Forex Manual

ForexConfidential

SECTION THE FX MARKET (PAGE 2)

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I. What is the FX Market?

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II. Why Trade FX?

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Enormous Liquidity No Slippage Market Transparency Trending Markets 24-hour Access Low to Zero Transaction Cost High Leverage Low account Minimums No Bear-Only Market Above Average Profit Potential

III. Brief History of the FX Market

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IV. Market Structure Overview Interbank Market Hours Markets within the FX Market

V. Key Players in FX Market Commercial and Investment Banks Central Banks The Federal Reserve (Fed) The European Central Bank (ECB) Bank of England (BoE) Swiss National Bank (SNB) The Bank of Japan (BOJ) Bank of Canada (BoC) Corporations Hedge Funds and International Funds FX Funds Individuals

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VI. International Overview

(PAGE 4-6) Gold Exchange Standard Bretton Woods Accord Smithsonian Agreement Free-Floating System

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VII. FX Regulations CFTC NFA

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VIII. Your Role in the FX Market

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IX. How Can Forex be Accessed?

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THE FX MARKET Part I. What is the FX Market? The “Foreign Exchange” market, also referred to as the “Forex” or “FX market”, is the largest market in the world with over $1.5 trillion changing hands daily and soon expected to top $2 trillion. Compare that to the New York Stock Exchange at $28 billion, the equities market at $191 billion, and the daily value of the futures market at $437.4 billion, and you will clearly see that the FX market alone is approximately three times the total amount of the US Equity and Treasury markets combined.

Unlike other financial markets, the Forex market has no physical location and no central exchange. It operates through an electronic network of banks, corporations, institutional investors, and individuals trading one currency for another. The lack of a physical exchange enables the Forex market to operate on a 24-hour basis, spanning from one time zone to another, across the major financial centers around the world. The FX market plays a key role in transferring financial payments across borders and moving funds and purchasing power from one currency to another. This international market plays an extensive and direct role in national economies and has a major impact that

affects our lives and our prosperity. The movement of different currencies between countries determines a very important price — the exchange rate. It is the exchange rate that allows the currencies to be traded for profit. There are two major reasons to buy and sell currencies: 1) About 5% of daily turnover is from companies and governments that buy or sell products and services in foreign countries, then profits made are converted back into their domestic currency. 2) The other 95% is trading for profit or speculation, which translates to the tremendous profit- potential in this highly lucrative market. Trading for speculation in the FX market has increased tremendously throughout the years as institutions and individuals recognize the high profit potential in this highly lucrative market. Although speculative trading is increasing, not everyone involved in Forex is a speculator. Therefore, there is far less risk of manipulation within the FX market. Even in the case of central bank intervention, the overall effect on the FX market is relatively insignificant. Forex is a genuine market in which the prices of currencies are solely determined by the forces of supply and demand. As a result, all market participants, including individual traders, are well-protected from artificial manipulation of prices. Unfortunately, this protection for traders does not extend to other markets. In the equity market, everyone is a speculator, including individuals and corporations. When everyone is speculating for profit, manipulation of prices is inevitable. Consequently, traders in the equity market suffer immensely when prices are manipulated by various institutions. Until recently, large international banks dominated the FX market, only allowing access via telephone trading to major corporations, large funds, and high net worth individuals. This little known, underexposed, foreign exchange currency market can now be traded online and is available to the general public with a minimal capital investment of $300. Individual investors now have the opportunity to trade in the largest and most liquid financial market in the world.

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THE FX MARKET Part II. Why Trade FX? Foreign exchange is by far the preferred market choice for aggressive traders. The FX market offers unparalleled liquidity, no slippage, market transparency, trending markets, 24-hour access, low to zero transaction cost, high leverage, low account minimums, no bear-only market, and most importantly, above average profit potential. Enormous Liquidity The FX market is the most liquid market in the world. It can absorb trading volumes and per-trade sizes that may overwhelm any other market. Trading essentially consists of two parts: opening a position and closing of that position. Liquidity, which is highly correlated with volume, qualitatively evaluates how easily traders can enter and exit positions. A liquid market enables participants to execute large volume transactions with little impact on market prices. On the simplest level, the enormous liquidity alone is powerful enough to attract any investor to the FX market, as it suggests the freedom to open or close a position at will. In addition, technical analysis, the study of price movements, operates better in liquid markets. Illiquid markets make it much more difficult to accurately determine entry and exit points. No Slippage Traders in illiquid markets may experience delays and subsequently, suffer from slippage. In these markets, there may be delays in the execution of traders’ orders and thus, market orders could potentially be filled at a different price from the market rate when the order was initially placed. Furthermore, traders may experience difficulty in exiting or selling positions, which greatly compromises the ability to clear profitable trades. In the FX market, there is absolutely no slippage — traders will always get in and out at the price they placed their orders. This is due to the tremendous amount of volume that the FX market generates. Market Transparency Market transparency is highly desired in a trading environment. It is a condition in which market participants are able to observe the detailed information

in the trading process. Ultimately, the greater the market transparency, the more efficient the market becomes. The FX market offers the highest level of market transparency out of all financial markets. Informed traders are better off than uninformed traders because most financial markets could be exploited by those with private information. Traders in all financial markets rely on market transparency because it allows them to see a transparent spread, which enables them to employ their premeditated strategies while still flexible enough to accommodate an ever-changing marketplace. With the transparency of information, traders can exercise their risk management strategies in accordance to their fundamental and technical approaches. For example, in the case of Enron, inaccurate reporting by officers of the company resulted in the downfall of the company and losses of many shareholders. Markets where this could occur are considered a poor trading market. Furthermore, market transparency ensures the ability to trade from live, executable prices. Markets that do not offer executable prices and force traders to absorb slippage, obviously compromise traders’ profit potential. Trending Markets Although currency prices in the FX market may be volatile, they generally repeat themselves in cycles, creating trends. The trends can be analyzed by traders using technical tools. Since technical analysis statistically works better in markets characterized by cycles and trends, traders benefit from this attribute of Forex. The entire premise of technical analysis is based on the study of price movements. Through this analysis, traders can identify trends and capture key entry and exit points at which they should execute their trades and maximize their profit potential. 24-hour Access Forex is a true 24-hour, 6 days a week, market. FX trading begins each day in Australia and moves around the globe as the business day begins in each financial center — first to Tokyo, then London, and New York.

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THE FX MARKET Unlike any other financial market, investors can respond to currency fluctuations caused by economic, social, and political events at the time they occur regardless if it is daytime or nighttime. The only breaks in trading occur during a brief period over the weekend. A trader is able to put on a trade during the London session, follow it during the New York session, and close the trade in the middle of the following day during the Tokyo session. This type of market access is invaluable to a market participant who needs to react quickly to global events. Low to Zero Transaction Cost The amount of cost to execute trades has dropped considerably in recent years. Transaction costs include all the expenses to actually execute a trade. Because transaction costs reduce profits, the lower the transaction costs, the more beneficial it is for the trader. Markets that have centralized exchanges tend to have higher transaction costs due to exchange and clearing fees associated with trading. Active stock and futures traders often see substantial portions of their gross profits going to broker commissions, exchange fees, and data/chart feeds. Transaction costs can also be increased with faulty executions. As regards the FX market, there are minimal to no brokerage fees and zero exchange and clearing fees since it is an over-thecounter market.. What you see is what you get, allowing you to make quick decisions on your trades without having to account for fees that may affect your profit/loss or slippage. High Leverage The FX market provides traders with access to much higher leverage than other financial markets. FX traders can benefit from leverage in excess of 100 times their capital versus the 10 times capital that is typically offered to professional equity day traders. In the FX market, the margin deposit for leverage is not a down payment on a purchase of equity; instead, it is a performance bond, or good faith deposit, to ensure against trading losses. This is very useful to short-term day traders who need the enhancement in capital to generate quick returns.

Low Account Minimums Many individuals believe that entering the highly lucrative foreign exchange market requires large initial trading capital. This was indeed true prior to 1996, without the integration of online trading into the FX market. Today, individuals can get Started with a miniaccount for as little as $300. No Bear-Only Market One of the biggest advantages of trading FX is that there is no fear of a bear-only market. In many markets, high-return investments can often be difficult to sell after they are bought. However, in Forex, the major currency pairs always have buyers and sellers; hence, the FX investor should never worry about being “stuck” in a trade due to lack of market interest.

Above Average Profit Potential There is no question that speculative trading in Forex offers huge profit potential. It is an exciting way to earn exceptionally high returns on one’s investment capital.

Part III. Brief History of the FX Market

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THE FX MARKET The Foreign Exchange market, (“FX” or “Forex”) as we know it today, originated in 1973. However, money has been around in one form or another since the time of the Egyptian Pharaohs. While the Babylonians are credited with the first use of paper bills and receipts, Middle Eastern moneychangers were the first currency traders exchanging coins of one culture for another. During the middle ages, paper bills emerged as an alternative form of currency besides coins. These paper bills represented transferable third party payments of funds, which made foreign exchange much easier and less cumbersome for merchants and traders. From the infantile stages of Forex during the Middle Ages to World War I (WWI), the Forex market was relatively stable and without much speculative activity. After WWI, it became very volatile and speculative activity increased ten fold. Speculation in the Forex market was not looked on as favorable by most institutions and the public in general. The Great Depression and the removal of the gold standard in 1931 created a serious lull in Forex activity. From 1931 until 1973, the Forex market went through a series of changes. These changes greatly impacted the global economies at the time. There was little if any speculation in the Forex market during these times. Gold Exchange Standard The “Gold Exchange Standard”, which prevailed between 1876 and WWI, dominated the international economic system. Under the gold exchange standard, currencies gained a new phase of stability as they were supported by the price of gold. It abolished the age-old practice in which kings and rulers arbitrarily debased money and triggered inflation. However, the gold exchange standard had its weakness. As an economy strengthened, it would import heavily from abroad until it ran down its gold reserves required to back its money. As a result, money supply would shrink, interest rates would rise, and economic activity would slow down to the extent of recession. Ultimately, prices of goods would bottom out, appearing attractive to other nations. Consequently, this would cause a rush in buying sprees that would inject

the economy with enough gold to increase its money supply, drive down interest rates, and recreate wealth into the economy. Such patterns prevailed throughout the gold standard until the outbreak of WWI, which interrupted trade flows and the free movement of gold. Several other major transformations occurred after the Gold Exchange Standard, leading to the birth of the current FX market: the Bretton Woods Accord, Smithsonian Agreement, and the Free-Floating System. Bretton Woods Accord The first major transformation, the Bretton Woods Accord, occurred toward the end of World War II. A total of 44 countries, including the United States, Great Britain, and France met in New Hampshire in July 1944, to design a new economic order.

The design of the Bretton Woods framework was to have the United States become an anchor for all free world currencies. The accord aimed at installing international monetary stability by preventing money from fleeing across nations and restricting speculation in the world currencies. Major currencies were pegged to the dollar, which was in turn tied to gold at a value of $35 per ounce. The dollar was the primary reserve currency and member countries were able to sell currency to the Federal Reserve in exchange for gold at the present rate. In addition to these interventions, the International Monetary Fund (IMF) and the International Bank for Reconstruction and Development (World Bank) were established to ensure that the Bretton Woods system would operate effectively.

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THE FX MARKET Once the Bretton Woods Agreement was founded, the participating countries agreed to try and maintain the value of their currency with a narrow margin against the dollar and a corresponding rate of gold as needed. Countries were prohibited from devaluing their currencies to their trade advantage and were only allowed to do so for devaluations of less than 10%. Trading under the Bretton Woods system had unique characteristics. Since exchange rates were fixed, intense trading took place around devaluation or revaluation, known as creeping pegs. Speculation against the British pound in 1967 demonstrated creeping pegs patterns. Despite all the efforts by the Bank of England and other central banks to support the pound, the pound was devalued. This failure was monumental because it was the first time that the central bank intervention failed under the Bretton Woods system. The failure of the central bank intervention continued with the dollar in the following years. As the Bretton Woods system was highly dependant on a strong US dollar, the dollar began to experience pressure in 1968, causing extreme speculation on the future of this system. The Agreement was finally abandoned in 1971, and the US dollar would no longer be convertible into gold. Smithsonian Agreement After the Bretton Woods Accord came to an end, the Smithsonian Agreement was signed in December of 1971. This agreement was similar to the Bretton Woods Accord, but it allowed for a greater fluctuation band for foreign currencies. The Smithsonian Agreement strived to maintain fixed exchange rates, but to do so without the backing of gold. Its key difference from the Bretton Woods system was that the value of the dollar could float in a range of 2.25%, as opposed to just 1% under Bretton Woods. Ultimately, the Smithsonian Agreement proved to be unfeasible as well. Without exchange rates fixed to gold, the free market gold price shot up to $215 per ounce. Moreover, the U.S. trade deficit continued to grow, and from a fundamental standpoint, the US dollar

needed to be devalued beyond the 2.25% parameters established by the Smithsonian Agreement. In light of these problems, the foreign exchange market was forced to close in February of 1972. In 1972, the European community tried to move away from their dependency on the dollar. The European Joint Float was established by West Germany, France, Italy, the Netherlands, Belgium, and Luxemburg. Both agreements made mistakes similar to the Bretton Woods Accord and by 1973, collapsed. Free-Floating System The collapse of the Smithsonian agreement and the European Joint Float in 1973 signified the official switch to the free-floating system. This occurred by default as there were no new agreements to take their place. Governments were now free to peg their currencies, semi-peg, or allow them to freely float. In 1978, the freefloating, system was officially mandated. The value of the US dollar was to be determined entirely by the market, as its value was not fixed to any commodity, nor was the fluctuation of its exchange rate confined to certain parameters. While this did provide the US dollar, and other currencies by default, the agility required to adapt to a new and rapidly evolving international trading environment, it also set the stage for unprecedented inflation. Europe tried to gain independence from the dollar by creating the European Monetary System in July of 1978. This, like all of the earlier agreements, failed in 1993. The major currencies today move independently of other currencies. The currencies are traded by anyone who wishes to trade. This has caused a recent influx of speculation by banks, hedge funds, brokerage houses, and individuals. Central banks intervene on occasion to move or attempt to move currencies to their desired levels. The underlying factor that drives today’s Forex market, however, is supply and demand. The freefloating system is ideal for today’s markets.

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THE FX MARKET Part IV. Market Structure Overview Unlike other financial markets, the Forex market has no physical location and no central exchange; hence, it is considered an over-the-counter (OTC) market. The FX market operates through an electronic network of banks, corporations, institutional investors, and individuals trading one currency for another. Forex traders and market makers are all linked to one another round the clock via computers, telephones, and faxes where currency denominations, amounts, settlement dates, and prices are negotiable. The lack of a physical exchange enables the Forex market to operate on a 24hour basis, spanning from one time zone to another, across the major financial centers around the world. The FX market is organized into a hierarchy, which consists of participants with different ranking. The standards that determine the participants’ positions are credit access, volume of transactions, and level of sophistication; those with superiority in these measures receive priority in the FX market. At the top of the hierarchy is the interbank market, which generates the highest volume in trades. Interbank Interbank is a credit-approved system where banks trade on the sole basis of their credit relationships with one another. In the interbank market, the largest banks are able to trade with each other directly, via interbank brokers or through electronic brokering systems such as Reuters and EBS. While all the banks can see the rate that everyone is dealing at, each bank has a specific credit relationship with the other bank and trade at the rates being offered.

