures to boost inflation.

Frequency of Meeting - Monthly

Bank of Japan (BoJ)
Structure - The Bank of Japan's monetary policy committee consists of the BoJ governor, two deputy governors and six other members. Because Japan is very dependent on exports, the BoJ has an even more active interest than the ECB does in preventing an excessively strong currency. The central bank has been known to come into the open market to artificially weaken its currency by selling it against U.S. dollars and euros. The BoJ is also extremely vocal when it feels concerned about excess currency volatility and strength.

Mandate - To maintain price stability and to ensure stability of the financial system, which makes inflation the central bank's top focus.

Frequency of Meeting - Once or twice a month

Swiss National Bank (SNB)
Structure - The Swiss National Bank has a three-person committee that makes decisions on interest rates. Unlike most other central banks, the SNB determines the interest rate band rather than a specific target rate. Like Japan and the euro zone, Switzerland is also very export dependent, which means that the SNB also does not have an interest in seeing its currency become too strong. Therefore, its general bias is to be more conservative with rate hikes.

Mandate - To ensure price stability while taking the economic situation into account

Frequency of Meeting - Quarterly

Bank of Canada (BoC)
Structure - Monetary policy decisions within the Bank of Canada are made by a consensus vote by Governing Council, which consists of the Bank of Canada governor, the senior deputy governor and four deputy governors.

Mandate - Maintaining the integrity and value of the currency. The central bank has an inflation target of 1-3%, and it has done a good job of keeping inflation within that band since 1998.

Frequency of Meeting - Eight times a year

Reserve Bank of Australia (RBA)
Structure - The Reserve Bank of Australia's monetary policy committee consists of the central bank governor, the deputy governor, the secretary to the treasurer and six independent members appointed by the government.

Mandate - To ensure stability of currency, maintenance of full employment and economic prosperity and welfare of the people of Australia. The central bank has an inflation target of 2-3% per year.

Frequency of Meeting - Eleven times a year, usually on the first Tuesday of each month (with the exception of January)

Reserve Bank of New Zealand (RBNZ)

Structure - Unlike other central banks, decision-making power on monetary policy ultimately rests with the central bank governor.

Mandate - To maintain price stability and to avoid instability in output, interest rates and exchange rates. The RBNZ has an inflation target of 1.5%. It focuses hard on this target, because failure to meet it could result in the dismissal of the governor of the RBNZ.

Frequency of Meeting - Eight times a year

Putting It All Together
Now that you know a little more about the structure, mandate and power players behind each of the major central banks, you are on your way to being able to better predict the moves these central banks may make. For many central banks, the inflation target is key. If inflation, which is generally measured by the Consumer Price Index, is above the central bank's target, then you know that it will have a bias toward tighter monetary policy. By the same token, if inflation is far below the target, the central bank will be looking to loosen monetary policy. Combining the relative monetary policies of two central banks is a solid way to predict where a currency pair may be headed. If one central bank is raising interest rates while another is sticking to the status quo, the currency pair is expected to move in the direction of the interest rate spread (barring any unforeseen circumstances).

A perfect example is EUR/GBP in 2006. The euro broke out of its traditional range-trading mode to accelerate against the British pound. With consumer prices above the European Central Bank's 2% target, the ECB was clearly looking to raise rates a few more times. The Bank of England, on the other hand, had inflation slightly below its own target and its economy was just beginning to show signs of recovery, preventing it from making any changes to interest rates. In fact, throughout the first three months of 2006, the BoE was leaning more toward lowering interest rates than raising them. This led to a 200-pip rally in EUR/GBP, which is pretty big for a currency pair that rarely moves.

Figure 3

5 Forex Day Trading Mistakes to Avoid

In the high leverage game of retail forex day trading, there are certain practices that, if used regularly, are likely to lose a trader all he has. There are five common mistakes that day traders often make in an attempt to ramp up returns, but that end up resulting in lower returns. These five potentially devastating mistakes can be avoided with knowledge, discipline and an alternative approach.

Averaging Down
Traders often stumble across averaging down. It is not something they intended to do when they began trading, but most traders have ended up doing it. There are several problems with averaging down.

The main problem is that a losing position is being held - not only potentially sacrificing money, but also time. This time and money could be placed in something else that is proving itself to be a better position.

Also, for capital that is lost, a larger return is needed on remaining capital to get it back. If a trader loses 50% of her capital, it will take a 100% return to bring her back to the original capital level. Losing large chunks of money on single trades or on single days of trading can cripple capital growth for long periods of time.

