4x Info and Tips

Forex Basics

2007-10-19T20:49:00.000-07:00

The following is an introduction to some basic terms, definitions and concepts used in forex trading.

Introduction
Foreign Exchange

The simultaneous transaction of one currency for another.

Foreign Exchange Market

An informal network of trading relationships between the world's major banks and other market participants, sometimes referred to as the 'interbank market'. The foreign exchange market has no central clearing house or exchange and is considered an over-the-counter (OTC) market.

Spot Market

The market for buying and selling currencies at the current market rate.

Rollover
A spot transaction is generally due for settlement within two business days (the value date). The cost of rolling over a transaction is based on the interest rate differential between two currencies in a transaction. If you are long (bought) the currency with a higher rate of interest you will earn interest. If you are short (sold) the currency with a higher rate of interest you will pay interest. Most brokers will automatically roll over your open positions allowing you to hold your position indefinitely.

How to calculate rollover interest
Rollovers in Forex
Exchange Rate

The value of one currency expressed in terms of another. For example, if EUR/USD is 1.3200, 1 Euro is worth US$1.3200.

Currency Pair

The two currencies that make up an exchange rate. When one is bought, the other is sold, and vice versa.

Base Currency

The first currency in the pair. Also the currency your account is denominated in.

Counter Currency

The second currency in the pair. Also known as the terms currency.

ISO Currency Codes

USD = US Dollar
EUR = Euro
JPY = Japanese Yen
GBP = British Pound
CHF = Swiss Franc
CAD = Canadian Dollar
AUD = Australian Dollar
NZD = New Zealand Dollar

Currency Pair Terminology

EUR/USD = "Euro"
USD/JPY = "Dollar Yen"
GBP/USD = "Cable" or "Sterling"
USD/CHF = "Swissy"
USD/CAD = "Dollar Canada" (CAD referred to as the "Loonie")
AUD/USD = "Aussie Dollar"
NZD/USD = "Kiwi"

FCM

Futures Commission Merchant. An individual or organisation licensed by the U.S. Commodities Futures Trading Commission (CFTC) to deal in futures products and accept monies from clients to trade them.

Market Maker

A market maker runs a dealing desk and provides liquidity for a particular currency pair by standing ready to buy or sell that instrument by displaying a bid and offer price. Market makers earn their commission from the spread between the bid and the offer price.

Forex ECN Broker

ECN stands for Electronic Communications Network. A Forex ECN does not operate a dealing desk, but instead provides a marketplace where multiple market makers, banks and traders can enter competing bids and offers into the platform either inside or outside the spread, resulting in tighter spreads and allowing traders to trade on those prices. Orders are routed to the best available bid/offer price for a fee or commission.

Dealing Desk

A dealing desk is where all trades are executed and where prices originate from.

NDD

No Dealing Desk broker. A no dealing desk broker acts as an agent, matching up orders to one or more liquidity providers connected to their platform.

Counterparty

One of the participants in a transaction.

Sell Quote / Bid Price

The sell quote is displayed on the left and is the price at which you can sell the base currency. It is also referred to as the market maker's bid price. For example, if the EUR/USD quotes 1.3200/03, you can sell 1 Euro at the bid price of US$1.3200.

Buy Quote / Offer Price

The buy quote is displayed on the right and is the price at which you can buy the base currency. It is also referred to as the market maker's ask or offer price. For example, if the EUR/USD quotes 1.3200/03, you can buy 1 Euro at the offer price of US$1.3203.

Pip

The smallest price increment a currency can make. Also known as points. For example, 1 pip = 0.0001 for EUR/USD, or 0.01 for USD/JPY.

Pip Value

The value of a pip. Pip value can be fixed or variable depending on the currency pair and base currency of your account. e.g. The pip value for EURUSD is always $10 for standard lots and $1 for mini-lots. To calculate the pip value, divide 1 pip by the exchange rate and multiply it by the unit lot size to get the base currency pip value. To convert this back to your account currency, multiply it by the appropriate exchange rate. e.g. EURUSD = 0.0001 / 1.30000 * 100,000 = 7.69 Euro * 1.30000 = $10.00 pip value (fixed). USDJPY = 0.01 / 120.00 * 100,000 = $8.33 pip value (variable)

Lot

The standard unit size of a transaction. Typically, one "standard" lot is equal to 100,000 units of the base currency, or 10,000 units if it's a "mini" lot, and even 1,000 units if it's a "micro" lot. Some dealers offer the ability to trade in any unit size, down to as little as 1 unit!

Spread

The difference between the sell quote and the buy quote or the bid and offer price. For example, if EUR/USD quotes read 1.3200/03, the spread is the difference between 1.3200 and 1.3203, or 3 pips. In order to break even on a trade, a position must move in the direction of the trade by an amount equal to the spread.

Standard Account

Trading with standard lot sizes

Mini Account

Trading with mini lot sizes

Margin

The deposit required to open or maintain a position. A 1% margin requirement allows you to control a $100,000 position with a $1,000 margin deposit.

Leverage

The extent to which you are using borrowed funds to gear your account. Increasing your leverage magnifies both gains and losses. To calculate leverage used, divide total open positions by account equity to get the leverage ratio. e.g. If a trader has $1,000 in his account and opens a $100,000 position, he is leveraging his account by 100 times, i.e. 100:1 leverage. If he opens a $200,000 position with $1,000 in his account, he is leveraging his account by 200 times, i.e. 200:1 leverage.

Manual Execution

An order which is executed by dealer intervention.

Automatic Execution

The order is executed by computer software without human intervention or involvement.

Slippage

The difference between the order price and the executed price.

Drawdown

The extent to which equity is lost in a trading account from a trade or series of trades, measured from peak to subsequent trough, most commonly in percentage terms.