Other institutions in the market, such as corporations, online FX market makers, and hedge funds trade FX through commercial banks. However, many banks

(community banks and banks in emerging markets), corporations, and institutional investors do not have access to these rates because they do not have established credit relationships with large commercial banks. Subsequently, these smaller participants are obligated to trade FX through a large bank, and often, this equates to much less competitive rates. The rates become less and less competitive as it trickles down the hierarchy of participants. Eventually, the customers of banks and foreign exchange agencies receive the least competitive rates. However, in the late 1990’s, technological advances have eliminated the barriers that existed between the interbank and end-users of FX. Since 1996, retail clientele can connect directly to market makers via online trading. Average traders can enjoy the competitive rates and trade alongside the world’s largest banks.

The FX market is no longer reserved for big corporations; it is now made available to all types of consumers. Furthermore, the boundless opportunity to trade foreign exchange awaits all aspiring corporations and individual traders. Market Hours The spot FX market is unique to any other market in the world since trading is available. 24 hours a day. Somewhere around the world, a financial center is open for business, and banks and other institutions exchange currencies every minute of the day with only minor gaps on the weekend. The FX market opens at 5 pm (EST) on Sunday and close at 1 pm (EST) on Friday. The major financial centers around the world overlap due to their time zones. The International Date Line is located in the Western Pacific. Each business day begins in Wellington, New Zealand, then Sydney, Australia, followed by the Asian financial markets starting with Tokyo, Japan, Hong Kong, China, and finally Singapore. Only a few hours later, markets will open in the Middle East. When the markets in Tokyo are starting to wind down, Europe opens for business.

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THE FX MARKET Finally, New York and other major U.S. centers start their day. Towards the late afternoon in the United States, the next day arrives in the Western Pacific areas and the process begins again. Hence, the FX market is opened 6 days a week, 24 hours a day.

Markets within the FX Market Although spot trading accounts for 48% of all FX transactions worldwide, the three main markets, Tokyo, London, and New York, represent almost 70% of the world’s FX volume. Foreign exchange activity does not flow evenly, and throughout the course of the international trading day, there are certain markets characterized by very heavy trading activity in some (or all) currency pairs. At other times, the same markets are characterized by light activity in some (or all) currency pairs. Foreign exchange activity tends to be the most active when markets overlap, particularly the U.S. markets and the major European markets; i.e., when it is morning in New York and afternoon in London. As Japan’s economy has dwindled over the past decade, Japanese banks have been unable to commit to FX, the large amounts of capital they once did in the 1980’s. Despite this, Tokyo is the first major market to open, and many large participants use it to get a read on dynamics or to begin scaling into positions. Approximately 10% of all FX trading volume takes place during the Tokyo session. Trading can be relatively thin.

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THE FX MARKET Hedge funds and banks have been known to use the Tokyo lunch hour to run important stop and option barrier levels. Japanese yen, New Zealand dollar, and Australian dollar pairs tend to be the biggest movers during Tokyo hours as other currencies are quite thin and usually remain constant.

London is by far the most important and influential FX market, with approximately 30% of all worldwide transactions. Most big bank’s dealing desks stem from London and the market is responsible for roughly 28% of the total world spot volume. London tends to be the most orderly market due to the large liquidity and ease of completing transactions. Most large market participants use London hours to complete serious foreign exchange deals.

New York is the second most important market that represents approximately 16% of total worldwide market volume. In the United States spot market, the majority of deals are executed between 8am and 12pm, when European traders are still active. Trading often becomes slower in the afternoon as liquidity dries up. In fact, there is a drop of over 50% in trading activity since California never served to bridge the gap between the U.S. and Asia. As a result, traders tend to pay less attention to market development in the afternoon. New York is greatly affected by the U.S. equity and bond markets, thus the pairs will often move closely in tandem with the capital markets.

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THE FX MARKET Part V. Key Players in the FX Market With the advances of technology and especially the opening on the Internet, the foreign exchange market has expanded from simple foreign exchange and bank transactions to a more speculative nature. Today, an increasing number of FX transactions are trading for profit or speculation, which translates to the tremendous profit-potential in this highly lucrative market. There are five major players in the FX market; Commercial/Investment Banks, Central Banks, Corporations, Hedge/International Funds, and individuals. Commercial and Investment Banks Commercial and investment banks account for the largest portion of FX trading volume. The lnterbank market caters to both the majority of commercial turnovers as well as enormous amounts of speculative trading everyday. Their primary role in the FX market is essentially selling currencies, as other participants execute trades through them. Banks trade currencies because it is highly lucrative and it limits their credit exposure on Letters of Credit. Banks gain profits by acting on their clients’ behalf and making trades. About three quarters of all foreign exchange trading is between banks. They generate billions of dollars worth of currency in a day’s volume. Below is a list of the top financial institutions in the world as rated by Euromoney Magazine in their May, 2001 edition.

Central Banks Central banks play a significant role in the FX market as they can influence spot price fluctuations. Central banks generally do not speculate in currencies, but they use currencies to promote acceptable trading conditions to their banking industries by affecting money supply and interest rates through open market operations or the active trading of government securities. Central banks also often attempt to restore order to volatile markets through interventions. The reasons for central bank interventions may be a result of a variety of factors: to restore stability, protect a certain price level, slow down currency movements, or to reverse a trend. An example would be the recent intervention by the Bank of Japan to push down the value of the yen. On the surface, this may disturb many traders to make their investment decisions. However, it has been proven time and again that central banks can only influence currency values for short periods. Over time, the markets adjust to the changes, creating trend formations that may be very beneficial to traders. Trend strategies may guide FX traders to take advantage of these trends in the market. Central banks normally keep sizeable amounts of foreign currencies on hand; hence, their influence is so great that the mere mention of central banks’ interventions would violently move the market. As their investments are generally more long-term, central banks’ trades are quite profitable. The major central banks include: The Federal Reserve, European Central Bank, Bank of England, Swiss National Bank, Bank of Japan, and Bank of Canada. The Federal Reserve (Fed): The Federal Reserve Board (Fed) is the central bank of the United States. They are responsible for setting and implementing monetary policy. The board consists of a 12-member committee, which comprise the Federal. Open Market Committee (FOMC). The voting members of the FOMC are the seven Governors of the Federal Reserve Board, plus five Presidents of the twelve district reserve banks. The FOMC holds 8 meetings per year, which are widely watched for interest rate announcements or changes in

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THE FX MARKET growth expectations. The Fed has a high degree of independence to set monetary authority. They are less subject to political influences, as most members are assigned long term positions that allow them to remain in office through periods of alternate party dominance in both the Presidency and Congress. The U.S. Treasury is responsible for issuing government debt and for making fiscal policy decisions. Fiscal policy decisions include determining the appropriate level of taxes and government spending. The U.S. Treasury is the actual government body that determines dollar policy. That is, if. they feel that the USD rate in the foreign exchange market is under- or overvalued, they are in the position of giving the NY Federal Reserve Board the instructions to intervene in the FX market by physically selling or buying USD. Therefore, the Treasury’s view on dollar policy, and changes to that view, is very important to the currency market. The European Central Bank (ECB): The European Central Bank (ECB) is the governing body responsible for determining the monetary policy of the countries participating in the European Member Union (EMU). The Executive Board of the EMU consists of the President and Vice President of the ECB and four other members. These individuals along with the governors of the national central banks comprise the Governing Council. The ECB is set up so that the Executive Board implements the policies dictated by the Governing Council. New monetary policy decisions are typically made by a majority vote in biweekly meetings, with the President having the casting vote in the event of a tie. The primary objective of the European Central Bank is to maintain price stability. ECB is considered “inflation paranoid” as it has strong German influence. ECB aand the ESCB are independent institutions from both national governments and other EU institutions, giving them total control over monetary and currency policy. The European central bank is a strict monetarist and much more likely to keep interest rates high. Two edicts of monetary policy are: to keep a harmonized Consumer Price Index (CPI) below 2% and an M3 annual growth (Money supply) around 4.5%. Refinance rate is the main weapon used by the

ECB to implement EU monetary policy. ECB watches the fiscal discipline of its members closely. ECB is considered an untested central bank and doubts linger as to how they will react to any future crisis. The ECB keeps close tabs on budget deficits of the individual countries as the Stability and Growth Pact states that they must be kept below 3% of Gross Domestic Production (GDP). The ECB does intervene in the FX markets, especially when inflation is a concern. Comments by members of the Governing Council frequently move the EUR and are widely watched by FX market participants. Bank of England (BoE): The Bank of England (BoE) is the central bank of the United Kingdom. The bank was founded in 1694, nationalized in 1946, and gained operational independence in 1997. The BoE is committed to promoting and maintaining a stable and efficient monetary and financial framework as its contribution to a healthy economy. In 1997, parliament passed the Bank of England Act, giving the BoE total independence in setting monetary policy. Prior to 1997, the BoE was essentially a governmental organization with very little freedom. Treasury’s role in setting monetary policy diminished markedly since 1997. However, the Treasury still sets inflation targets for the B0E, currently defined as 2.5% annual growth in Retail Prices Index (RPI), excluding mortgages (RPIX). The treasury is also responsible for making key appointments at the Central Bank. The BoE’s nine member Monetary Policy Committee (MPC) is responsible for making decisions on interest rates. Although the MPG has independence in setting interest rates, the legislation provides that in extreme circumstances the government may intervene. The Bank of England’s main policy tool is the minimum lending rate or base rate. Changes to the base rate are usually seen as a clear change in monetary policy. The BoE most frequently affects monetary policy through daily market operations (the buying/selling of government bonds). The BoE is infamous for attempting to influence exchange rates through impure market interventions.

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THE FX MARKET Swiss National Bank (SNB): The Swiss National Bank is the central Bank of Switzerland. The Swiss National Bank enjoys 100% autonomy in determining the nation’s monetary and exchange rate policies. In December 1999, the SNB shifted from a monetarist approach to an inflation-targeting one (2% annual inflation target). Discount rate is the official tool used to announce changes in monetary policy; however, it is rarely used as the bank relies more on the 3-month London Interbank Offer Rate (LIBOR) to manipulate monetary policy. The LIBOR is the rate at which major international banks lend to one another; it primarily serves as a benchmark for short-term interest rates. SNB officials often affect the Franc spot movements by making remarks on liquidity, money supply, and the currency itself. Intervention is frequent; however, most often intervention is used to enforce economic policy. It is also used in open market operations, such as raising or lowering interest rates, to affect the value of its currency. As a country where international trade has been the primary source of the country’s economic development, its preference is for a weaker franc, in order for its exports to remain competitive. SNB is highly regarded and the franc is considered by most market participants to be the world’s best managed currency. The Bank of Japan (BOJ): The Bank of Japan (BoJ) is the key monetary policymaking body in Japan In 1998 the Japanese government passed laws giving the BoJ operational independence from the Ministry of Finance (MoF). It was given the complete control over monetary policy. However, despite the government’s attempts to decentralize decision-making, the MoF still remains in charge of foreign exchange policy. The MoF is considered the single most important political and monetary institution in Japan. MoF officials frequently make statements regarding the economy, which have notable impacts on the yen. The BoJ is responsible for executing all official Japanese FX transactions at the direction of the MoF. However, it is important to note that the Bank of Japan does possess total autonomy

over monetary policy and can have significant indirect impacts on foreign exchange rates. The BoJ’s main economic tool is the overnight call rate. The call rate is controlled by the open market operations and any changes to it often signify major changes in monetary policy. Since the introduction of a floating exchange rate system in February 1973, the Japanese economy has experienced large fluctuations in Forex rates, with the yen on a long rising trend. The reason for the yen’s strength, despite the excessive problems that have plagued the Japanese economy, is the fact that Japan has a trade surplus accounting for 3% of GDP. This is the highest of the G-7 countries and therefore creates a strong inherent demand for the currency for trade purposes, regardless of their economic conditions. The Japanese government is notorious for directly intervening on behalf of the yen through market interventions. BoJ interventions are frequent and violent. As an export-driven country, there are strong political interests in Japan for maintaining a weak yen in order to keep exports competitive. Accordingly, the BoJ has been known to go into the market and sell off the yen when its rate is perceived to be too strong. Bank of Canada (BoC): The Bank of Canada (BoC) is the central bank of Canada. The Governing Council of the Bank of Canada is the board that is responsible for setting monetary policy and is an independent Central bank that has a tight reign on its currency. This council consists of seven members: the Governor and six Deputy Governors. The BoC does not have regular periodic policy setting meetings. Instead, the council meets on a daily basis and may make changes in policy at any time. Due to its tight economic relations with the United States, the Canadian dollar has a strong connection to the US dollar. Corporations Corporations which comprise a diverse group of small and large corporations, importers/exporters, financial service firms, and consumer service firms, were the major traders in currencies for many years.

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THE FX MARKET Corporations’ main interests in foreign exchange are to perform transactions related to cross border payments. Multinational corporations may need to make payments to foreign entities for materials, labor, marketing/advertising costs, and/or distributions, which would require the exchange of currencies. The primary focus of multinational corporations in the marketplace is to offset risk by hedging against currency depreciation, which would affect future payments. Now, however, a minority has begun to use the marketplace as a speculative tool; meaning, they enter the FX market purely to take advantage of expected currency fluctuation. This group of corporations using the FX market for speculative purposes is growing, and as very active participants, they have a great impact on spot market prices. Corporations’ approach to trading tends to be longer-term since they use the market for covering commercial needs, hedging, and speculations. Hedge Funds and International Funds Global fund managers, hedge, large mutual, pension, and arbitrage funds that invest in foreign securities and other foreign financial instruments are relatively small. Although they may be small when compared to other market participants, they are the most aggressive. These groups can have substantial impacts on spot price movements as they are constantly re-balancing and adjusting their international equity and fixed income portfolios. These portfolio decisions can be influential because they often involve sizable capital transactions. A majority of the hedge funds are highly leveraged and actively seeking to profit in whichever way possible. Despite the highly criticized, sometimes devious nature of hedge funds, they are valued by traders because they often push the markets to retract from extreme levels. Hedge funds are used by high net worth individuals investing a minimum of $1 million. One of the best known Hedge Funds is the George Soros Quantum Group of Funds that made a billion dollar profit by shorting the British pound in 1992. International Funds are non-currency funds consisting of large capital, which exert substantial influence on the FX market. With more and more funds delegated to hedging activities, international funds are becoming a

main driver of international capital and equities trends, which in turn, greatly affects the Forex market. FX Funds Funds that invest in the FX are commonly called Global Macro funds. These funds depending on size tend to take different positions in the FX market. Many large funds tend to carry large trade positions, exploiting global interest rate differentials. Others tend to seek out opportunities to take advantage of misguided economic policies or currencies that overshoot their real value; by entering large positions, they are bethng on a return to equilibrium. Others simply gauge global events and take a longer-term view on which currencies will strengthen or weaken in the next six to eight months. Fund participation in the FX market has risen sharply in recent years and its total trading share is now around 20%. There is no doubt that with the increasing amount of money some of these investment vehicles have under management, the size and liquidity of the foreign exchange market is very appealing. While relatively small compared to other market participants, when acting together, they can have a profound effect on the currency spot movements. Individuals Retail spot currency trading is the new frontier of the trading world. Up until 1996, foreign exchange trading was only available to large banks, institutions, and extremely high net worth individuals. Prior to online retail FX dealers, individuals could not realistically participate in the FX market from a speculative standpoint. The interbank market operated as a tight circle; it acted somewhat like a specialist, as it manipulated the fates of tiers 2 and 3 to accommodate its own needs. Accordingly, individual traders looking to trade FX could not find a market maker capable of providing competitive spreads, fair quotes, and equitable customer service. With the advancement of technology, the internet, and online trading platforms, retail clients are provided with access to trading that is highly comparable to the offerings of the interbank market. Spreads are slightly wider at 5 pips on most currency pairs, as opposed to

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THE FX MARKET the interbank standard of 3 pips, but execution is unsurpassed. Now retail clients and multinational institutions can participate in the FX market on a highly equitable playing field.