While it may work a few times, averaging down will inevitably lead to a large loss or margin call, as a trend can sustain itself longer than a trader can stay liquid - especially if more capital is being added as the position moves further out of the money.

Day traders are especially sensitive to these issues. The short time frame for trades means opportunities must be capitalized on when they occur and bad trades must be exited quickly.

Pre-Positioning for News
Traders know the news events that will move the market, yet the direction is not known in advance. A trader may even be fairly confident what a news announcement may be - for instance that the Federal Reserve will or will not raise interest rates - but even so cannot predict how the market will react to this expected news. Often there are additional statements, figures or forward looking indications provided by news announcements that can make movements extremely illogical.

There is also the simple fact that as volatility surges and all sorts of orders hit the market, stops are triggered on both sides of the market. This often results in whip-saw like action before a trend emerges (if one emerges in the near term at all).

For all these reasons, taking a position before a news announcement can seriously jeopardize a trader's chances of success. There is no easy money here; those who believe there is may face larger than usual losses.

Trading Right after News
A news headline hits the markets and then the market starts to move aggressively. It seems like easy money to hop on board and grab some pips. If this is done in a non-regimented and untested way without a solid trading plan behind it, it can be just as devastating as placing a gamble before the news comes out.

News announcements often cause whipsaw-like action because of a lack of liquidity and hair-pin turns in the market assessment of the report. Even a trade that is in the money can turn quickly, bringing large losses as large swings occur back and forth. Stops during these times are dependent on liquidity that may not be there, which means losses could potentially be much more than calculated.

Day traders should wait for volatility to subside and for a definitive trend to develop after news announcements. By doing so there is likely to be fewer liquidity concerns, risk can be managed more effectively and a more stable price direction is likely.

Risking More Than 1% of Capital
Excessive risk does not equal excessive returns. Almost all traders who risk large amounts of capital on single trades will eventually lose in the long run. A common rule is that a trader should risk (in terms of the difference between entry and stop price) no more than 1% of capital on any single trade. Professional traders will often risk far less than 1% of capital.

Day trading also deserves some extra attention in this area. A daily risk maximum should also be implemented. This daily risk maximum can be 1% (or less) of capital, or equivalent to the average daily profit over a 30 day period. For example, a trader with a $50,000 account (leverage not included) could lose a maximum of $500 per day. Alternatively, this number could be altered so it is more in line with the average daily gain - if a trader makes $100 on positive days, she keeps losing days close to $100 or less.

The purpose of this method is to make sure no single trade or single day of trading hurts the traders account significantly. By adopting a risk maximum that is equivalent to the average daily gain over a 30 day period, the trader knows that he will not lose more in a single trade/day than he can make back on another.

Unrealistic Expectations
Unrealistic expectations come from many sources, but often result in all of the above problems. Our own trading expectations are often imposed on the market, leaving us expecting it to act according our desires and trade direction. The market doesn't care what you want. Traders must accept that the market can be illogical. It can be choppy, volatile and trending all in short, medium and long-term cycles. Isolating each move and profiting from it is not possible, and believing so will result in frustration and errors in judgment.

The best way to avoid unrealistic expectations is formulate a trading plan and then trade it. If it yields steady results, then don't change it - with forex leverage, even a small gain can become large. Accept this as what the market gives you. As capital grows over time, the position size can be increased to bring in higher dollar returns. Also, new strategies can be implemented and tested with minimal capital at first. Then, if positive results are seen, more capital can be put into the strategy.

Intra-day, a trader must also accept what the market provides at different parts of the day. Near the open, the markets are more volatile. Specific strategies can be used during the market open that may not work later in the day. As the day progresses, it may become quieter and a different strategy can be used. Towards the close, there may be a pickup in action and yet another strategy can be used. Accept what is given at each point in the day and don't expect more from a system than what it is providing.

Bottom Line
Traders get trapped in five common forex day trading mistakes. These must be avoided at all costs by developing an alternative approach. For averaging down, traders must not add to positions but rather exit losers quickly with a pre-planned exit strategy. Traders should sit back and watch news announcements until the volatility has subsided. Risk must be kept in check, with no single trade or day losing more than what can be easily made back on another. Expectations must be managed, and what the market gives must be accepted. By understanding the pitfalls and how to avoid to them, traders are more likely to find success in trading.