Technical Analysis

A style of trading that involves analysing price charts for technical patterns of behaviour.

Fundamental Analysis

A style of trading that involves analysing the macroeconomic factors that underpin the value of a currency.

Support

Support is a technical level where buyers outnumber sellers, causing prices to bounce off a temporary price floor.

Resistance

Resistance is a technical level where sellers outnumber buyers, causing prices to bounce off a temporary price ceiling.

Common Order Types
Market Order

An order to buy or sell at the current market price.

Limit Order

An order to buy or sell at a specified price level.

Stop-Loss Order

An order to restrict losses at a specified price level.

Limit Entry Order

An order to buy below the market or sell above the market at a specified level, believing that the price will reverse direction from that point.

Stop-Entry Order

An order to buy above the market or sell below the market at a specified level, believing that the price will continue in the same direction.

Common Trade Types
Long

A position in which the trader profits from an increase in price. Buy low, sell high.

Short

A position in which the trader profits from a decrease in price. Sell high, buy low.

Carry Trade

A position whereby the trader attempts to profit from holding a currency with a higher interest rate and shorting a currency with a lower interest rate.

Common Trading Styles
Trend Trading

A style of trading that attempts to profit from riding short, medium or long term trends in price.

Range Trading

A style of trading that attempts to profit from buying technical levels of support and selling technical levels of resistance. The upper level of resistance and lower level of support defines the range.

News Trading

A style of trading whereby a trader attempts to profit from fundamental news announcements that may affect the price of a currency, usually immediately after the announcement is released.

Scalping

A style of trading that involves frequent trading seeking small gains over a very period of time. Trades can last from seconds to minutes.

Day Trading

A style of trading that involves multiple trades on an intra-day basis. Trades can last from minutes to hours.

Swing Trading

A style of trading that involves seeking to profit from short to medium term swings in trend. Trades can last from hours to days.

Position Trading

A style of trading that involves taking a longer term position that reflects a longer term outlook. Trades can last from weeks to months.

Discretionary Trading

A style of trading that involves the human decision making process for every trade.

Automated Trading

A style of trading that involves neither human decision making or involvement, but uses a pre-programmed strategy that automatically executes trades via trading software.

Example Transaction
Assume you have a trading account of $25,000 and you are trading with a 1% margin requirement. The current quote for EUR/USD is 1.3225/28 and you place a market order to buy 1 standard lot of 100,000 Euros at 1.3228, expecting the euro to strengthen against the U.S. dollar. At the same time you place a take profit order at 1.3278, 50 pips above your order price.

The notional value of this transaction is $132,280 (100,000 units * $1.3228). Your required margin deposit is 1% of the total, which means you need $1322.80 in account equity to open this trade.

As you expected, the Euro strengthens against the U.S. dollar and your take profit order is reached at 1.3278. Your total profit for this trade is $500 (each pip being worth $10) for a total return of 38% on this trade.

How Is The Forex Market Different From The Stock Market ?

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As a result of its global dimension, the Forex market is open 24 hours a day, which enables investors to correct their positions at any point in time. Given the large number of players, the Forex market has narrow spreads and virtually no price gaps. The lack of price gaps enables investors to count on non-slippage order execution. However, in a very volatile market the possibility for slippage exists.The large volume of participants also reduces opportunity for insider information. To put it simply, there has never been a case of complete currency collapse in a developed country. The volatility of leading currencies rarely exceeds 1% per day, in contrast to the volatility of stocks, which may fluctuate by up to 10% over one trading session. The Forex market generally provides more opportunities for leveraged trading

How Is The Forex Market Different From The Stock Market ?

2007-10-19T20:47:00.000-07:00

What Is Technical Analysis ?

2007-10-19T20:46:00.002-07:00

The entry "Fundamental Analysis" into your search engine will yield over a million results. Fundamental Analysis was first used to identify under or over-valued companies and forecast and profit from future price movements on the stock market. To take a fundamental approach on the Forex market you should view a country as if it were a company and consider the underlying forces affecting the country's economy.This fundamentalist approach is informed by a wide range of elements. Let's consider the currency of country "X".

A Fundamentalist would analyze economic indicators (Interest rate; Employment figures and GDP to name but a few) as well as government policy (is the government right or left leaning; how secure the government's tenure is; the geo-political pressures on the government, etc.) and societal pressures (are the people "spenders" or "savers"? How do they perceive country X's economy and its economic institutions?) The information both pertinent and available is a vast ever-changing mosaic and it is impossible to keep on top of everything simultaneously. The first thing to remember is that the more you research and the more you learn, the more you will understand the subtle dynamic of the market. The second thing to do is to choose which indicators you feel are most indicative of price action. The only way to make a measured choice is to research and to listen to and learn from more experienced traders.News of economic indicators is released at set times and has a marked effect on the behavior of traders on the market, so an ignorance of these indictors would make the moves of the market completely inexplicable. It is important, therefore, to know when news is going to be announced and what the implications of the news are. Keep fully informed using the wealth of information available on the Internet. Visit the sites of the Central banks of the currencies you are considering (see the Links page), access their calendars of Economic Indicators and develop a clear idea of what economic information is about to be released and how it will affect the currency. Forex Club's internet trading platform, IDSystem, provides a constant flow of real-time, up-to-the-minute financial news from Dow Jones Newswires directly to your trading screen, equipping you to devise sound, informed trading strategies. The two services available are Dow Jones Business News and Dow Jones Money News. These services are available to Forex Club clients absolutely free-of-charge.Fundamental Analysis is generally held to be an effective method of forecasting economic conditions, but is less precise when it comes to outlining a profitable trading strategy. A trader has to derive his or her own responsive strategy. Bear in mind, also, that not only are the figures themselves important but also how these figures influence expectations.One major difference between fundamental analysis on the stock market and fundamental analysis on the Forex market is that on the Forex market you have to consider two currencies, as there are two sides to every trade.