Part VII. International Overview The International Monetary Fund (IMF) is a cooperative organization that 182 countries have voluntarily joined. It exerts an international influence over world monetary issues, including the foreign exchange market. However, it has no effective authority, either by law or implied, over the domestic policies of its members.

Part VII. FX Regulations For many years, the retail online foreign exchange industry languished due to the lack of a regulatory environment to uphold investor protection. In December of 2000, however, Congress passed and the President signed the Commodities Modernization Act. The Act finally regulated the foreign exchange industry and placed its oversight under the auspices of the Commodities Futures Trading Commission (www.cftc.gov). CFTC The Commodity Futures Trading Commission (CFTC) was created by Congress in 1974 as an independent agency with the mandate to regulate commodity futures and option markets in the United States. The agency protects market participants against manipulation, abusive trade practices, and fraud. Through effective oversight and regulation, the CFTC enables the markets to better serve their important functions in the nation’s economy, providing a mechanism for price recovery and a means of offsetting price risk. The CFTC sets forth many of the guidelines that the National Futures Association is required to follow. NFA The National Futures Association (NFA) officially began its operations on October 1, 1982, with the goal of maintaining the integrity of the futures marketplace. All companies trading in futures must become NFA members. Those companies that are not registered with the NFA are subject to closure by the CFTC. The passage of the Commodities Modernization Act requires that any company trading online forex be registered with the NFA. The NFA has many capital requirements and makes sure companies maintain high bookkeeping and ethical standards in order to be registered. With the passage of the Modernization Act, the NFA required forex market makers to register as Futures Commission Merchants (FCMs).

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THE FX MARKET Part VIII. Your Role in the FX Market

Part IX. How Can Forex be Accessed? At the most basic retail level, one can access Forex at any airport currency booth. For a service fee and a mark-up of 5-10%, one can buy or sell currencies. In fact, for many individuals, a trip to the currency exchange booth overseas is their first introduction to Forex.

You may not realize it, but you already play a role in the foreign exchange market. Do you have some currency in your pocket or wallet? Do you have a checking or savings account? Do you have a mortgage? Do you run a business? Do you hold stocks, bonds, or other investments with a value expressed in a specific currency? A “yes” response to any of the above questions already makes you an investor in the currency markets.

Investors wishing to speculate in the FX market can now access Forex through dealers offering margin accounts as small as $300, with a price spread that is as little as 4-5 pips. High net worth individuals, corporations, or fund managers with private banking relationship should be able to trade through their banks, while corporate clients requiring the actual delivery of currencies would create a credit relationship with a Forex dealer.

When you decide to hold assets in the currency of one country, you are investing in that country’s currency and economy. At the same time, you are also electing not to hold the currencies of other nations. For example, when you hold most of your portfolio (stocks, bonds, bank accounts, etc.) in US dollars, you are relying heavily on the integrity and value of the US dollar and economy, including the government that governs it. Concurrently, you are choosing not to hold the Japanese yen, British pound, or the euro. Almost all businessmen, businesswomen, and travelers actively trade currency. If you travel overseas, you would generally exchange your own currency for the currency of the country you are visiting. In view of this, it is not surprising that more and more prudent investors are deciding to diversify their portfolios by holding assets in multiple denominations within the FX market.

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I. What is Trading?

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II. How a Forex Trade Works? What are ISO Codes Currency Pairs How to Calculate which Currency is Increasing or Decreasing in Value EUR/USD USD/JPY Hard and Soft Currencies Chart Reading Basics Trends Lot Sizes and Margin Lot Sizes Margin Risk Management Determining Position Size What is PIP? Calculating Profit/Loss Calculating pip values when the dollar is the counter currency Calculating pip values when the dollar is the base currency Bid/Ask Spread Position Trading 100 K Account vs. Mini-Account

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III. Types of Transactions Spot Transactions Outright Forward Transactions Futures Transactions Swap Transactions Option Transactions Settlement and Delivery Volumes & Open Interest Interest Rollover Trader A buying GBP/USD at 1.5755 How to Estimate Interest Rollover GBP/USD USD/JPY Triple Rollover on Wednesday

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IV. Types of Orders Market Order Limit Order (Take Profit Order) Stop-Loss Order Entry Order Limit Entry Order Stop Entry Order

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V. Proper Phone Etiquette

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VI. Fundamental Analysis Vs. Technical Analysis

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CURRENCY TRADING BASICS currencies to help you get accustomed to the trading language.

Part I. What is trading? Trading is a unique form of speculation in order to generate profit. It can be a part-time or full time business, a profession or just a lifetime passion. You can trade almost anything from various commodities, stocks, bonds and of course, currencies. Currency trading is not gambling; rather it is a game in which a trader, applying different fundamental or technical analysis, makes a risk-calculated and educated trading decision. Making logical trading decisions and developing a sound and effective trading strategy is an important foundation of trading. Successful trading is often described as optimizing your risk with respect to your reward or upside. Any trading strategy should have a disciplined method of limiting risk while making the most out of favorable market moves.

Part II. How a Forex Trade Works? To begin trading in the FX market, you must familiarize yourself with how currencies are handled and traded. Hard and soft currencies are traded in pairs and through ISO codes. There are five different types of transactions and six different ways to execute a trade. Additionally, it is very important to understand some common terms surrounding a trade which include: lot sizes and margin, PIP, bid-ask spread, position trading, settlement-delivery, volume, and open interest. ISO Codes Currencies in the FX market are not referred to by their full names; instead, they are identified by standardized codes or ISO Codes, developed by the International Organization for Standardization. ISO abbreviations are used widely on charts and trading platforms, but they are rarely used in conversations among traders. Traders or the media may refer to the currencies by their nicknames during everyday conversations. “Throughout our training materials, we interchangeably use the full names, ISO codes, and nicknames of

The table below lists the ISO codes and nicknames for the most commonly traded currencies:

Currency Pairs In the Forex market, currency trading is always done in currency pairs, such as USD/CAD or USD/JPY, reflecting the exchange rate between the two currencies. An exchange rate is merely the ratio of one currency valued against another currency. For instance, the USD/JPY exchange rate specifies how many US dollars are required to buy a Japanese yen, or conversely, how many Japanese yen are needed to purchase a US dollar. In a pair of currencies, the first currency is known as the base (dominant) currency, and the second one is referred to as the counter or quoted (subordinate) currency. In the USD/JPY example, the US dollar is the base currency that we wish to trade, while the Japaneseyen is the counter currency that the exchange rate is quoted in. In simple and practical terms, the currency pair is a structure that can be bought or sold. The base currency acts as the basis for all transactions, regardless if it is buying or selling. When you buy a currency pair, it is implied that you are buying the first (base) currency and selling the second (counter or quoted) currency. Alternatively, a trader sells the currency pair when he/she anticipates that the base currency will depreciate relative to the quoted currency.

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CURRENCY TRADING BASICS How to Calculate which Currency is Increasing or Decreasing in Value Always remember that the simplest way to remember which currency is increasing or decreasing in value is to view rate changes from the perspective of the base currency. If we look at a chart and see an exchange rate increasing, it means that the value of the base currency is appreciating (getting stronger). Conversely, if we look at a chart and see an exchange rate decreasing, it represents that the value of the base currency is depreciating (getting weaker). The diagram below may help you to have a more lucid understanding of this relationship.

USD/JPY: In the USD/JPY pair, the US dollar acts as the base currency while the Japanese yen acts as the quoted currency. Therefore, the dollar (base currency) is the basis for buying and selling in trading. If you think that the Japanese government is going to weaken the yen in order to strengthen their export industry, you would buy the currency pair. By buying the pair, you are buying dollars in anticipation that they will increase in value against the yen. On the other hand, if you believe that Japanese investors are pulling money out of US financial markets and repatriating funds back to Japan, you would sell the pair. By selling the pair, you expect the yen to strengthen against the dollar. Hard & Soft Currencies Alongside the US dollar, four major currencies dominate trading in the Forex market by nature of their popularity and activity. According to a recent survey on 300 major traders by Greenwich Associates, the trading volume on the euro, Japanese yen, British pound, and Swiss franc accounts for over 70% of North American activity. According to currency market expert, Cornelius Luca, in his book Trading in the Global Currency Markets, second edition, market share for the five major currencies after the introduction of the euro is estimated at:

The following is a couple of examples to help you grasp these key concepts: EUR/USD: In the EUR/USD pair, the euro acts as the base currency while the US dollar acts as the quoted currency. Therefore, the euro (base currency) is the basis for buying and selling in trading. If you anticipate that the stock market will fall and cause the USD to depreciate, you will buy the currency pair. By buying the EUR/USD pair, you are buying euros in anticipation that the euro will appreciate against the USD. If you choose to sell the pair, you are then buying the US dollars, expecting it to climb against the euro.

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CURRENCY TRADING BASICS Other tradable currencies include the Canadian, Australian, and New Zealand dollars. Each of these accounts for 3-7% of the total market volume and they are often referred to as “minor” currencies. Together, the majors and minors constitute all hard currencies that are currently traded in Forex. Soft currencies are currencies such as the Argentine peso, the Russian ruble, the Hong Kong dollar, and the Polish zloty. These are not tradable or recognized outside their country of origin.

As mentioned before, currencies are often referred to by their nicknames. Similar to currencies, it is important to familiarize yourself with the common names of the currency pairs. There is a specific trading terminology that is used frequently to describe each currency pair.

In the spot FX market, currency pairs can be divided into two categories: dollar-based currency pairs and cross-currency pairs. Dollar-based currency pairs are those that consist of the US dollar and another currency, while cross-currency pairs are those with neither of its currencies being the US dollar. The most actively traded dollar-based currency pairs are the EUR/USD, USD/JPY, GBP/USD, and the USD/CHF. The most actively traded cross-currency pair is the EUR/JPY. Normal daily movement on just these five pairs can be anywhere from 50 pips on a slow day to over 100, 200, even 300 pips on a very active day. (See definition of ‘pips’ below.)

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CURRENCY TRADING BASICS Chart Reading Basics Charts are used to show the correlation between the value of the base and quoted currencies. The following charts are in the format in which you would see them on an actual computer screen. In these charts, the changing currency is the quoted currency. Trends Trend is a term used to describe the persistence of price movements in one direction over a period of time. Trends move in three directions: up, down and sideways. An uptrend signifies the strengthening of the base currency, while a downtrend represents the weakening of the base currency. A sideways trend occurs when markets bounce back and forth between support and resistance levels, the lowest and highest points within a given period, resulting in less significant price movements. It is estimated that 70% of the time, markets will fluctuate randomly or move between support and resistance levels. The rest of the time, market behavior is characterized by persistent price movements — trends — that break through support and resistance levels. It is highly possible to increase your ability to capitalize on trends by locating trend signals, identifying specific entry points within the trend, and using risk management techniques to limit losses. More information on trends and strategies is discussed in section 4: technical analysis.

Lot Sizes and Margin The FX market attracts many new traders because currency trading can be conducted on a highly leveraged basis. Every trader should have a thorough

understanding of lot sizes and margin requirements before trading in order to employ proper risk management. Lot Sizes In Forex, one million dollars worth of a currency is generally accepted as a minimum round lot and is often referred to as one “dollar” or one “buck”. Single orders, in excess of a million dollars, are regularly traded by large institutions and corporations. However, smaller size orders are available to individual FX traders. For example, some dealers offer sizes in half-dollar (.5) and quarter-dollar increments (.25), while others offer sizes of approximately $200,000 USD (.2), $100,000 USD (.1), $50,000 USD (.05), and even $10,000 USD (.01). An advantage of currency trading is that most brokers will allow you to trade 100 times the value of your deposit. Therefore, if you deposit $2,000 into your account, you would be able to trade $200,000 worth of currency units. This is referred to as trading on margin, which is also common with stockbrokers; however, stockbrokers’ leverage is typically 50% greater than your investment. Hence, if you invest $2,000 with a stockbroker, you would be able to trade with a market value of only $3,000. Margin Margin is a monetary deposit that you provide as collateral to cover any losses. All dealers establish their own margin policy based on a percentage of the lot size. Normal margins range from 1% to 5%. For example, if the margin for day trading is 1% (100:1) with a dealer that offers lot sizes of $200,000, you may open a one-lot position with $2,000 in your account. The requirements for margin vary with account size, and may be changed from time to time at the sole discretion of the dealing desk, based on volume traded and market conditions. As the account size and the ability to trade more lots increase, the margin percentage may also increase. Risk Management For the purpose of risk management, traders must have position limits. This number is set relative to the money

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CURRENCY TRADING BASICS in a trader’s account. Risk is minimized in the spot FX market because the online capabilities of the trading platform will automatically generate a margin call if the required margin amount exceeds the dollar value of the account as a result of trading losses. All open positions will be closed immediately regardless of the size or the nature of positions held within the account. This advanced feature is very beneficial for traders. In the futures market, on the other hand, if the price moves against your position, it may be liquidated at a large loss, making you liable for any resulting deficit in the account. Determining Position Size Prior to starting up your trade station, an assessment should be made of the maximum account loss that is likely to occur overtime, per lot. For example, assume you have determined that the worst case scenario is to lose 20 pips on any trade. This translates into approximately $200 per $100,000 position size. Further assume that the $100,000 position size is equal to one lot. Six consecutive losing trades would result in a loss of $1,200 (6 x $200); a difficult period but not an unrealistic one over the long run. This scenario would translate to a 12% loss for an account that has a trading capital of $10,000. Therefore, even though it may be possible to trade 5 lots or more with a $10,000 account, this analysis suggests that the resulting drawdown would be too great - 60% or more of the capital would be wiped out. Traders should have a sense of this maximum loss per lot and determine the amount he/she wishes to trade for a given account size that will yield tolerable drawdown. What is a PIP? A pip (price interest percentage) is the smallest increment a price moves and it determines the profit or loss of a trade. It is simply a base point value — to the right of the decimal point of the quoted currency — that is used to measure changes in exchange rates (the difference between the rates of the currency). A few examples of where the pip is located within the exchange rate are listed below. The one-digit for pip

values is underlined and highlighted in red for each example.