How Does 1 Analyze Forex ?

2007-10-19T20:46:00.001-07:00

analyzing the Forex market requires understanding price movement on financial markets. There are two types of analysis used in the financial markets: "fundamental" and "technical". While technical analysis gives the trader a grasp of patterns of movement in the market, fundamental analysis explains the reasons behind movements in the market and attempts to predict changes in price and market trends. A fundamental analysis takes into account the economic conditions of the countries whose currencies he or she trades, follows political events and trends in the world, and reacts to emergency news. Whatever method you prefer, the reality is that it has become increasingly difficult to be a purist of either persuasion. Fundamentalists need to follow the various signals derived from the changes in price on charts, while few technicians can afford to completely shrug off incoming economic data or critical political decisions. For example, if one looks at the chart that shows EUR/USD moves over the recent war in Iraq, it becomes obvious that victories of the Coalition forces meant a stronger Dollar and a weaker Euro. Conversely, military failures resulted in a decline of the American currency, and a strengthened Euro.

Is The Forex Market Risky ??

2007-10-19T20:45:00.001-07:00

Forex is sometimes described as one of the riskiest financial markets. However, the volatility of currencies rarely exceeds 1-1.5% per day and risks are only high when unreasonable leverage is used. By choosing the leverage size traders actually determine their risks themselves. We do not recommend our clients use leverage higher than 1:5. The Forex market is a highly speculative market. Hence, the ability to analyze price bahavior becomes an invalubale asset for any trader.

What Is The Role of Forex Club ???

2007-10-19T20:44:00.002-07:00

Forex Club is a broker, which monitors global currency prices and delivers quotes to its clients via the Trading Terminal software. Its clients may buy or sell all major currencies. In addition, the clients of Forex Club are supplied with informational support, market analysis and learning materials. Forex Club does not charge any commission for its services. It is compensated for its work via a spread (which is a difference between purchasing and sell price of currencies).

How To Learn Trading...?

2007-10-19T20:44:00.001-07:00

What is Forex ?

There are many currencies in the world and their prices fluctuate against one another and change value over time. This creates the potential for investment and/or speculation. Forex (short for FOReign EXchange) is the market where international currencies are traded against one another. Evolution of communication technologies in recent years has made it possible for millions of individual investors to access Forex, market which not so long ago had been accessible only for banks and large institutional investors. FOREX is one of the newest financial markets and it is a good idea to learn how it is different from other markets. Currency rates are determined by many factors, such as political events and economic developments in national economies. They are also determined by the investor attitude influencing the market at any given moment. If you were able to foresee these developments you would be able to make profitable trades on Forex. However, if you assessment is not correct, you may suffer significant losses. Just like anything else the key to successful Forex trading is knowledge.

What is Forex II ?

The Global Forex market is one of the largest markets in the world in terms of daily volume. Its trade volume varies from 1 to 3 trillion USD every day, which is 6-8 times higher than the volume in the stock exchange worldwide. The commodies traded on Forex are national currencies. The Forex market enables exporters and importers to engage in international trade, banks and financial institutions to provide sophisticated financial services, governments to implement policies, and tourists to travel. In essence, it is a truly global market, which operates around-the-clock and around-the-globe. The global nature of the Forex market, utilizing modern information technologies and financial services, enables private investors to participate in the market from their homes or offices via telephone or computer.

How does Forex work ?

The Forex market is nowhere and everywhere. There is no central place where market players execute trades. Instead, Forex is comprised of currency transactions between banks, investment funds, Forex brokers and traders. Currency supply and demand and investors' expectations determine the market price of a currency. Some currencies also come under significant influence from Central Banks. The Forex market is a virtual market, which means that it is not followed by a physical delivery of currency.

Market Psychology

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Market psychology and trader perceptions influence the foreign exchange market in a variety of ways:
Flights to quality: Unsettling international events can lead to a "flight to quality" -with investors seeking a "safe haven". There will be a greater demand, thus a higher price, for currencies perceived as stronger over their relatively weaker counterparts.

Long-term trends: Currency markets often move in visible long-term trends. Although currencies do not have an annual growing season like physical commodities, business cycles do make themselves felt. Cycle analysis looks at longer-term price trends that may rise from economic or political trends.

"Buy the rumor, sell the fact:" This market truism can apply to many currency situations. It is the tendency for the price of a currency to reflect the impact of a particular action before it occurs and, when the anticipated event comes to pass, react in exactly the opposite direction. This may also be referred to as a market being "oversold" or "overbought".

To buy the rumor or sell the fact can also be an example of the cognitive bias known as anchoring, when investors focus too much on the relevance of outside events to currency prices.Economic numbers: While economic numbers can certainly reflect economic policy, some reports and numbers take on a talisman-like effect - the number itself becomes important to market psychology and may have an immediate impact on short-term market moves. "What to watch" can change over time. In recent years, for example, money supply, employment, trade balance figures and inflation numbers have all taken turns in the spotlight.

Technical trading considerations: As in other markets, the accumulated price movements in a currency pair such as EUR/USD can form patterns that may be recognized and utilized by traders for the purpose of entering and exiting the market, leading to short-term fluctuations in price. Many traders study price charts in order to identify such patterns

Financial Instruments

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There are several types of financial instruments commonly used.

Spot: A spot transaction is a two-day delivery transaction, as opposed to the futures contracts, which are usually three months. This trade represents a “direct exchange” between two currencies, has the shortest time frame, involves cash rather than a contract; and interest is not included in the agreed-upon transaction. The data for this study come from the spot market. Spot has the largest share by volume in FX transactions among all instruments.
Forward transaction: One way to deal with the Forex risk is to engage in a forward transaction. In this transaction, money does not actually change hands until some agreed upon future date. A buyer and seller agree on an exchange rate for any date in the future, and the transaction occurs on that date, regardless of what the market rates are then. The duration of the trade can be a few days, months or years.