For instance, the US dollar moves from 1.6000 to 1.6004 in the cable/dollar pair, it has moved 4 pips. When you have an open position, each upward or downward pip movement in the market price can be either a profit or a loss, depending on which currency (base or quoted) you bought and which one you sold. Calculating Profit/Loss Many Forex retail brokers assign a fixed dollar value per pip that varies according to the lot size and the makeup of each currency pair. For example, the pip value may be $10 per pip on each $100,000 lot of cable/dollar, while only $6.50 per pip on each $100,000 lot of dollar/franc. Other dealers offer a floating pip value that is calculated according to the lot size of each currency pair and the fluctuating exchange rate. For example, notice how the pip value on a 15,000,000 lot of dollar/yen is calculated based on a one-pip movement from 120.00 to 120.01:

The value of a pip is determined by the currency pair and the rate at which the pair is trading. For currency pairs where the dollar is not the base currency (EUR/USD, AUD/USD, NZD/USD, GBP/USD), each pip has a fixed value of $10. For example, if you are trading EUR/USD and the market moves 10 pips in your favor,

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CURRENCY TRADING BASICS then your profit would be exactly $100. On the other hand, when a currency other the dollar is the counter currency (USD/JPY, USD/CHF USD/CAD) the pip value in dollar terms fluctuates based on prevailing market rates. Although most online trading platforms with reputable brokers offer live Profit/Loss tracking whereby profits and losses are calculated and re-calculated every time the exchange rate changes, it is fundamental for a trader to have an understanding of the value of a pip. The table below gives you an idea of the dollar value attached to each pip:

then those 100,000 Euros would be worth 114,700 dollars (10 US dollars more) when the market price moves to 1.1470. The trader could choose to close the position out and take this $100 profit. Conversely, let’s say the trader initially sold 100,000 euros by buying 114,600 dollars when EUR/USD was trading at 1.1460. If the market price moves to 1.1470 and the traders chooses to close the position, he/she would have to buy back the 100,000 Euros with 114,700 dollars. The loss on the trade would be $100. Calculating pip values when the dollar is the base currency When the USD is the base currency, the value of a pip will fluctuate according to the exchange rate of the currency pair. For example, if the current exchange rate for USD/CAD is 1.3300, then one dollar is worth 1.33 Canadian Dollar; hence, 100,000 dollars are worth 133,000 CAD. If the market price of USD/CAD moves up by one pip to 1.3301, then I dollar will be worth 1.3301 CAD; hence, one lot of 100,000 dollars equal 133,010 CAD. In this particular case, a one pip fluctuation is valued at $10 Canadian Dollar or $7.52 USD when the USD/CAD price is 1.3301. The calculation is simple, since at this time I USD=1.3301, then 10 CAD= 7.52 USD. Simply divide 10 by 1.3301.

Calculating pip values when the dollar is the counter currency If the current exchange rate for EUR/USD is 1.1460, then one euro is worth 1.1460 US dollars. Consequently, 100,000 euros are worth 114,600 US dollars. If the market price moves one pip to 1.1470, then one euro is now worth 1.1470 US dollars. This is a pretty small change in the value of the euro (one thousandth of a dollar to be exact) but this can be substantial when we are talking about a lot of euros, 100,000 Euros are now worth 114,700 dollars. If a trader had bought 100,000 euros by selling 114,600 dollars when the market price was 1.1460,

If a trader closes out a position at a one pip profit when the USD/CAD market price is 1.3301, he/she automatically locks in a 10 CAD profit which is equivalent to $7.52 at that time. At a different market price, however, such as 1.3200, those 10 CAD will have a value of $7.58. Bid/Ask Spread All FX quotes include a two-way price, the bid and ask. The bid price is always lower than the ask price. The bid is the price at which a market maker is willing to buy (and traders can sell) the base currency in exchange for

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CURRENCY TRADING BASICS the counter currency. The ask is the price at which a market maker will sell (and a trader can buy) the base currency in exchange for the counter currency. The difference between the bid and the ask price is referred to as the spread, which can be recovered with a favorable currency movement.

In the above example, the bid price for EUR/USD is 1.1797, which indicates the price at which a trader can sell the currency pair. The ask price is 1.1801, indicating the price at which a trader can buy the currency pair. The difference between the bid and the ask price gives us a 4-pip spread in this example. The 4-pip spread represents the cost of the transaction. It is important to note that since the FX market is a decentralized market, the spreads that a trader receives for a given currency pair will vary according to the market maker one trades with. Generally, there is an average of 4-5 pips on the major currency pairs and 520 pips on the cross currency pairs.

Position Trading The objective of currency trading is to exchange one currency for another in the anticipation that the market rate or price will change, thus, increasing the value of the currency bought relative to the one sold. In trading language, a long position is one in which a trader buys a new currency at one price and aims to sell it later at a higher price. When a trader buys a currency and the price appreciates in value, the trader must sell the currency back in order to secure the profit. A short position is one in which the trader sells a currency in anticipation that it will depreciate. If a trader sells a currency and the price depreciates in value, the trader must buy the currency back in order to secure the profit. While a long position is to buy and a short position is to sell, an open trade or position is one in which a trader has either bought or sold a currency pair and has not sold or bought back the equivalent amount to effectively close the position.

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CURRENCY TRADING BASICS l00K Account vs. Mini-Account You may choose to open a regular (l00K) account or a mini account. As a novice trader, we recommend that you begin trading with a mini-account once you are ready to trade live. As you have developed a disciplined trading system, you may choose to proceed to a regular account. Below is a chart that illustrates the differences between the two accounts.

Part III. Types of Transactions There are several types of transactions that take place in the FX market. These transactions are Spot, Outright Forward, Futures, Swap, and Option. According to the Bank for International Settlements, market share for these five transactions are estimated at: Spot = 48%, Swap = 39%, Forwards = 7%, Options = 5%, Futures = 1%

Spot Transactions This type of transaction accounts for almost half of all FX market transactions. The exchange of two currencies at a rate agreed on the date of the contract for delivery in two business days (except for USD/CAD, which is the next business day).

Outright Forward Transactions One way to deal with the foreign exchange risk is to engage in forward transaction. In this transaction, money does not actually change hands until an agreed upon future date. A buyer and seller agree on an exchange rate for any date in the future and the

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CURRENCY TRADING BASICS transaction occurs on that date, regardless of what the market rates are then. The date can be a few days, months, or years in the future.

enables customers to trade on a margin basis, and pay margin on a daily basis when the position is marked to the market.

Futures Transactions 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. These contracts are traded on a separate exchange set up for that purpose.

Option Transaction To address the lack of flexibility in forward transactions, the foreign currency option was developed. An option is similar to a forward transaction. It gives its owner the right to buy or sell a specified amount of foreign currency at a specified price at any time up to a specified expiration date.

Swap Transactions 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. The purpose of a swap transaction is to manage liquidity and currency risk, by executing foreign exchange transactions at the most appropriate moment. For example: selling US dollars for euros value spot and agreeing to reverse the deal at a later date commonly I day, 1 week, I month, or 3 months. Effectively, the underlying amount in each currency is simultaneously borrowed or lent — the ‘long’ lent and the ‘short’ borrowed.

For a price, a market participant can buy the right, but not the obligation, to buy or sell a currency at a fixed price on or before an agreed upon future date. The agreed upon price is called the strike price. Depending on which—the option rate or the current market rate—is more favorable, the owner may exercise the option or let the option lapse, choosing instead to buy/sell currency in the market. This type of transaction allows the owner more flexibility than a swap or futures contract. In all of these transactions, market rates might change. However, the buyer and seller are locked into a contract at a fixed price that cannot be affected by any changes in the market rates. These tools allow the market participants to plan more safely, since they know in advance what their FX will cost. It also allows them to avoid an immediate outlay of cash.

Since currency risk is replaced by interest rate risk, such transactions are conceptually different from spot transactions. They are, however, closely linked because foreign exchange swaps are often initiated to move the delivery date of a foreign currency originating from spot, or outright forward transactions to a more optimal moment in time. It is by using swaps that traders can hold a position without ever being delivered. This

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CURRENCY TRADING BASICS Settlement and Delivery The Spot market is traded on a two-business day value date. It requires a two-day settlement between the banks as they may be in different time zones (the only exception is the Canadian dollar, where 24 hours is the requirement). For instance, for trades executed on Monday, the value day (day of delivery) is Wednesday. Volume & Open Interest Volume consists of the total amount of currency traded within a specific period, usually one day. Of course, traders are more interested in the volume for a specific currency. A high trading volume suggests that there is high interest and liquidity in a market. Also, some chart patterns require heavy volume for successful development. A low trading volume is a warning sign to traders to be extra careful. In a low-volume market, rates can be all over the map and make it harder to get the price one wants. Open interest is the net outstanding position in a specific instrument. It normally represents the difference between the outstanding long (buy) positions and the outstanding short (sell) positions. Volume and open interest are difficult to quantify in most of the foreign exchange markets because about 97% of the markets are decentralized. Volume figures can be calculated in the foreign exchange futures markets because these transactions take place on centralized trading floors, and all trades go through clearinghouses. However, futures transactions (pure futures and options on futures) only account for about 3% of the world’s foreign exchange activity. The other 97% of currency trading takes place in the spot, swap, forwards, and cash options markets, where trading is completely decentralized. Hence, volume is impossible to measure with any precision and can only be roughly extrapolated from futures market data.

encounter inflation, in which prices of goods and services are rising rapidly. Along with rapid economic growth and inflation, interest rates may often rise as a result. In turn, raised interest rates increase the cost of the currency and thus, decrease the overall demand for goods and services. The decreased demand will inhibit prices from continuing to rise at an excessive, rapid pace. Conversely, economies facing recessionary periods may require economic stimuli to encourage consumer spending, which in turn expedites economic growth. A cut in interest rates may make money more accessible and cheaper to borrow. The decreased interest rate would enable entrepreneurs to borrow capital with less financial stress. Therefore, a cut in interest rates would ideally revitalize the economy and cease the economic recession or, to a greater extent, depression. Rollover charges are determined by the difference between the interest rates of the two corresponding countries. The greater the interest rate differential between the currency pair, the greater the rollover charge will be. It takes place when the settlement of a trade is rolled forward to the next value date. As mentioned above, trades must be settled in two business days in the FX market. If a trader sells 100,000 euros on Tuesday, the trader must deliver 100,000 euros on Thursday, unless the position is rolled over. Traders that hold a position overnight pay interest on the currency they borrow, and earn interest on the currency they purchase. Typically, interest rollover charges are applied at 5pm (17:00) New York time (9pm GMT; 10pm GMT when New York is operating on daylight savings time from late March to late October) in coordination with the international trading day. For the FX trader, interest rollover charges can have a small impact on their overall profit and loss from exchange rate speculation. To illustrate how interest rollover charges work, consider the following example:

Interest Rollover Interest rollover fees are a function of the interest rates established by the various central banks and federal authorities used to regulate the official policy of the currency. Economies that are growing rapidly may

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CURRENCY TRADING BASICS Trader A buying GBP/USD at 1.5755. In this case, Trader A is borrowing US dollars, and hence will pay interest on the borrowed funds. Trader A is, however, earning interest on the British pounds that have been purchased. If the Bank of England — which regulates the pound — offers a higher interest rate than the Federal Reserve — which regulates the US dollar —the client has an opportunity to earn interest. Alternatively, if the Federal Reserve issues a higher interest rate on the US dollar than the Bank of England offers on the British pound, then the client will experience a net interest payment. Because banks can lend to each other at rates different from what the central bank lends to them, the rollover calculations can never be reduced to an exact science. Like the currency exchange rate, the rollover interest rates are subject to market conditions, and hence can fluctuate as well. How to Estimate Interest Rollover Since interest rates raise the cost of the currency — it is more expensive to borrow currencies with a high interest rate — a central bank’s interest rate policy can be used to adjust the economy to its respective needs. However, since the interest rollover charge is generally quite small, it should not serve as the core of a trading strategy. The following is a sample calculation of interest rollover: Suppose the Bank of England has an official interest rate of 3.5%, while the Federal Reserve has an official interest rate of 1%. Consequently, a client who is buying GBP/USD will earn interest, since he/she is only paying 1% while earning 3.5%. Because interest rates are quoted on a yearly basis, it is divided down to a daily basis that can be applied for daily interest rollover charges. Although there are 365 days in a year, financial transactions in a year are rounded off to 360 days. For instance, in the United States, 1% of the principal balance for the whole year is divided by 360. The following is the equation to calculate the amount for interest rollover:

(No. of Lots) x (No. of Units per Lot) x (Annual Interest Rate Differential / 360) x (No. of Days)

GBP/USD Trader A buys 2 contracts of GBP/USD on Thursday and closes them on the next day Contract Value: GBP 100,000 Opening Price: 1.6770 Yearly Interest Rate Differential: GBP 3.5% - USD 1% = 2.5% Calculation: GBP 100,000 x 2 x (2.5%/360) x 1 = 13.88 USD/JPY Trader A sells 3 lots of USD/JPY on Monday and closes them on the next day Lot Value: USD 100,000 or JPY 12,200,000 Opening Price: 110.00 Yearly Interest Rate Differential: USD 1% - JPY 0% = 1% Calculation: USD 100,000 x 3 (-1%/360) x I = -8.31 Triple Rollover on Wednesday Since there is a two-day settlement period in foreign exchange, the transactions that are opened on Wednesday at 5 pm — which is the Thursday trading day — should not get settled until Saturday. Of course, banks are closed during the weekend, so the transaction cannot effectively be settled until Monday (which begins on Sunday at 5 pm New York time). Therefore, for positions opened and held overnight on Wednesday, rollover fee is charged for the following Monday as well, meaning an extra two days of fees for the weekend. As a result, rollover fees are tripled in the FX market on Wednesday. It is important to understand that every transaction has a value day. If the deal is not

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CURRENCY TRADING BASICS closed on the same day, the trade is subject to rollover charges.

Part IV. Types of Orders When placing an order in the FX market, you can choose from the 4 different options available. This includes: market, limit, stop-loss, and entry orders. Market Order A market order is an order to buy or sell a currency pair at the current market price. One of the key advantages of trading in a spot market is that market orders are guaranteed when dealing with a reputable broker, as the vast liquidity of the market ensures that there are always buyers and sellers. Limit Order (Take Profit Order) A limit order allows a client to specify the rate at which he will take profits and exit the market. Essentially, it defines the amount of profit that the trader is looking to capture on this particular trade. Let’s assume a trader has an open position where he is long (meaning he has bought) GBP/USD, he would place a limit order at 1.5900; if the market reached that rate, he would be taken out of the market, and his profit from the trade would immediately be reflected in his balance. Alternatively, a trader could place a limit order to an existing sell position. Stop-Loss Order A stop-loss order works like a limit order, but in an opposite fashion: it specifies the maximum loss that a trader is willing to accept on a given position. For example, if a trader is long USD/JPY at 121.50 with a limit at 121.70, he may wish to maximize the loss he is willing to accept by placing a stop-loss order at 121.30. In such a case, if the market reached 121.30, he would be stopped out of the position and would have suffered a loss no greater than 20 pips. Entry Order All entry orders are essentially contingent orders: they will only be filled if the market reaches that rate. For example, suppose you are trading USD/JPY, and the

current quote is 120.50 — 120.55. You can place an entry order to buy at 120.15 so that your order will only be filled if the market reaches 120.15. Ultimately, there are two types of entry orders: limit entry orders and stop orders. Limit Entry Order Limit entry orders are classified as entry orders whereby the rate specified is either below the current market rate if it is a buy order, or alternatively, above the market rate if it is a sell order. Limit entry orders are often conducive to strategies pertaining to range-bound markets, whereby clients can place orders to buy at the bottom of the range and sell at the top. Suppose the current market rate to sell EUR/USD is at 1.0800, and to buy is at 1.0804. There are two types of limit entry orders that a trader could place in such a situation: 1. A trader could place an order to sell at a price above the current market rate, for instance, sell at 1.0820. If the sell rate in the spot market reaches 1.0820, the sell order would be activated. In this case, the trader expects that the market will reach 1.0820 and then reverse its direction. 2. A trader can place a limit entry order to buy at a price that is below the current market rate. For instance, a trader could place a limit entry order to buy at 1.0790. His order would only be activated — meaning it would only begin to affect his P/L — if the buy rate reached 1.0790. The trader is expecting a reversal of the trend after the market reaches the rate he/she specified. In other words, the trader will profit if the market bounces off the 1.0790 level. Since both buy and sell limit entry orders assume the reversal of a trend, they are most commonly used by traders who believe the market is trading within an upper and lower range, and that it will not break out of this range.