Futures: Foreign currency futures are forward transactions with standard contract sizes and maturity dates — for example, 500,000 British pounds for next November at an agreed rate. Futures are standardized and are usually traded on an exchange created for this purpose. The average contract length is roughly 3 months. Futures contracts are usually inclusive of any interest amounts.

Swap: The most common type of forward transaction is the currency swap. In a swap, two parties exchange currencies for a certain length of time and agree to reverse the transaction at a later date. These are not contracts and are not traded through an exchange.

Options: A foreign exchange option (commonly shortened to just FX option) is a derivative where the owner has the right but not the obligation to exchange money denominated in one currency into another currency at a pre-agreed exchange rate on a specified date. The FX options market is the deepest, largest and most liquid market for options of any kind in the world.

Market Participants

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Unlike a stock market, where all participants have access to the same prices, the forex market isdivided into levels of access. At the top is the inter-bank market, which is made up of the largest investment banking firms. Within the inter-bank market, spreads, which are the difference between the bid and ask prices, are razor sharp and usually unavailable, and not known to players outside the inner circle. As you descend the levels of access, the difference between the bid and ask prices widens. This is due to volume. If a trader can guarantee large numbers of transactions for large amounts, they can demand a smaller difference between the bid and ask price, which is referred to as a better spread. The levels of access that make up the forex market are determined by the size of the “line” (the amount of money with which they are trading). The top-tier inter-bank market accounts for 53% of all transactions. After that there are usually smaller investment banks, followed by large multi-national corporations (which need to hedge risk and pay employees in different countries), large hedge funds, and even some of the retail forex market makers. According to Galati and Melvin, “Pension funds, insurance companies, mutual funds, and other institutional investors have played an increasingly important role in financial markets in general, and in FX markets in particular, since the early 2000s.” (2004) In addition, he notes, “Hedge funds have grown markedly over the 2001-2004 period in terms of both number and overall size” Central banks also participate in the forex market to align currencies to their economic needs.

Market Size & Liquidity

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The foreign exchange market is unique because of:

1.its trading volume,
2.the extreme liquidity of the market,
3.the large number of, and variety of, traders in the market,
4.its geographical dispersion,
5.its long trading hours - 24 hours a day (except on weekends).
6.the variety of factors that affect exchange rates,According to the BIS ,

average daily turnover in traditional foreign exchange markets was estimated at $1,880 billion. Daily averages in April for different years, in billions of US dollars, are presented on the chart below:Global foreign exchange market turnover:$621 billion$1.26 trillion in derivatives, ie$208 billion in outright forwards$944 billion in forex swaps$107 billion in FX options.Exchange-traded forex futures contracts were introduced in 1972 at the Chicago Mercantile Exchange and are actively traded relative to most other futures contracts. Forex futures volume has grown rapidly in recent years, but only accounts for about 7% of the total foreign exchange market volume, according to The Wall Street Journal Europe .Average daily global turnover in traditional foreign exchange market transactions totaled $2.7 trillion in April 2006 according to IFSL estimates based on semi-annual London, New York, Tokyo and Singapore Foreign Exchange Committee data. Overall turnover, including non-traditional foreign exchange derivatives and products traded on exchanges, averaged around $2.9 trillion a day. This was more than ten times the size of the combined daily turnover on all the world’s equity markets. Foreign exchange trading increased by 38% between April 2005 and April 2006 and has more than doubled since 2001. This is largely due to the growing importance of foreign exchange as an asset class and an increase in fund management assets, particularly of hedge funds and pension funds. The diverse selection of execution venues such as internet trading platforms has also made it easier for retail traders to trade in the foreign exchange market.Because foreign exchange is an OTC market where brokers/dealers negotiate directly with one another, there is no central exchange or clearing house. The biggest geographic trading centre is the UK, primarily London, which according to IFSL estimates has increased its share of global turnover in traditional transactions from 31.3% in April 2004 to 32.4% in April 2006.The ten most active traders account for almost 73% of trading volume, according to The Wall Street Journal Europe, These large international banks continually provide the market with both bid (buy) and ask (sell) prices. The bid/ask spread is the difference between the price at which a bank or market maker will sell ("ask", or "offer") and the price at which a market-maker will buy ("bid") from a wholesale customer. This spread is minimal for actively traded pairs of currencies, usually only 0-3 pips. For example, the bid/ask quote of EUR/USD might be 1.2200/1.2203. Minimum trading size for most deals is usually $100,000.These spreads might not apply to retail customers at banks, which will routinely mark up the difference to say 1.2100 / 1.2300 for transfers, or say 1.2000 / 1.2400 for banknotes or travelers' checks. Spot prices at market makers vary, but on EUR/USD are usually no more than 3 pips wide .Competition has greatly increased with pip spreads shrinking on the major pairs to as little as 1 to 2 pips.

Foreign Exchange Market

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The foreign exchange (currency or forex or FX) market exists wherever one currency is traded for another. It is by far the largest financial market in the world, and includes trading between large banks, central banks, currency speculators, multinational corporations, governments, and other financial markets and institutions. The average daily trade in the global forex markets currently exceeds US$1.9 trillion. Retail traders (individuals) are a small fraction of this market and may only participate indirectly through brokers or banks.

Speculation

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Controversy about currency speculators and their effect on currency devaluations and national economies recurs regularly. Nevertheless, many economists have argued that speculators perform the important function of providing a market for hedgers and transferring risk from those people who don't wish to bear it, to those who do. Other economists however, may consider this argument to be based more on politics and a free market philosophy than on economics.