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CURRENCY TRADING BASICS Stop Entry Order Stop entry orders rely on rationale that is the opposite of limit entry orders. If a trader wishes to buy at a price above the current market rate, or, alternatively, sell at a price below current market price, then he is placing a stop entry order. Stop entry orders are conducive to “breakout” strategies, whereby the trader believes that if the specified rate is reached, the trend’s movement is confirmed and thus will continue in that direction. Suppose the current market rate for the USD/JPY is at 117.04; in other words, traders can enter the market to sell at 117.04, and can buy at 117.09. There are two types of stop entry orders that a trader could place in such a situation: 1. The trader could place an order to sell at a price below the current market rate. So, for instance, he could place an order to sell at 116.75; if the sell rate in the spot market reaches 116.75, the sell order would be activated. In this case, the trader expects that the market will reach this level; it will break out and continue in this direction. 2. The trader can place a stop entry order to buy at a price that is above the current market rate. For instance, if the trader placed an order to buy at 117.85, his order would only be activated — meaning it would only begin to affect his PIL — if the buy rate reached 117.85. In this example, the trader is expecting a breakout if the market reaches the rate he/she specified. In other words, the trade will break through the 117.09 level. Since both buy and sell stop entry orders assume a breakout, they are most commonly used by traders who believe the market will make a big move.

Part V. Proper Phone Etiquette Although most trades are placed online, traders always have the option of calling the dealing desk to place an order. It is important for spot traders to get their point across quickly and accurately, leaving no room for interpretation or error. Let’s take a look at a typical spot trade: Please give me a price on USD/JPY (or USD/CHF, or EUR/USD, or GBP/USD) for (the number of lots you want to trade) lot(s). Example: Trader says, ‘Please give me a price on USD/JPY for 3 lots”. The dealer will respond with a 2-way price quote. For example, he may quote USD/JPY at: 125.10-125.15 (but he will probably just say 125.10-1 5). Dealer replies, ‘125.10-15”. So you can either buy USD/JPY at 125.15, or you may sell USD/JPY at 125.10. To buy USD/JPY you can say any of the following: ‘15’, ‘I buy’, ‘I buy at 15’, ‘mine”, or ‘mine at 15”. To sell USD/JPY, you can say any of the following: ‘10”, ‘I sell’, ‘I sell at 10”, ‘yours’, or ‘yours at 10”. Trader states, ‘I buy at 15”. You would normally have 3-5 seconds to respond (sometimes more, sometimes less) prior to a price change, depending on market volatility. If no response is given and the price changes, the dealer will say ‘change”, “price change”, ‘off’, or ‘your risk”. In this case, you may ask for a price again. If you do respond with a buy or sell, the dealer will say, ‘done’ or indicate to you that your trade is executed. You can also state to the dealer that you would like your stop-loss at_____ and a limit at _____ Dealer responds, ‘Done’. Trader says, ‘Place a stop-loss at 124.80 and a limit at 126.00”. Dealer answers, ‘Got it’. The dealer will hang up.

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CURRENCY TRADING BASICS Below is another example of sentences that may be used in a telephone conversation with the dealer.

Part VI. Fundamental Analysis vs. Technical Analysis There are two primary approaches of analyzing financial markets: fundamental analysis and technical analysis. Fundamental analysis is based on economic theories that examine underlying economic conditions. Events, such as political environments, are used in fundamental analysis to determine forces of supply and demand. On the other hand, technical analysis uses historical price

and volume data to predict future market movements. There is an ongoing debate as to which methodology is more successful. Day or swing traders prefer to use technical analysis, focusing their strategies primarily on price action, while position traders use fundamental analysis focusing their efforts on determining a currency’s proper current as well as future valuation. One clear point of distinction is that fundamental analysis studies the causes of market movements, while technical analysis studies the effects of market movements.

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I. How the Economy Works? Theories Used to Analyze the Economy Purchasing Power Parity (PPP) Balance of Payments Model Asset Market Model Factors that Affect the Economy Economic Factors Confidence Factors Approaches to Analyze the FX Market

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II. Fundamental Analysis Two Main Factors in Fundamental Analysis Trade Flows Capital Flows Physical Investments Portfolio Investments

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III. Factors Moving the FX Market G7 Meeting Inflation Gross Domestic Product (GDP) Interest Rates Nominal and Real Rate of Interest Producer Price Index (PPI) Consumer Price Index (CPI) Personal Income and Personal Consumption Expenditures Trade Deficits Industrial Production Unemployment Rates Business Inventories Durable Goods Orders Retail Sales Housing Starts

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IV. Profiles on the Major Currencies US Dollar (USD) Overview of the US Economy USD Trading Aspects Euro (EUR) Overview of the European Monetary Union Economy EUR Trading Aspects Japanese Yen (JPY) Overview of the Japanese Economy JPY Trading Aspects Great British Pound (GBP) Overview of the British Economy GBP Trading Aspects Switzerland (Confederatio Helvetica Franc—CHF) Overview of Swiss Economy CHF Trading Aspects: Canadian Dollar (CAD) Overview of the Canadian Economy CAD Trading Aspects

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V. Tips for Trading with Fundamental Analysis

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VI. Tips to Interpret Economic Indicators

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FUNDAMENTAL ANALYSIS Part I. How the Economy Works? FX traders should have a proper understanding of the trading and investment environment. This requires some understanding of the economy and how it operates. An economy moves in cycles. Each cycle includes a period of economic expansion leading to a peak, followed by a period of economic contraction leading to a trough. After economic activity has reached a trough and bottomed out, a new cycle begins again with economic recovery and expansion. A period of at least six consecutive months of economic contraction is generally called a recession and if the downturn is extremely severe, as in the early 1930s, it is called a depression. The price movements of the major currencies follow these economic circular trends, forming well-defined patterns that can be tracked and predicted by fundamental and technical analysis. Theories Used to Analyze the Economy Several theories are utilized as tools to analyze the economy. These include: the purchasing power parity theory, balance model, and asset model. Purchasing Power Parity (PPP) The PPP theory asserts that exchange rates are determined by the relative prices of similar baskets of goods sold in different countries. It is expected that changes in inflation rates are to be offset by equal but opposite changes in the exchange rate. For example, a can of Pepsi costs 1.5 euros in France and $1.25 in the U.S. Based on the PPP theory, the 1.5 (euros) divided by 1.25 (USD) equals to 1.2. If the current exchange rate for EUR/USD is more than 1.2, the exchange rate overstates current market values and should depreciate until it reaches to the PPP value, which is 1.2. On the other hand, if the current exchange rate is less than 1.2, the exchange rate understates current market values and should appreciate until it reaches the PPP value. Therefore, the theory postulates that the two currencies will eventually move towards the exchange rate at which one euro can buy 1.20 US dollar.

Every few years, the OECD (Organization for Economic Cooperation and Development) publishes PPP values for all currencies. These values, in turn, are used by traders to anticipate exchange rates. PPP is a long term indicator and does not take into account short term fluctuations based on market news or rumors. Another weakness is that it assumes goods are easily tradable with no costs to trade such as tariffs, quotas, or taxes. In addition to ignoring the costs to trade, this theory only accounts for goods and neglects services, where room for value differentials is significant. From empirical evidence, we learn that PPP is only applicable to longterm (3-5 years) price movements, when prices eventually correct themselves towards parity. Balance of Payments Model This model suggests that a foreign exchange rate must be at its equilibrium level — the rate that produces a stable current account balance. The theory asserts that if a country has a trade deficit, its currency will depreciate. The cheaper currency renders the nation’s goods (exports) more affordable in the global market while making imports more expensive. The combination over time, forces imports to decline and exports to rise thus stabilizing the trade balance and the currency towardf equilibrium. In other words, the Balance of Payment Model is hinged on the theory that a currency will move as a result of a nation’s global trading position. Those countries that run a trade deficit will have their currency decline, while those with a surplus will have their currency appreciate. Critics of the Balance of Payment Model state that it does not take into consideration the flow of funds into financial assets, but focuses solely on the trade of goods and services from one country to another. This explains why a country like the United States, with a large trade deficit, did not have its currency suffer markedly in recent years. Asset Market Model The explosion in trading of financial assets has reshaped the way analysts and traders view currencies. The basic premise of this theory is that the flow of funds into other financial assets of a country (i.e. equities and

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FUNDAMENTAL ANALYSIS bonds) increases the demand for that nation’s currency. Advocates point out that the proportion of foreign exchange transactions stemming from cross bordertrading of financial assets has dwarfed the extent of currency transactions generated from trading in goods and services through import and export. Since the asset market approach views currencies as asset prices traded in an efficient financial market, it asserts that currencies are increasingly demonstrating a strong correlation with asset markets. This helps explain the currency phenomena during the 1990’s, when the Japanese stock market and yen depreciated while the U.S. stock market and US dollar appreciated — a condition that was contrary to what the previous theories suggest, given the low level of Japanese interest rates relative to U.S. rates. In this case, interest rates did not have a strong influence. The price of comparable goods did not drive the market prices. The factor that exerted the greatest influence over the market was the net flow of funds into the investment sector. It is this variable that affected the demand for currencies to be bought and sold, one over the other. Factors that Affect the Economy Forex is a perfect market for applying trading strategies and disciplined methods of limiting risk while taking full advantage of favorable market conditions. A trader must learn how to analyze the market in order to become successful. There are a lot of factors that can cause a nation’s currency to fluctuate. The key concept is that the movement of currencies is based on supply and demand, which is influenced by both economic factors and confidence factors. Economic Factors Economic factors examine specific demand stemming from purchases, goods, services, or assets. Currencies are affected by changes in interest rates of a country, which in turn, affect inflation. If the currency value goes down, it costs more to import goods from another country; hence, the cost of living goes up, leading to inflation.

Confidence Factors Confidence factors are general, and often nonquantitative, explanations for a past or prospective move. They include political events, market sentiment about the management of a country’s currency, or hunches concerning other players in the market. Political events can fall under this category. For example, if the leader of a country is suddenly removed from office or, worse yet, assassinated, the world’s confidence in that country’s currency is, at least in the short-term, sure to suffer. Approaches to Analyze the FX Market There are two distinct methods to analyze financial markets: fundamental analysis and technical analysis. Fundamental analysis is based on underlying economic conditions, while technical analysis uses historical prices to predict future movements. There is an ongoing debate as to which methodology is more successful. Technical traders focus their strategies primarily on price action, while fundamental traders focus their efforts on determining a currency’s proper current and future valuation.

Part II. Fundamental Analysis Fundamental analysis focuses on the economic, political, and social forces that dictate supply and demand in the market. It is a method that attempts to predict price action and identify market trends by analyzing economic indicators, government policy, and societal factors within a business cycle framework. Fundamental analysts pay close attention to the causes of currency movements by studying the various asset markets, growth rates, gross domestic product (GDP), interest rates, inflation, unemployment rates, political events, social developments, and macroeconomic indicators. Political events that impact the level of confidence in a nation’s government, the climate of stability, and the level of certainty have a great influence on the FX market. All this information is combined to assess current and future market performance. Thus, fundamental analysts need to constantly stay current with news and announcements, as these can indicate

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FUNDAMENTAL ANALYSIS potential changes to the economic, political, and social environment. By studying reports and events, fundamental analysts examine the underlying reasons for the fluctuation of the exchange rate, in either the past or the future, towards one direction or the other. They endeavor to do this before the rest of the market participants, placing themselves in a good trading position to earn profits. Two Main Factors in Fundamental Analysis There are two main factors that impact exchange rate movements from a fundamental perspective: trade flows and capital flows. Trade Flows One factor affecting exchange rates between two respective countries is the trade balance. Trade balance shows the net differences between a nation’s imports and exports. It is, by definition, the merchandise trade balance — the net difference between the value of merchandise being exported and imported into a particular country. When an economy’s imports are more than its exports, the trade balance is said to be in deficit. If an economy’s exports are more than its imports, the trade balance is in surplus. Trade balances are important as they indicate a redistribution of wealth among countries. Generally, trade deficits negatively impact the value of a currency by forcing money to flow out of the country. Conversely, positive trade balances cause appreciation in the country’s currency. Capital Flows Capital flows take the form of both physical and portfolio investments. They measure the net amount of a currency that is being purchased or sold in capital investments. This provides a recording for an economy’s incoming and outgoing investment flows. A positive capital flow balance implies that foreign inflows into a country exceed outflows. A negative capital flow balance indicates that there are more physical or portfolio investments bought by domestic investors than foreign investors.

Physical Investments Physical Investments are actual foreign direct investments by corporations, such as investments in manufacturing, real estates, and local acquisitions. All these transactions require foreign corporations to sell their local currency and purchase the foreign currency, which leads to movements in the Forex market. These movements represent the underlying changes in actual physical investment activity. Global corporate acquisitions are extremely important to currency movements as they involve more cash than stock. Portfolio Investments As technology advances, investing in global equity markets has become increasingly feasible. Subsequently, the dynamic stock market in any part of the world serves as an ideal potential for all, regardless of the, geographic location. As a result, a strong correlation has developed between a country’s equity market and its currency. If the equity market is rising, investment dollars enter the country to seize the opportunity. Conversely, if the equity market is falling, domestic investors sell their shares of local publicly traded firms and invest in other nations.