Large hedge funds and other well capitalized "position traders" are the main professional speculators.
Currency speculation is considered a highly suspect activity in many countries. While investment in traditional financial instruments like bonds or stocks often is considered to contribute positively to economic growth by providing capital, currency speculation does not, according to this view; it is simply gambling, that often interferes with economic policy. For example, in 1992, currency speculation forced the Central Bank of Sweden to raise interest rates for a few days to 150% per annum, and later to devalue the krona. Former Malaysian Prime Minister Mahathir Mohamad is one well known proponent of this view. He blamed the devaluation of the Malaysian ringgit in 1997 on George Soros and other speculators.

Gregory Millman reports on an opposing view, comparing speculators to "vigilantes" who simply help "enforce" international agreements and anticipate the effects of basic economic "laws" in order to profit.

In this view, countries may develop unsustainable financial bubbles or otherwise mishandle their national economies, and forex speculators only made the inevitable collapse happen sooner. A relatively quick collapse might even be preferable to continued economic mishandling. Mahathir Mohamad and other critics of speculation are viewed as trying to deflect the blame from themselves for having caused the unsustainable economic conditions.

'Forex Markets in India - Some Thoughts'

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"It gives me great pleasure to address this gathering of Forex professionals from all over the country. Looking at the list of speakers from the Central Bank who have addressed this August Assembly in the past. I find you have opted for change by inviting the regulator/supervisor rather then the exchange rate policy maker and manager from the RBI. Although I am not very certain as to why, maybe the fact that I was on your side of the market till a few months ago might have prompted this change!
Ever since I have accepted this invitation, I have been pondering about the content of this address. I shall not obviously be speaking at great length either about RBI's Exchange Rate Policies or Management. We have left nobody in doubt about our intentions in this regard i.e., ensuring orderly market conditions and combating excess volatility. Having achieved this to a great degree of success, even in the face of turmoil all around us, this is perhaps the ideal forum for an informed debate as to how we should move forward.
It was once Keynes who remarked that knowing nothing about the past makes a man as primitive as knowing nothing about the future. In other words, one cannot live in the present alone. Although in the financial markets, future need not have a link to the past, nevertheless, it is important to know a bit of the past to make informed predictions about the future. The outline of my address would therefore be to take a birds eye view of the past, reflect on the present scenario and chapter a road map for the future.
In a market orientated economy, segmented markets tend to obscure the transmission of public policies and often result in sub-optimal allocation of resources. In India for a long time the pace of development in the financial segment markets like the money market, foreign exchange market, government securities market, and the capital market have been slow and consequently the markets remained stagnated. A comprehensive package of reform measures recommended by the Narasimham Committee in 1991 became the starting point of gradual deregulation of the financial market. However, it was the implementations of the recommendations of the Sodhani Committee on foreign exchange markets that furthered the course of integration between call money market and foreign exchange market.
The linkage between the call money and forex market existed in a small way in the past as banks were permitted to maintain nostro account surpluses or avail of overdrafts in a limited extent. This has further strengthened following the introduction of FCNR (B) Scheme and particularly after the permission was accorded to burrow and lend overseas up to 15% of the capital. This linkage is often more pronounced in times of volatile market conditions.
The emerging linkages among money, Government securities and foreign exchange markets have required the RBI at times to use short term RBI measures alongside meeting demand-supply mismatches to arrest excessive volatilities in the foreign exchange market. While there is no settled conclusion about the appropriateness of an exchange rate regime, the primary objective of the Reserve Bank, as stated earlier continues to be the maintenance of orderly market conditions no doubt, in a regime where exchange rate is determined by demand and supply conditions. Some of the recent empirical works in the Indian context do suggest evidence of growing integration between money, debt and foreign exchange markets with relatively weak convergence of capital markets. In the aftermath of the terrorist attacks in the US, the Indian financial markets have sometimes exhibited some tendencies to be in tandem with the movements in global financial markets, reflective of the growing inter-linkages between domestic and international markets on the one hand and among various segments of the domestic financial market on the other, as a result of financial sector reforms and increasing globalization led by IT.
In this context, I would like to highlight some critical data regarding the forex market. There is a widespread feeling that market volumes have dropped significantly on account of certain measures taken by the Reserve Bank in the past like withdrawing the freedom to rebook cancelled forward contracts, placing restrictions on swabs etc. But the data collected by the Reserve Bank belie this belief. The average monthly turn over in the merchant segment of the forex market increased from USD 20 billion in 1999-2000 to USD 23 billion during 2000-01. The average monthly turn over in the inter bank foreign exchange market has also increased to USD 90 billion in 2000 -2201. A recent survey of the foreign exchange market turn over during April 2001 by the BIS in which 43 countries including India participated reveals the interesting fact that while forex turn over world over has declined considerable as compared to 1998, India bucks this trend by showing an increased turn over.
Let me now turn to specific issues relating to the Indian forex market that would need to be addressed. The market is skewed with a handful of public-sector banks accounting for the major share of the merchant transactions and private and foreign banks having a greater share of inter-bank business. It is conducive for healthy market development to have much larger number of players active in the market with enhanced volumes of business. The presence of increased number of players and larger volumes alone lend certainly greater depth to the forex market leading to a more efficient functioning.
Forex derivatives have not picked up sufficiently. The development of a vibrant derivatives market in India would critically depend on the growth in the rupee based derivative products, which in turn depends on a well-developed and liquid forward dollar-rupee market. This would in turn require development of a deep and liquid inter-bank term money market. In this regard, making tax laws pertaining to derivatives unambiguous and liberal will go a long way in the development of an active derivative market. In our market in its present stage, the focus of reforms should be the growth of rupee-based derivatives. The RBI took a major step in this context by putting in place an Asset-Liability Management(ALM) system for the banks. But any attempt at making ALM as a catalyst for the development of more vibrant and integrated financial markets would need to recognize the following characteristics of the Indian Financial System.
1) Retail nature of the Indian banking system that makes it difficult to get real time information. The answer lies in spreading technology based solutions.
2) Absence of clear-cut transfer-pricing system, firstly on account of lack of centralization of treasury operation and secondly on account of the absence of a rupee yield curve across maturities. A recent article Zagorski in the Capital Markets News published by the Federal Reserve Bank of Chicago highlights the important transfer pricing system. To quote "without a well-implemented funds transfer pricing system the impact of interest rate risk is buried within the results of the other operating units. Thus a bank would not be able to accurately measure the profitability of either its Treasury units or its business units, and would not precisely understand the volatility of its net interest margin".
3) Absence of adequate instruments to hedge interest rate risk.There is also a need to put comprehensive risk management system in place. Risk management concept, such as, value at risk (VaR) need to be developed and implemented in India market. Technological up gradation in forex transaction, clearing and settlement is pre-requisite for developing a proper risk management system. The setting up of Clearing Corporation of India is a step in this direction. The Clearing Corporation of India, in addition to government securities, will also handle inter-bank forex settlements, which will go a long way in enhancing the efficiency and security of our settlement system for government and forex securities. The objective of forex clearing arrangement is to provide market infrastructure to mitigate and manage settlement risks while also reducing the costs associated with these transactions. The Corporation which is planning to act as a central counter party for effecting clearing and settlement through de facto multilateral netting is in an advanced stage of operationalisation. It is in interest of the authorized Dealers they become members of Clearing Corporation at the earliest and undertake the changes required in regard to their back office software systems to get them integrated with the CCIL system. I understand that shortly FEDIA will be organizing a seminar to help its members to expedite the formalities of taking up membership of Clearing Corporation to hasten the process of implementation of the project. Reserve Bank attaches considerable significance to an early operationalisation of the forex clearing system.
In the context of integration of Indian financial market with international markets, the move towards capital account convertibility, which has an important bearing on our forex market, assumes paramount significance. Some of the preconditions/signposts for capital account convertibility, as mentioned in the CAC committee report, such as, fiscal consolidation mandated inflation rate, consolidation of the financial sector, adequacy of foreign exchange reserves, sound BoP situation, etc need to be adhered to properly before rupee is made fully convertible on capital account. As CAC integrates both the real as well as the financial sectors with the international economy, the impact of external impulses would be felt more strongly, which makes it imperative to have the preconditions in place before full capital account convertibility is allowed.
In the present context, the major thrust of RBI Policies would continue to focus on the development of deep, liquid and integrated financial markets. The importance attached to the forex market would be evident from preamble to the newly enacted Foreign Exchange Management Act. One of the main objectives of FEMA is to promote the orderly development of the foreign exchange market in India.
In this context let us identify issues that are of immediate concern both to the market and to the regulator.
The first issue that would need to be addressed relates to depth and liquidity in the market particularly in the forward segment. It is well known that barring well-developed markets, forward markets are rather shallow in many of the emerging countries. Why? Given the constraints in such emerging markets are there any solutions.?
In most of the developing markets, liquidity is not there for maturities are not available beyond one year period. I believe that this would be the case in most of the markets where there are restrictions on capital movements. In other words, in markets dominated by trade related flows and which are not financially driven, where capital control exist, liquidity across the spectrum as seen in the developed markets, may prove to be difficult at least in the early stages of development of market. The question that we would need to address is within these constraints, how can the liquidity improve? Indian experience suggests that there could be two impending factors in this regard. First is the absence of a well-developed local money market and second more important the reluctance of larger public sector banks who handle the major portion of the export-import transactions to assume the mantle "market makers". While the solution to the first problem partly lies with the central bank and there have been many initiatives in this regard as I had stated earlier, it is entirely up to the bank managements to make their bank more pro-active in the market and realize that forex dealing rooms could be an important profit center, provided proper risk management systems are in place. You may have a point of view that liquidity has come down after the imposition of restrictions on re-booking of cancelled contracts. While this kind of liquidity is an emerging market, which often tends to get one sided, is a database issue, absence of this freedom is more acceptable than wide swings policy prescriptions whenever volatility erupts.
In the developing markets where volumes are not large, it has to be remembered that the positioning of the markets, types of players allowed entry into the market, the amount of unhedged position, all could prove crucial when turbulence erupts. The last mentioned issue that of unhedged positions of the corporates is currently attracting the attention world over. Reserve Bank would welcome and support efforts of bank in monitoring such positions on an ongoing basis since this is closely linked to the issue of credit risk as well.
A major issue that has attracted sustained debate among the Forex market participants during the last one year, has been the issue of long term rupee-foreign currency swap. This was permitted in 1997 as a hedging mechanism for corporates who run long term foreign currency exposures. When instances of use of this product to merely take a view on the currency movements and putting in place structures that would be tantamount to corporates effecting pre payment of the foreign currency loan were noticed, banks were advised last year to put through transactions only on a fully matched basis. The matter has since been reviewed and the banks accorded limited freedom to run a swap book. We are aware that banks have been raising a few issues in this regard and demanding greater freedom to make this product a genuine hedging tool. Reserve bank would continue to monitor transactions in this area and take pro-active decisions with a view to offering further relaxation wherever warranted.
There have been demands from the market players to be accorded greater freedom in the investment of foreign currency funds and using new products like options to better manage their balance sheet and proprietary trading positions. Given the fact that FCNR (B) deposits are presently accepted for maturity ranging up to three years, there is justifiable demands for permitting longer tenor investment out of these funds. Reserve Bank Of India is actively reviewing the current restriction in this regard. Although options could be a very useful to any managing risk positions, particularly at the Treasurer level, there have been very limited demands from the market for using this product. Reserve Bank is open to the suggestions from the banks for using new products to help them in better managing risk.
Finally, Reserve Bank is alive to the developments around us, with its epicenter in US that could have a bearing on the Indian Economy and the financial markets. Several groups within the Reserve Bank are reviewing the positions in its various dimensions on an ongoing basis. Options are considered as developments unfold and expectations are formed. Actions are explored as appropriate to meet the dynamic situation. Our actions since September 11, in regard to various financial markets testify to alertness and promptness of RBI, whenever considered necessary.