Part III. Factors Moving the FX Market Each week, economic statistics and indicators are released by various nations’ governments, professional organizations, and academic institutions. Economic indicators are snippets of financial and economic data published by various agencies of the government or private sector. These statistics, which are made public on regularly scheduled intervals, enable market observers to monitor the pulse of the economy. Hence, they are religiously followed by almost everyone in the financial markets. Since so many people are ready to react to the same information, economic indicators in general have tremendous potential to generate volume and to move prices in the markets. Most economic indicators can be divided into two categories: leading and lagging indicators. Leading indicators are economic factors that change before the

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FUNDAMENTAL ANALYSIS economy starts to follow a particular pattern or trend. They are used by traders to predict changes in the economy. Lagging indicators are economic factors that change after the economy has already begun to follow a particular pattern or trend. Economic indicators may range from interest rates and central bank policies to natural disasters. The fundamentals are a dynamic mix of distinct plans, erratic behaviors, and unforeseen events. Therefore, it is better to get a handle on the most influential contributors to this diverse mix than it is to formulate a list that includes all of the indicators, as that is merely impossible. Some indicators are more significant than others, with respect to their influence on the FX market, but most closely looked at is the data related to interest rates and international trade. Below is a brief overview of some of the major economic news, events, reports, and announcements that can have a significant effect on currency market movement: G7 Meetings There are periodic meetings of financial leaders from the United States, Great Britain, Germany, Japan, France, Italy, and Canada who gather to discuss world monetary policies. Recently, Russia has taken part in this forum as an ‘observer”; hence, this group is sometimes referred to as the G-8. Inflation Price index numbers are used to assess inflation. Inflation is a rise in the general level of prices in an economy. When the price of goods rises, there is a general increase in prices, which constitutes inflation. This price level increase has a direct impact on currency exchange rates. If the general price level falls, it is called deflation. The currency of countries with low inflation will normally rise in value, while the currency of countries with high inflation will fall. Gross Domestic Product (GDP) The Gross Domestic Product (GDP) is the sum of all goods and services produced by both domestic and foreign companies in the economy in a year. GDP is a good indicator for the pace at which a country’s

economy is growing or shrinking as it measures the country’s economic output and growth. In order to measure the performance of an economy, economists are usually most interested in the real rate of change of GDP. Real GDP is calculated by adjusting nominal GDP for inflation or deflation. When real GDP increases from the previous year, the currency becomes stronger. Interest Rates Interest rates are charged by various financial institutions. For example, the Prime Rate is an interest rate charged by banks to reputable customers and the Federal Funds Rate is an inter-bank rate for borrowing reserves to meet margin requirements. If there is an uncertainty in the market in terms of interest rates, any developments regarding interest rates could have a direct affect on the currency markets. Generally, when a country raises its interest rates, the country’s currency will strengthen in relation to other currencies as assets are shifted to gain a higher return. The timing of interest rate moves is usually known in advance. Nominal and Real Rate of Interest The rate of interest reflects the cost of borrowing money. Since the rate of inflation affects the purchasing power of money, the rate of interest is affected by it. Just like GDP can be adjusted for the effects of inflation, interest rates can also be adjusted for inflation. The rate of interest is categorized as nominal and as real rate of interest. The nominal rate of interest is the rate of interest advertised or stated in a financial contract. The real rate of interest is the rate of interest that is adjusted for the loss in purchasing power due to inflation. To calculate the real rate of interest, subtract the rate of inflation from the nominal rate of interest. Rate of Inflations - Nominal Rate of Interest = Real Rate of Interest

Producer Price Index (PPI) The Producer Price Index (PPI) measures the average changes in selling price as indicated by domestic

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FUNDAMENTAL ANALYSIS producers for their output in various industries. The FX market tends to focus on the PPI for seasonally adjusted finished goods on a monthly, quarterly, semiannual and annual basis. PPI is an accurate precursor of the important Consumer Prices Index (CPI) figure. Consumer Price Index (CPI) The Consumer Price Index (CPI) is a primary indicator of inflation that measures the average price for goods and services most commonly used by a typical household. By definition, it is a measure of the average price level paid by urban consumers (80% of population) for a fixed basket of goods and services. It reports price changes in over 200 categories. Items included in the CPI reflect prices of food, clothing, shelter, fuel, transportation, health care and all other goods and services that people buy for day-to-day living. These items are divided into seven categories (housing, food, transportation, medical care, apparel, entertainment, and other), each of which is weighted by its relative importance. The CPI also includes various user fees and taxes directly associated with the prices of specific goods and services. Personal Income and Personal Consumption Expenditures (PCE) The PCE, constituting the largest component of GDP, represents the change in the market value of all goods and services purchased by individuals. Personal income represents the change in compensation that individuals receive from all sources including: wages and salaries, proprietors’ income, income from rents, dividends and interest, and transfer payments (Social Security, unemployment, and welfare benefits). The release of these two figures gives the savings rate, which is the difference between disposable income (personal income minus taxes) and consumption, divided by disposable income. The ever-declining savings rate has become a key indicator to watch as it signals consumer spending patterns. Trade Deficits When the export value is smaller than import value, the result is a trade deficit. This renders an outflow of currency, which in turn makes a currency weaker.

Industrial Production Industrial Production is the quarterly measure of the change in the amount of goods and services produced per unit of input. It incorporates labor and capital inputs. The unit cost of labor component is a useful indicator of any emerging wage pressures. The importance of productivity has grown over the past few years since the Federal Reserve has begun attributing its growth trend to relatively low levels of inflation. When this figure increases, the currency becomes stronger. Unemployment Rates The unemployment rate is calculated with the number of people unemployed in the labor force — represented in a percentage. The labor force is the sum of people who are employed and those who are receiving unemployment benefits. Although it is a highly proclaimed figure (due to simplicity of the number and its political implications), the unemployment rate gets relatively less importance in the market because it is known to be a lagging. Business Inventories Business inventories and sales figures consist of data from other reports such as durable goods orders, factory orders, retail sales, and wholesale inventories and sales data. Inventories are an important component of the GDP report because they help distinguish which part of total output produced (GOP) remains unsold. When inventories of unsold output are high, it means the economy is slowing down and the currency is becoming weaker. Durable Goods Orders Durable Goods Orders measures the new orders placed with domestic manufacturers for delivery of hard goods. A durable good is defined as a product that lasts an extended period of time (three years and over) during which its services are extended. These include large ticket items such as capital goods (machinery, plant and equipment), transportation, and defense orders. They are extremely important in that they anticipate changes in production and thus, signal turns in the economic cycle. Rising figures are often supportive to a currency in the short term.

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FUNDAMENTAL ANALYSIS Retail Sales The retail sales report measures total receipts of retail stores and includes the retail sales for both durable and non-durable goods. It reflects broad consumer spending patterns and is adjusted to normal seasonal variation, holidays, and trading-day differences. This is a true indicator of the strength of consumer expenditure. Rising figures are often supportive to a currency in the short term.

sustains a large trade deficit of approximately $500 billion, which makes the U.S. rely heavily on capital flows. Hence, the dollar is a capital flow dominated currency.

Housing Starts The Housing Starts report measures the number of residential units on which construction is begun each month. A start in construction is defined as the beginning of excavation of the foundation for the building and is comprised primarily of residential housing. Rising figures are often supportive to a currency in the short term.

Part IV. Profiles on the Major Currencies It is essential to have a general understanding of the economic characteristics of the major currencies. Alongside the US dollar, trading in the FX market is dominated by 5 other major currencies: the euro, Japanese yen, British pound, Swiss franc, and the Canadian dollar. US Dollar (USD) Overview of the U.S. Economy The United States (U.S.) has the largest and most technologicallyadvanced economy in the world. This leading industrial power absorbs 71% of world net foreign savings. Being responsible for 20% of total world trades, the U.S. is the largest trading partner for many countries. Its primary trading partners include: Canada 22.4%, Mexico 13.9%, Japan 7.9%, UK 5.6%, and Germany 4.1%. With roughly 40% of its capital market assets coming from foreign investment, the U.S. equity is the most liquid in the world. Regardless of its high liquidity, the U.S.

The U.S. Central Bank, the Federal Reserve (Fed), has full independence in setting monetary policy to achieve maximum non-inflationary growth. There are primarily three policy signals that the Federal Reserve manipulates to assert control over the country’s economy. These are: the Discount Rate, Fed Funds Rate, and Open Market Operations. The Discount Rate is an interest rate at which the Fed charges commercial banks for emergency liquidity purposes. Although this is more of a symbolic rate, changes in it imply clear policy signals. The Discount Rate is almost always less than the Fed Funds Rate. Fed Funds Rate is clearly the foremost interest rate. It is the rate at which depositary institutions charge one another for overnight loans. Changes are made in the Fed Funds rate when the Fed wishes to send clear monetary policy signals. Generally, announcements of changes in this rate create a large impact on all bond, stock, and currency markets. The Federal Open Market Committee, also known as the FOMC, holds the responsibility to make decisions on monetary policy. It is this committee that makes the crucial decisions on interest rate announcements, which are made eight times per year. There are twelve

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FUNDAMENTAL ANALYSIS members altogether and they include the president of the Federal Reserve Bank of New York, the seven members of the Board of Governors, and the remaining four seats carrying a one-year term each are rotated among the presidents of the 11 other Reserve Banks. USD Trading Aspects The US dollar is involved in over 90% of all currency trades. The Treasury and Federal Reserve have favored a strong dollar for the past two decades, and occasionally, interventions are applied to support this policy. Prior to 9/11, the USD was considered one of the world’s safest currencies to trade. It still is the safest currency to some extent, however, the States’ vulnerability to terrorism has somewhat diminished this belief. Many emerging market countries peg their local currencies to the dollar in efforts to stabilize their own economy. Most of the world’s raw materials trade, even if it does not involve the U.S., is charged in USD. Since the interest rate differentials between U.S. treasuries and foreign government bonds are useful tools to determine potential currency movements, market participants closely follow the US Dollar Index that depicts the strength of the currency. It is important to closely monitor USD/CAD prior to important U.S. economic announcements as the pair often provide early indications of potential market reactions. The value of the dollar against one currency is sometimes impacted by the exchange rate of another currency pair that may not even involve the dollar. To illustrate, a sharp rise in the yen against the euro (falling EUR/JPY) may cause a general decline in the euro, including a fall in EUR/USD. For more information on the US dollar, refer to section 7: Tools & Resources. Euro (EUR) Overview of the European Monetary Union Economy The European Union (EU) developed as an institutional framework for the construction of a united Europe. The EU consists of 15 member countries that share the euro as a common

currency. The EU has a single monetary policy dictated by the. European Central Bank (ECB). The decision making body is the Governing Council which consists of the Executive Board and the governors of the national central banks. The Executive Board consists of the ECB President, Vice-President, and four other members. These same 15 countries constitute the European Monetary Union (EMU). The EMU is the world’s second largest economic entity with a GDP valued over 8 trillion USD in 2002. The EMU is both a trade and a capital flow driven economy, therefore, trade is very important to the economies within the EMU. The EMU exports account for 19% of total world trade while imports account for 17%. It is primarily a service-oriented economy since services in 2001 accounted for approximately 70% of the total GOP.

EUR Trading Aspects: The EUR/USD is the most liquid currency pair in the world and its movement is used as the primary gauge of both general European and U.S. strength/weakness. The EUR/USD exchange rate is sometimes impacted by movements in cross exchange rates (nondollar exchange rates), such as the EUR/JPY or EUR/ GBP pairs. For instance, positive news in Japan could potentially cause a significant drop in the EUR/USD pair following the drop in the EUR/JPY

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FUNDAMENTAL ANALYSIS exchange rate. Even though USD/JPY may also be declining, euro weakness will spill onto a falling EUR/USD. The EUR/USD rate serves as an indicator of movements in other currency pairs. There is a strong negative correlation between EUR/USD and USD/CHF, reflecting a consistently similar relation between the euro and Swiss franc. Since the Swiss economy is highly dependently on the EU economy, an upward spike in the EUR/USD is often accompanied by a downward dip in USD/CHF, and vice versa. EUR/JPY and EUR/CHF are very liquid currency pairs that are usually the indicator for general Japanese or Swiss strength/weakness. The EUR/USD and EUR/GBP crosses are great trading currencies, as they move systematically, have very little gapping, and have tight spreads. Since the EU is comprised of so many governments under parliamentary coalitions, it is highly susceptible to political instabilities, which in turn affects the value of the EUR. Political instability may include threats to coalition governments in France, Germany, or Italy. Political or financial instability in Russia may also cause devaluation of the EUR because of the substantial amount of German investment in Russia. Devaluations of the euro due to political instability in the EU are often fully manifested in the EUR/USD exchange rate. FX traders should pay close attention to comments by members of the Central Bank Governing Council and trade EUR crosses accordingly. For more information on the euro, refer to section 7: Tools & Resources, page 88. Japanese Yen (JPY) Overview of the Japanese Economy Japan has the third largest economy in the world, with a GDP valued over 4 trillion USD in 2002, and is a key member of the G7 Japan is one of the largest exporters in the world and is responsible for over 400 billion USD in exports per year. Its large industrial base (almost 40% of GDP) and limited natural resources create a high dependence on imported raw materials from foreign countries. The primary trade partners for Japan in terms of imports and exports are the U.S. and

Japan is also the largest creditor (lender and investor) in the world; however, exporters tend to keep the majority of their profits invested in U.S. assets. Japan’s economy tends to be both capital and trade flow driven as international investors contribute to a high influx of currencies into Japan’s equity and fixed income markets. Furthermore, Japan attracts substantial amounts of inflows into its markets. JPY Trading Aspects The Japanese yen is a key indicator for Asian strength or weakness. This being said, economic crises or political instability in other Asian economies can often have dramatic impact on the yen spot movements. The yen is closely monitored by the single most important political and monetary institution in Japan, the Ministry of Finance (MoF). Despite Japan’s gradual measures to decentralize decision-making, the MoF’s influence in guiding the currency is more significant than the influence of the ministries of finance of the U.S., U.K., or Germany on their countries. The Bank of Japan (BoJ) is also a very active participant in the FX market. Together, the two parties guide the movement of the yen through interventions. There are three main factors behind the BoJ and the MoF intervention: when the JPY moves by 7 or more JPY in under 6 weeks, when the yen is getting very strong, especially when it reaches above the 115 level, and when market participants hold positions in the opposite direction. The JPY is easily influenced by political speeches, particularly those pertaining to intervention. Generally, the JPY tends to trade in an orderly fashion during Japanese and London hours, but this trading pattern becomes variable in the U.S. hours. However, the most dangerous time to trade JPY is during lunchtime in Japan (10-11pm EST) because at this time, the market becomes illiquid and prone to volatility. FX traders should closely monitor banking stocks as movements in banks can often lead to movements in the yen. USD/JPY is one of the most popular major currency pairs in the FX market. The USD/JPY exchange rate is

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FUNDAMENTAL ANALYSIS sometimes impacted by movements in cross exchange rates such as EUR/JPY. For example, a rising USD/ JPY could be a result of an appreciating EUR/JPY, rather than direct strength in the dollar. Therefore, it is important to pay close attention to potential EUR/JPY price movement when trading the USD/JPY pair. Great British Pound (GBP) Overview of the British Economy The United Kingdom (U.K.) is the world’s fourth largest economy, with a GDP valued over 1.4 trillion USD in 2001. It is also a key member of the G7. The U.K. has a service oriented economy, with manufacturing representing only one-fifth of national output. Their capital market systems are one of the most developed in the world; hence, their finance and banking have become the strongest contributors to the GDP. The U.K. is also one of the largest producers and exporters of natural gas in the EU. The energy production industry accounts for 10% of the nation’s GDP. Its largest trading partner is the EU, which accounts for over 50% of all the country’s import and export activities. GBP Trading Aspects The GBP has always played a significant role in the FX market and accounts for approximately 6% of the world’s currency trading volume. Although its presence is not as evident in other currencies, it maintains a strong presence when compared to the euro and USD. Because of the intimate trading relationship between the U.K. and EU, moves in the EUR/GBP pair often leads to fluctuations in GBP/USD. A rise in EUR/GBP (depreciating in sterling) could lead to a like decline in GBP/USD. News or speeches by political figures indicating that the U.K. is closer to joining the euro will usually put pressure on GBP, causing it to depreciate in value. Conversely, reports indicating that the U.K. may not join the single currency project will cause the GBP to appreciate in value. Since the largest energy companies worldwide are located in the U.K.,

GBP is positively correlated to energy prices. Switzerland (Confederatio Helvetica Franc - CHF) Overview of the Swiss Economy Switzerland is the nineteenth largest economy worldwide and the only major currency that does not belong to the G7. Switzerland’s stable economy has a per capita GPD that is greater than any other Western European economy. It has a prosperous tourism industry and the world’s most advanced banking system. Similar to the British economy, the back bone of the Swiss economy stems from banking and insurance sectors. The two, combined, comprise over 70% of the country’s total GDP. It is important to note that, with the sophisticated banking system, Switzerland has become the world’s largest destination for offshore capital, which totals over $2 trillion in offshore assets. Since the country lacks significant natural resources, its economy is highly dependent on services and manufacturing businesses. International trade has always been the foundation and primary source of the country’s economic development. CHF Trading Aspects: J Switzerland’s neutral political status makes the CHF a safe currency to trade. During international chaos involving countries outside of Europe, the Swiss franc is the second safest choice against the US dollar. In 1990, the franc broke its historically high exchange rate against the US dollar. However, its strength decreased significantly in. 1991, when it suffered adjustment periods. The trend in Swiss franc is highly dependent on outside events and international economic stability, as opposed to domestic economic news. Since the law requires that the franc be 40% backed by gold, the CHF is strongly correlated to the prices of precious metals. In regards to currency pairs, the USD/CHF is relatively illiquid and tends to gap; therefore, most active trading of the CHF occurs in EUR/CHF. Due to the lack of liquidity in USD/CHF,

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FUNDAMENTAL ANALYSIS price movements typically follow those in EUR/USD and EUR/CHF. Because of the close proximity of the Swiss economy to the EU, the Swiss franc is positively correlated to the euro. This relationship is most evident in the inverse relationship between USD/CHF and EUR/USD. To illustrate, a sudden move in EUR/USD is most likely to cause an equally sharp move in USD/ CHF in the opposite direction. FX traders tend to favor USD/CHF because they can use EUR/USD and EUR/CHF as leading indicators for trading USD/CHF. Evidently, news of Switzerland joining the European Union (EU) would have negative impact on the CHF as the euro would overpower the CHF. At the present, economists and politicians remain uncertain on the long-term fate of the Swiss franc. Whether it is capable of maintaining its independence from the euro continues to be a debate.