12th NATIONAL FOREX ASSEMBLY

2007-10-19T20:32:00.000-07:00

'Forex Markets in India - Some Thoughts'

"It gives me great pleasure to address this gathering of Forex professionals from all over the country. Looking at the list of speakers from the Central Bank who have addressed this August Assembly in the past. I find you have opted for change by inviting the regulator/supervisor rather then the exchange rate policy maker and manager from the RBI. Although I am not very certain as to why, maybe the fact that I was on your side of the market till a few months ago might have prompted this change!

Ever since I have accepted this invitation, I have been pondering about the content of this address. I shall not obviously be speaking at great length either about RBI's Exchange Rate Policies or Management. We have left nobody in doubt about our intentions in this regard i.e., ensuring orderly market conditions and combating excess volatility. Having achieved this to a great degree of success, even in the face of turmoil all around us, this is perhaps the ideal forum for an informed debate as to how we should move forward.

It was once Keynes who remarked that knowing nothing about the past makes a man as primitive as knowing nothing about the future. In other words, one cannot live in the present alone. Although in the financial markets, future need not have a link to the past, nevertheless, it is important to know a bit of the past to make informed predictions about the future. The outline of my address would therefore be to take a birds eye view of the past, reflect on the present scenario and chapter a road map for the future.

In a market orientated economy, segmented markets tend to obscure the transmission of public policies and often result in sub-optimal allocation of resources. In India for a long time the pace of development in the financial segment markets like the money market, foreign exchange market, government securities market, and the capital market have been slow and consequently the markets remained stagnated. A comprehensive package of reform measures recommended by the Narasimham Committee in 1991 became the starting point of gradual deregulation of the financial market. However, it was the implementations of the recommendations of the Sodhani Committee on foreign exchange markets that furthered the course of integration between call money market and foreign exchange market.

The linkage between the call money and forex market existed in a small way in the past as banks were permitted to maintain nostro account surpluses or avail of overdrafts in a limited extent. This has further strengthened following the introduction of FCNR (B) Scheme and particularly after the permission was accorded to burrow and lend overseas up to 15% of the capital. This linkage is often more pronounced in times of volatile market conditions.

The emerging linkages among money, Government securities and foreign exchange markets have required the RBI at times to use short term RBI measures alongside meeting demand-supply mismatches to arrest excessive volatilities in the foreign exchange market. While there is no settled conclusion about the appropriateness of an exchange rate regime, the primary objective of the Reserve Bank, as stated earlier continues to be the maintenance of orderly market conditions no doubt, in a regime where exchange rate is determined by demand and supply conditions. Some of the recent empirical works in the Indian context do suggest evidence of growing integration between money, debt and foreign exchange markets with relatively weak convergence of capital markets. In the aftermath of the terrorist attacks in the US, the Indian financial markets have sometimes exhibited some tendencies to be in tandem with the movements in global financial markets, reflective of the growing inter-linkages between domestic and international markets on the one hand and among various segments of the domestic financial market on the other, as a result of financial sector reforms and increasing globalization led by IT.

In this context, I would like to highlight some critical data regarding the forex market. There is a widespread feeling that market volumes have dropped significantly on account of certain measures taken by the Reserve Bank in the past like withdrawing the freedom to rebook cancelled forward contracts, placing restrictions on swabs etc. But the data collected by the Reserve Bank belie this belief. The average monthly turn over in the merchant segment of the forex market increased from USD 20 billion in 1999-2000 to USD 23 billion during 2000-01. The average monthly turn over in the inter bank foreign exchange market has also increased to USD 90 billion in 2000 -2201. A recent survey of the foreign exchange market turn over during April 2001 by the BIS in which 43 countries including India participated reveals the interesting fact that while forex turn over world over has declined considerable as compared to 1998, India bucks this trend by showing an increased turn over.

Let me now turn to specific issues relating to the Indian forex market that would need to be addressed. The market is skewed with a handful of public-sector banks accounting for the major share of the merchant transactions and private and foreign banks having a greater share of inter-bank business. It is conducive for healthy market development to have much larger number of players active in the market with enhanced volumes of business. The presence of increased number of players and larger volumes alone lend certainly greater depth to the forex market leading to a more efficient functioning.

Forex derivatives have not picked up sufficiently. The development of a vibrant derivatives market in India would critically depend on the growth in the rupee based derivative products, which in turn depends on a well-developed and liquid forward dollar-rupee market. This would in turn require development of a deep and liquid inter-bank term money market. In this regard, making tax laws pertaining to derivatives unambiguous and liberal will go a long way in the development of an active derivative market. In our market in its present stage, the focus of reforms should be the growth of rupee-based derivatives. The RBI took a major step in this context by putting in place an Asset-Liability Management(ALM) system for the banks. But any attempt at making ALM as a catalyst for the development of more vibrant and integrated financial markets would need to recognize the following characteristics of the Indian Financial System.

1) Retail nature of the Indian banking system that makes it difficult to get real time information. The answer lies in spreading technology based solutions.

2) Absence of clear-cut transfer-pricing system, firstly on account of lack of centralization of treasury operation and secondly on account of the absence of a rupee yield curve across maturities. A recent article Zagorski in the Capital Markets News published by the Federal Reserve Bank of Chicago highlights the important transfer pricing system. To quote "without a well-implemented funds transfer pricing system the impact of interest rate risk is buried within the results of the other operating units. Thus a bank would not be able to accurately measure the profitability of either its Treasury units or its business units, and would not precisely understand the volatility of its net interest margin".