CAD Trading Aspects: The Canadian economy is highly dependent on gold and oil so price movements in these commodities greatly affect the value of the CAD. Additionally, since the United States is the biggest trading partner of Canada, the U.S. economy exerts a strong influence on the CAD. The USD/CAD rate often moves as a result of sentiment encompassing the U.S. economy. In the first half of 2003, the CAD peaked a six-year high, exceeding the 0.75 USD mark. FX traders should closely follow the interest rate differentials between the cash rates of Canada and the short-term interest rate yields of other industrialized countries. These differentials can be good indicators of potential money flows as they indicate how much premium the Canadian dollar (loonie) will yield in short-term fixed income assets, or vice versa.

Canadian Dollar (CAD) Overview of the Canadian Economy Canada is the second largest country in the world but had a GDP of only 700 billion USD in 2001, making it the seventh largest world economy. Canada is also one of the leading members of the G7 countries. Economically and technologically, the nation has developed in parallel with the United States. As an affluent, high-tech industrial society, Canada closely resembles the U.S. in its market-oriented economic system, pattern of production, and high living standards. The United States accounts for more than 85% of Canada’s exports and produces three-quarters of its imports. The Canadian economy is highly dependent on natural resources such as gold and oil; Canada is the world’s fifth largest producer of gold and the fourteenth largest producer of oil. In 1997-98, the government recorded a surplus for the first time in 28 years and the following year marked the first back-to-back surplus in almost 50 years.

Part V. Tips for Trading with Fundamental Analysis Fundamental analysis is a very effective and efficient method to forecast economic conditions, but not necessarily exact market price movements. Two people can look at the exact same economic data and come up with two completely different conclusions about how the market will be influenced by it. Therefore, is it important to study the fundamentals and see how they best fit your trading style before casting yourself into a particular mold regarding any aspect of market analysis. For example, when analyzing an economist’s forecast of the upcoming US dollar or employment report, you begin to get a fairly clear picture of the general health of the economy and the forces at work behind it. However, you will need to come up with a precise method as to how best to translate this information into entry and exit points for a particular trading strategy. Furthermore, it is vital to stay current with public announcements and news that can suddenly move an exchange rate hundreds of pips in a matter of minutes. These are the 3 tips that may protect you from undesired losses:

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FUNDAMENTAL ANALYSIS 1. Always tune in to a live news source or channel during active trading. It is important to take note of the tremendous amount of data that is released at regular intervals. Identify the news source that can provide you with the latest breaking events and live broadcasts of scheduled speeches and reports by industry leaders.

you know what economists and other market pundits are forecasting for each indicator. Once again, market expectations for all economic releases are published by various sources on the Web and you should post these expectations on your calendar along with the release date of the indicator.

2. Know when all scheduled announcements will take place that may influence your trading. Know exactly when each economic indicator is due to be released. A calendar of these reports is usually available from FX Trainer’s online resource links or can be found in most investment newspapers. Keep a calendar that contains the date and time of these events on your desk or near your trading station. Developing this positive habit will also help you make sense out of price action that might otherwise be unanticipated and erratic.

Do not act too quickly should a particular economic indicator fall outside of market expectations. Each new economic indicator released to the public contains revisions to previously released data. For example, if durable goods rise by 0.6% this month, while the market is anticipating them to fall, the unexpected rise could be the result of a downward revision to the prior month. Look at revisions of older data. In this case, the previous month’s durable goods figure might have originally been reported as a rise of 0.6%, but now, along with the new figures, is being revised lower to perhaps a rise of only 0.1%. Therefore, the unexpected rise in the current month is likely the result of a downward revision to the previous month’s data.

3. Get out of the market prior to any major announcement if you are a short-term, technical trader. If you must hold on to a longer term position, reevaluate your stop loss orders before these announcements are made. If it is mathematically sound, tighten your stop loss orders.

Part VI. Tips to Interpret Economic Indicators The key is to understand that economic indicator forecasts come from a variety of sources, and all sources have a measure of subjectivity. Here are a few guidelines to help you track, organize, and make trading decisions based on the economic data. Identify whether the economic data falls within market expectations. The reason the market sometimes moves contrary to what many people expect is a result of the clash between expectations and reality. The market measures an economic statistic not only by the direction in which it moves, but by whether the number corresponds to the expectations. If unemployment moves up by one-tenth of a point but the market expected a one-fifth increase, the market could easily rally with surprised relief. Therefore, it is important that

Have a basic understanding of what particular aspect of the economy is being presented in the data. For instance, you should recognize that the GDP is measuring the growth of the economy versus the CPI and PPI which are measuring inflation. Over time, you will become familiar with the nuances of each economic indicator and what part of the economy they are measuring. Pay attention to which indicators the markets are focusing on. During some periods, certain indicators are more important than others. Although most economic indicators are created with equal importance, some may have acquired much greater potential to move the markets than others. Therefore, know which indicators are more important during the time you are making your trading decisions. Lastly, do not succumb to paralysis by analysis. Given the multitude of factors that fall under the heading of “The Fundamentals,” there is a danger of information overload. Sometimes traders fall into this trap and are unable to pull the trigger on a trade. This is one of the

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FUNDAMENTAL ANALYSIS reasons why many traders turn to technical analysis. To some, technical analysis is seen as a way to transform all of the fundamental factors that influence the markets into one simple tool, prices. However, trading a particular market without good fundamental knowledge about the exact nature of its underlying elements is rather risky. Achieve a balance between being uninformed and overwhelmed with economic data; be an informed FX trader who has enough knowledge of the underlying economic factors to make educated forecasts of market price movement.

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I. Technical Analysis vs. Fundamental Analysis

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Overview Two Major Forms of Technical Analysis

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II. Trends

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Types of Trends Uptrend Downtrend Sideways Trend Classifications of Trends

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III. Rally & Consolidation Phases Continuation Patterns Channel or Rectangle Triangles Wedge Trend Reversal Patterns Head and Shoulders 1-2-3 Tops and Bottoms Double or Triple Tops and Bottoms

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IV. Chart Scaling of Charts Choosing the Proper Time Period Day or Intraday Trading Swing Trader Position Trader Three Methods of Plotting Charts Bar Charts Line Chart Candlestick Chart Common Candlesticks Candlestick Patterns Doji Bearish Engulfing Pattern Bullish Engulfing Pattern Piercing Line Pattern Dark Cloud Pattern Shooting Star Pattern Morning Star Pattern Even Star Pattern Harami Pattern Hammer Pattern Hanging Man Pattern

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V. Pattern Interpretation Principle 1 - Patterns take on Significance from their size and depth

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Principle 2 - Do not wait for Perfect Pattern 61 Principle 3 - Combine Pattern Trading with Other Techniques Identifying Support and Resistance Drawing Trend Lines

Moving Averages (MA) Simple Moving Average Weighted Moving Average Exponentially Smoothed Moving Average Application of Moving Averages in Trading 1. Determine entry and exit points 2. Determine direction of trend 3. Determine strength of trend Most Commonly Used Moving Bollinger Bands Methods of interpreting Bollinger Bands 1. Breakouts 2. Overbought & Oversold Indicators

Relative Strength Indicator (RSI) Moving Average Convergence and Divergence (MACD)

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VI. Technical Indicators

VII. Oscillators

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VIII. Stochastics Application of Stochastics in Trading 1) Detect overbought and oversold Conditions 2) Divergence 3) Trade Signals Rate of Change (ROC)

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IX. The Basic Theories Fibonacci Retracement Application of Fibonacci Retracement Levels in Trading Factors to consider when using the Fibonacci Levels: Elliott Wave Theory

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X. Tips for Using Technical Analysis

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TECHNICAL ANALYSIS Part I. Technical Analysis vs. Fundamental Analysis Technical analysis concentrates on the study of market action while fundamental analysis focuses on the economic forces which cause prices to move. Both of these approaches attempt to achieve the same goal, that is, to determine the direction prices are likely to move. The only difference between the two is that they approach. the market from different angles. In essence, a fundamentalist studies the cause of market movement, while a technician studies the effect. On the surface, technicians may appear to ignore the fundamentals that drive market movement. It may seem that they are so absorbed by charts and data tables that they become ignorant of the underlying factors that move the market. However, a technical trader will explain to you that all the fundamentals are already represented in the price. In other words, the charts that depict price movements are actually a visual form that illustrates the fundamentals. All economic data are translated into patterns and trends of market prices that could easily be used for making important trading decisions. Basically, technical traders look at the charts to identify the trends in order to predict future prices. The bottom line when using any type of analysis, technical or fundamental, is to stick to the basics. The basics are the methods that work for you and have been proven to work over a long period of time. After finding a trading system that works best for you, other methods and strategies could be gradually incorporated as tools into your trading toolbox.

Part II. Technical Analysis Overview Technical analysis is the study of historical price action and volume data for the purpose of forecasting future market trends. This type of analysis focuses on the chart formations to analyze major and minor trends. It helps to identify buying/selling opportunities

by assessing the extent of market reversals. Technical analysis can be used on an intraday 5 minute, 15 minute, hourly, weekly, or monthly basis. Technical analysis is based on 3 assumptions listed in the table below.

Depending on the level of complexity, technical analysis may involve price charts, volume charts, and many other mathematical representations of market patterns. As you advance in your technical trading skills, technical indicators and mathematical ratios may be added to the charts to form a more comprehensive analysis of the market. Therefore, rather than merely relying on price charts, technicians may also use other tools in aid of forecasting future market values. Currencies rarely spend much time in tight trading ranges and have the tendency to develop strong trends. Over 80% of volume is speculative in nature and as a result, the market frequently overshoots and then corrects itself. A technically trained trader can easily identify new trends and breakouts, which provide multiple opportunities to enter and exit the market. Two Major Forms of Technical Analysis Technical analysis can be further divided into two major forms: Quantitative Analysis: uses various statistical properties to help assess the extent of an overbought/oversold currency. Chartism: uses lines and figures to identify recognizable trends and patterns in the formation of currency rates.

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TECHNICAL ANALYSIS trend is an overall directional price movement in a pre-defined time interval. It is estimated that 70% of the time, markets will fluctuate randomly or move between support and resistance levels. The rest of the time, market behavior is characterized by persistent price movements — trends — that break through support and resistance levels. The concept of trends forms the basis of the technical approach. Basically, the sole purpose of charting the price action of a market is to identify trends in early stages of their development for the purpose of trading in the direction of those trends. In fact, most of the techniques used in this approach are trend-following in nature; their intent is to identify and follow existing trends. Once a trend is defined, a sound strategy can reasonably predict its direction and duration. As a result, profits are accumulated and maximized, while losses are minimized. Types of Trends One of the first things you will hear in technical analysis is this saying: “Never go against the trend; the trend is your friend”. Prices can move in one of three directions, up, down or sideways. Once a trend is established in any of these directions, it usually will continue for some period. Based on the direction of movement, there are three types of trends: 1) Uptrend, 2) Downtrend, and 3) Sideways Trend. Uptrend

An uptrend is a succession of higher highs and higher lows. It indicates a bull market in which the base currency is appreciating in value. In essence, an uptrend can be considered intact until a previous relative low point is broken. A violation of this condition serves as a warning that the trend may be over. Once an uptrend is confirmed, traders should enter a buying position; in other words, go long on the currency pair. Downtrend

A downtrend is defined as a succession of lower lows and lower highs. It indicates a bear market in which the base currency is depreciating in value. Generally, a downtrend can be considered intact until a previous relative high is exceeded. Once a downtrend is established, traders should enter a selling position, which is also known as shorting the currency pair. Sideways Trend

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TECHNICAL ANALYSIS A sideways trend indicates a highly volatile market in which prices are moving within a narrow range. In other words, the value of currencies is not appreciating or depreciating in value. Classifications of Trends There are three classifications of trends: primary, intermediate, and short-term.

Rally & Consolidation Phases Currency price movements can usually be put into two main categories, a rally phase and a consolidation phase (also known as congestion). During the rally phase, buyers of one side of a currency pair have the upper hand over sellers, since it is their enthusiasm that strengthens the currency they have chosen to buy. During the consolidation phase, the enthusiasm of both buyers and sellers of both sides of a currency pair becomes more balanced, as neither one is able to win out over the other. Eventually, one will dominate and another rally phase will commence in either direction. Obviously, every purchase must be offset by a sale, and visa versa. However, if buyers are enthusiastic, they are more willing to accept a higher price which increases the value of the bought currency. If sellers are pessimistic, they are more likely to only be willing to accept a lower price, which decreases the value of the sold currency. Technical traders can notice these price struggles as buyers and sellers battle. These battles between buyers and sellers appear in reoccurring patterns or formations that can be seen within their charts. These patterns can also be categorized into two groups, continuation

patterns and trend reversal patterns, which naturally correlate with the two above-described phases. Continuation Patterns Continuation patterns reflect a gap or pause in trading that the market needs during sharp trends. Such periods of consolidation are usually quite short and often slope against the original trend. In contrast, breakouts occur in the same direction as the original trend. Let’s review, several common continuation patterns that can enhance your technical analysis. Although these patterns are normally considered bar patterns, we can also view them with candlestick charts. Channel or Rectangle A channel or rectangle is a pattern in which parallel lines can be drawn through or against price bar or candle highs and lows. Channels can be in several directions: horizontal (also called a “rectangle”), inclining, or declining. This pattern is easy to spot since it can be viewed as a brief sideways trend. If it occurs within an uptrend and breaks out on the upside, it is called a bullish rectangle. If the congestion occurs with a downtrend and breaks out on the downside, the formation is called a bearish rectangle.

Traders frequently trade on the breakout of the channel or test the breakout by placing a small risk stop order inside or on the other side of the channel. Upon breakout, the market will most likely move in the direction of the original trend.

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TECHNICAL ANALYSIS When a channel follows a strong rally phase, we refer to this as a flag formation since the rally phase resembles a “flagpole” and the consolidation phase (channel) that follows it resembles a “flag”. A flag pattern is very reliable and often easy to see in the early stages of its formation. Triangles A triangle is a pattern in which the slope of price bar or candle highs and lows are converging to a smaller pricing area or point so as to outline the shape of a triangle. Triangles can either be symmetrical, ascending, descending, or expanding. The ascending triangle is recognized by a flat resistance line and an upward sloping support line. The descending triangle is identified by a flat support line and downward sloping resistance line. The much less common expanding triangle is a mirror image of a symmetrical triangle, but the tip of the triangle, not the base, is next to the original trend. Traders frequently trade on the breakout of a triangle or test the breakout by placing a small risk stop order inside the triangle.