3) Absence of adequate instruments to hedge interest rate risk.
There is also a need to put comprehensive risk management system in place. Risk management concept, such as, value at risk (VaR) need to be developed and implemented in India market. Technological up gradation in forex transaction, clearing and settlement is pre-requisite for developing a proper risk management system. The setting up of Clearing Corporation of India is a step in this direction. The Clearing Corporation of India, in addition to government securities, will also handle inter-bank forex settlements, which will go a long way in enhancing the efficiency and security of our settlement system for government and forex securities. The objective of forex clearing arrangement is to provide market infrastructure to mitigate and manage settlement risks while also reducing the costs associated with these transactions. The Corporation which is planning to act as a central counter party for effecting clearing and settlement through de facto multilateral netting is in an advanced stage of operationalisation. It is in interest of the authorized Dealers they become members of Clearing Corporation at the earliest and undertake the changes required in regard to their back office software systems to get them integrated with the CCIL system. I understand that shortly FEDIA will be organizing a seminar to help its members to expedite the formalities of taking up membership of Clearing Corporation to hasten the process of implementation of the project. Reserve Bank attaches considerable significance to an early operationalisation of the forex clearing system.

In the context of integration of Indian financial market with international markets, the move towards capital account convertibility, which has an important bearing on our forex market, assumes paramount significance. Some of the preconditions/signposts for capital account convertibility, as mentioned in the CAC committee report, such as, fiscal consolidation mandated inflation rate, consolidation of the financial sector, adequacy of foreign exchange reserves, sound BoP situation, etc need to be adhered to properly before rupee is made fully convertible on capital account. As CAC integrates both the real as well as the financial sectors with the international economy, the impact of external impulses would be felt more strongly, which makes it imperative to have the preconditions in place before full capital account convertibility is allowed.

In the present context, the major thrust of RBI Policies would continue to focus on the development of deep, liquid and integrated financial markets. The importance attached to the forex market would be evident from preamble to the newly enacted Foreign Exchange Management Act. One of the main objectives of FEMA is to promote the orderly development of the foreign exchange market in India.

In this context let us identify issues that are of immediate concern both to the market and to the regulator.

The first issue that would need to be addressed relates to depth and liquidity in the market particularly in the forward segment. It is well known that barring well-developed markets, forward markets are rather shallow in many of the emerging countries. Why? Given the constraints in such emerging markets are there any solutions.?

In most of the developing markets, liquidity is not there for maturities are not available beyond one year period. I believe that this would be the case in most of the markets where there are restrictions on capital movements. In other words, in markets dominated by trade related flows and which are not financially driven, where capital control exist, liquidity across the spectrum as seen in the developed markets, may prove to be difficult at least in the early stages of development of market. The question that we would need to address is within these constraints, how can the liquidity improve? Indian experience suggests that there could be two impending factors in this regard. First is the absence of a well-developed local money market and second more important the reluctance of larger public sector banks who handle the major portion of the export-import transactions to assume the mantle "market makers". While the solution to the first problem partly lies with the central bank and there have been many initiatives in this regard as I had stated earlier, it is entirely up to the bank managements to make their bank more pro-active in the market and realize that forex dealing rooms could be an important profit center, provided proper risk management systems are in place. You may have a point of view that liquidity has come down after the imposition of restrictions on re-booking of cancelled contracts. While this kind of liquidity is an emerging market, which often tends to get one sided, is a database issue, absence of this freedom is more acceptable than wide swings policy prescriptions whenever volatility erupts.

In the developing markets where volumes are not large, it has to be remembered that the positioning of the markets, types of players allowed entry into the market, the amount of unhedged position, all could prove crucial when turbulence erupts. The last mentioned issue that of unhedged positions of the corporates is currently attracting the attention world over. Reserve Bank would welcome and support efforts of bank in monitoring such positions on an ongoing basis since this is closely linked to the issue of credit risk as well.

A major issue that has attracted sustained debate among the Forex market participants during the last one year, has been the issue of long term rupee-foreign currency swap. This was permitted in 1997 as a hedging mechanism for corporates who run long term foreign currency exposures. When instances of use of this product to merely take a view on the currency movements and putting in place structures that would be tantamount to corporates effecting pre payment of the foreign currency loan were noticed, banks were advised last year to put through transactions only on a fully matched basis. The matter has since been reviewed and the banks accorded limited freedom to run a swap book. We are aware that banks have been raising a few issues in this regard and demanding greater freedom to make this product a genuine hedging tool. Reserve bank would continue to monitor transactions in this area and take pro-active decisions with a view to offering further relaxation wherever warranted.

There have been demands from the market players to be accorded greater freedom in the investment of foreign currency funds and using new products like options to better manage their balance sheet and proprietary trading positions. Given the fact that FCNR (B) deposits are presently accepted for maturity ranging up to three years, there is justifiable demands for permitting longer tenor investment out of these funds. Reserve Bank Of India is actively reviewing the current restriction in this regard. Although options could be a very useful to any managing risk positions, particularly at the Treasurer level, there have been very limited demands from the market for using this product. Reserve Bank is open to the suggestions from the banks for using new products to help them in better managing risk.

Finally, Reserve Bank is alive to the developments around us, with its epicenter in US that could have a bearing on the Indian Economy and the financial markets. Several groups within the Reserve Bank are reviewing the positions in its various dimensions on an ongoing basis. Options are considered as developments unfold and expectations are formed. Actions are explored as appropriate to meet the dynamic situation. Our actions since September 11, in regard to various financial markets testify to alertness and promptness of RBI, whenever considered necessary.