When a triangle follows a strong rally phase, we refer to this as a pennant formation since the rally phase resembles a flagpole and the consolidation phase (triangle) that follows it resembles a pennant flag that tapers to a point. A wedge is a pattern that is similar to a triangle in appearance because it also has converging trend lines coming together at the tip. However, wedges

are distinguished by a noticeable slant in either direction.

There are several breakout-based approaches to trading wedges. The most common approach is to give a bias to the same direction of the overall trend when the wedge is pointed in the opposite direction of the trend. Below is an example of a falling wedge in a downtrend:

Trend Reversal Patterns Like most good things in life, all good trends must come to an end. In Forex, this is not unfavorable since we can simply reverse directions and go the other way. Fortunately, there are several trend reversal patterns that often signal the beginning of a new trend, or, at the very least, a strong countertrend move. Let’s review three common trend reversal patterns that can enhance your trade system. Again, although these patterns are normally considered bar patterns, we can also view them with candlestick charts. Head and Shoulders Head and shoulders is a bar pattern that signals a trend reversal. In an uptrend, the market begins to

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TECHNICAL ANALYSIS slow down and forces of supply and demand are generally achieving equilibrium. Sellers come in at the highs (left shoulder) and push the market down until the bearish force slows down (beginning neckline). Buyers soon return to the market and ultimately push through to new highs (head). However, the new highs are quickly turned back and the downside is tested again (continuing neckline). Short-term buying reemerges and the market rallies once more, but fails to take out the previous high (right shoulder). Buying subsides and the market turns back to the downside again. The pattern is complete when the market breaks the neckline. Head and Shoulders can be in an uptrend or inverted in a downtrend. Below is an example of a head & shoulders pattern in an uptrend:

Below is an example of a 1-2-3 top:

Double or Triple Tops and Bottoms Double or Triple Tops and Bottoms is another bar pattern that signals a trend reversal. In an uptrend, prices rally to a new high, pull back for an indefinite time period, rally to the same high price area again whereupon they reverse once again. This rally and pull-back action can occur two, three or more times, forming a double or triple top.

Part IV. Charts The most basic building blocks of technical analysis are price charts. Charts help traders determine ideal entry and exit points for a trade. They provide a visual representation of the historical price action of 1-2-3 Tops and Bottoms 1-2-3 tops and bottoms is a bar pattern that signals a trend reversal. In an uptrend, the market hits a new high (#1 top), pulls back to a short-term support level (#2 point), and resumes an upward move to a high that is below the #1 high point (#3 point), whereupon it reverses once again. In a downtrend, the preceding definition is inverted. The pattern is complete when the market breaks the #2 point.

whatever is being studied. Depending on their level of sophistication, charts can help with much more advanced studies of the markets.

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TECHNICAL ANALYSIS Scaling of Charts Pricing on FX Charts is always displayed on the vertical or “Y” axis, either to the right or left side. Pricing information is plotted on an arithmetic scale which plots each price variance with the same vertical distance; hence, the distance from 1.1400 EUR/USD to 1.1450 EUR/USD is the same as 1.1500 EUR/USD to 1.1550 EUR/USD. Choosing the Proper Time Period A day or intraday trader trades in very short time frames of minutes and hours. So, an FX day trader usually sets up a screen page or pages with a daily, 120, 60, 30, 15, 10, 5, or 1 minute chart. Below is a sample 5 minute chart for day or intraday trading:

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TECHNICAL ANALYSIS Often, an FX swing trader uses data from previous weeks and months to open positions on Monday or Tuesday with a goal of closing these positions by Thursday or Friday. So, an FX swing trader normally sets up a screen page or pages with weekly, daily, 120, or 60 minute charts. Below is a sample daily chart for swing or momentum trading:

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TECHNICAL ANALYSIS A position trader opens and holds positions in the market for weeks or even months at a time. When trading with this style, the trader is not as concerned about the daily noise in the market. So, an FX position trader sets up a screen page or pages with monthly, weekly and daily charts. Below is an example of a weekly chart for position trading:

Three Methods of Plotting Charts With technical analysis gaining wider acceptance, technicians have developed more than one way of physically representing market data on charts. Most charting methods plot prices on the vertical (Y-axis) and the time period on the horizontal (Xaxis). Time frames can be anywhere from one minute all the way to one month. There are three widely used methods of plotting charts; they include bar, line, and candlestick charts.

Bar Chart

This method portrays pricing action using vertical bars. The bar represents the trading range for the stated time period. The bars themselves usually

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TECHNICAL ANALYSIS have at least one horizontal mark. The top of the bar records the highest price and the bottom records the lowest price. A mark, extending to the left, records the opening price and a mark, extending to the right, records the closing. One advantage of bar charts is that they can provide a lot of visual information on a single page.

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TECHNICAL ANALYSIS Line Chart Usually on a line chart, the openings, highs, and lows are ignored. Only the closing price is plotted. A continuous line, with various peaks and valleys, joins the closing prices. The line chart offers less visual information than other charts; however, it can be more helpful in some respects. For example, since the highs and lows are ignored, most of the market “noise” (short-term price fluctuations) is eliminated. This makes it much easier to spot trends and reversal patterns.

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TECHNICAL ANALYSIS These vertical lines on the top and bottom are also referred to as the upper shadow and the lower shadow. The rectangle itself is known as the body, which represents the pricing activity between the opening and closing prices.

Candlestick Chart

This method was developed in Japan many centuries ago and basically provides the same information as bar charts. A candlestick or candle consists of a vertical rectangle, and often, a vertical line on top of the candle (wick) and a vertical line below the candle (tail).

If the opening price is higher than the closing price, the opening price is recorded at the top of the body and the closing price at the bottom; the candle is displayed in a solid red body. When the opening price is lower than the close, the opening price is recorded at the bottom of the body and the closing price at the top; the candle is displayed with a solid blue body. The biggest advantage of using candlesticks is that they can make it easier to spot certain price patterns that may not be as apparent in other charts. The disadvantage, of course, is that candlesticks take up a lot more horizontal space, giving a smaller view of market activity.

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TECHNICAL ANALYSIS Common Candlesticks There are 5 different types of candlesticks that are extremely common in the FX market. These candlesticks are as follows: “A” shows the high and low with no shadows. “B” shows when the opening and closing prices are identical. “C” shows a very small trading range. “D” shows the opening and closing near the high. “E” shows the opening and closing near the low.

Candlestick Patterns The information displayed in candlestick charts is identical to bar charts. Each one contains the opening, high, low, and closing prices. However, it is the way that candles are displayed that makes them unique and gives them different interpretive powers. While they can be used for any time period, candlesticks are used most often with daily price data. The most commonly used time scale for candlestick charts is 5 minutes 1 day. It is important to familiarize yourself with the various candlestick patterns. These patterns possess specific forecasting characteristics that indicate buying/selling opportunities.

A doji implies that the market has an unclear or undecided direction. Buyers and sellers are in equilibrium (equally strong). Opening and closing prices are equal; hence, a true doji has a horizontal line instead of a body. The color of the doji may be blue or red. A doji provides signals of potential market tops or bottoms. A doji formation is significant if it appears after a long blue candle in an uptrend or a long red candle in a downtrend. If there are two doji formations (double-doji), that means that the market is about to reverse.

Bearish Engulfing Pattern The bearish engulfing pattern is a trend reversal pattern, which typically occurs after a significant uptrend. It is formed when a red candle engulfs a blue candle. This indicates that sellers have gained control Bearish Engulfing of the market. The significance of the bearish engulfing pattern is dependent on the sizes of the two involved candles; the smaller the blue candle and the larger the red candle, the more significant the signal. Generally, it is a sell signal once a currency pair closes in this formation.

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TECHNICAL ANALYSIS Piercing Line Pattern The piercing line pattern is a bullish signal. It shows that there is strong buying power at lower levels and that the downward pressure is beginning to subside. The more the blue candle pierces into the red candle, the more significant the bullish signal.

Bullish Engulfing Pattern The bullish engulfing pattern is a trend reversal pattern that usually appears after a dramatic downtrend. It indicates that the downward momentum may be at an end. The formation of this pattern involves a red candle that is engulfed by a blue candle. The longer the blue candle, the more significant the trading signal is. Typically, it is perceived as a buy signal.

Dark Cloud Pattern A dark cloud cover is a bearish signal. This reversal pattern indicates that the buying pressure is weakening. The formation consists of the body of a red candle closing within the previous blue candle. The deeper the second candle covers the first candle, the stronger the signal.

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TECHNICAL ANALYSIS Shooting Star Pattern A shooting star is a reversal pattern that typically occurs after gaps. This is a bearish signal that has a long wick and a small body. It is usually located near the end of the trading range. This pattern shows that, the market has met with a strong selling pressure after it rallied. The color of the body can be either blue or red. More often it signals a downtrend reversal, as opposed to an uptrend reversal, is in the making.

Evening Star Pattern The evening star pattern is a bearish signal that occurs in an uptrend. It indicates that the market has hit a wall of sellers after a rally. This formation also involves three candles: a blue candle, followed by a small red or blue, then a long red candle. The last red candle does not touch the body of the second candle. Traders should not trade until confirming the close of the third candle.

Morning Star Pattern The morning star is a bullish signal reversal pattern that occurs in a downtrend. This formation involves three candles: a long red candle, a small red or blue candle, and a blue candle. The last blue candle usually has a long Morning Star body that does not touch the body of the second candle and closes well into the body of the first candle. It is very important that traders wait for the third candle to close prior to buying.

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TECHNICAL ANALYSIS Harami Pattern The harami pattern is a reversal formation that signifies a weakening trend. It is comprised of two candles: the first candle has a long body, while the second has a smaller body that is within the first candle and is in a different color than the first candle. The smaller the second candle, the stronger the reversal signal Hanging Man Pattern The hanging man pattern appears after a rally and is typically viewed as a bearish signal. Because the currency pair was not able to close higher than its opening price, the hanging man indicates weakening market sentiment. Prior to opening a new position, it is important to wait for the next candlestick to close. The next candlestick must close below the hanging man’s body in order to confirm the trend reversal. Hammer Pattern The hammer formation appears after a significant downtrend and is typically viewed as a bullish signal. It is particularly important if it occurs after a number of down days. Traders may buy Hammer once a hammer formation appears, aspiring for an imminent trend reversal. It is even more effective when a currency reaches a double bottom and a strong support line is in place.

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TECHNICAL ANALYSIS Pattern Interpretation There are 3 principles that should help increase your ability to successfully interpret the market data displayed within price patterns. Principle I — Patterns take on Significance from their Size and Depth The larger a pattern becomes, the greater its significance. Remember that patterns give us a visual picture of the battles fought between buyers and sellers. The bigger the battle and the longer it takes, the more exhausted the losing side becomes and the greater the probability for a new price movement. Principle 2— Do not wait for Perfect Patterns Novice traders will often miss out on great trade opportunities because a price formation is not a perfect match to the ones in the course. What they fail to grasp is that pattern interpretation is not perfect science. Experienced traders do not wait around to trade perfect patterns. They know that pattern interpretation is a subjective technique that must be adaptive. As a result, seasoned traders have their eyes wide open to a greater number of excellent opportunities available to them in the Forex market. Principle 3— Combine Pattern Trading with other Techniques A trader can be profitable trading high-probability patterns alone. However, when you combine other techniques, you can increase the probability of your success immensely.

Part V. Identifying Support & Resistance

trend. These peaks and troughs are more commonly referred to as support and resistance levels. Support and resistance levels are points where a chart experiences recurring upward or downward pressure. Support is enough buying pressure to halt a decline in prices for an extended period. A support level is usually the low point in any chart pattern (hourly, weekly or annually). In contrast, resistance is enough selling pressure to halt an increase in prices for an extended period. A resistance level is the high or the peak point of the pattern. These points are identified as support and resistance when they show a tendency to reappear. The area in between these levels is called a channel. As prices move between the support and resistance level, they are moving within the channel. It is best to buy or sell near support or resistance levels that are unlikely to be broken.

Once these levels are broken, they tend to take up the opposite role. Thus, in a rising market, a resistance level that is broken, could serve as a support for the upward trend, whereas in a falling market; once a support level is broken, it could turn into a resistance.

As a technical trader, identifying support and resistance along with the prevailing trend is the most important aspect of technical analysis. Prices move in a series of peaks and troughs. The direction of these peaks and troughs determine the

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TECHNICAL ANALYSIS The following chart shows rising support and resistance levels in an uptrend.

connecting two points or more. The validity of a trading line is partly correlated to the number of connection points. Yet, it is important to note that points must not be too close together.

This diagram is a trend line drawn by connecting three successive low points in an uptrend. There are several guidelines that are applicable when using support and resistance levels. These guidelines are listed in the table below.

Part VI. Technical Indicators Drawing Trend Lines A common approach to analyzing a prevailing trend is to use trend lines. Thus, FX traders should have a basic understanding of how to draw trend lines right on their charts. Trend lines are simple, yet helpful tools in confirming the direction of market trends. An upward straight line is drawn by connecting at least two successive lows. Naturally, the second point must be higher than the first. The continuation of the line helps determine the path along which the market will move. An upward trend is a concrete method to identify support levels. Conversely, downward lines are charted by

Technical indicators are mathematical equations applied to a price, time, or volume measurement that produce a numerical result. This numerical result is often represented in a graph or chart that shows a moving line or changing value. There are a number of indicators that are commonly used worldwide. There are two types of technical indicators: trendfollowing and oscillators. 1) Trend-following indicators are known as lagging indicators, which means they typically turn after trends reverse. They are most useful when markets are trending, but when the markets are rallying or flat, they may give false signals.

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TECHNICAL ANALYSIS 2) Oscillators are considered leading indicators and typically turn before price reversals. They work best in rallying or choppy markets, but give false signals in trending ones. Moving Averages (MA) Moving averages (MA’s) are trend-following indicators that are the most popular among all technical indicators. They are lines overlaid on a chart indicating long term price trends, with short term fluctuations smoothed out. An MA tells the average price in any given point over a defined period of time. They are called moving because they reflect the latest average, while adhering to the same time measure. Moving averages are important technical indicators because they eliminate minor fluctuations and provide traders with a clear depiction of price over a length of time. MA’s are widely used because they are easy to understand and calculate. A weakness for moving averages is that they lag the market. In other words, they follow market changes and do not necessarily signal a change in trends. To overcome this issue, shorter periods such as 5- to 10-day MA’s are used. Moving averages with a shorter time frame are more reflective of the recent price action rather than older data that 40 or 200-day moving averages illustrate. There are three kinds of mathematically distinct moving averages: Simple MA, Weighted MA, and Exponentially Smoothed MA. Simple Moving Average The simple moving average is the most basic of all moving averages. A simple moving average assigns equal weight to each price point over the specified period. The FX trader defines whether the high, low, or closing price is used and these price points are added together and averaged. This average price point is then added to the existing string and a line is formed. With the addition of each new price point, the sample set drops off the oldest point. In short, it is

the average of a specified number of prices for a specific period of time. Weighted Moving Average This indicator does not assign equal weight to all values in the data series; it can either assign more weight to the front or back. A front-weighted moving average gives greater weight to the newest data and a back-weighted moving average gives greater weight to the oldest data. However, a weighted moving average is most often used with giving more emphasis to the latest data. A weighted MA multiplies each data point by a weighting factor, which differs from day to day. These figures are then added and divided by the sum of the weighting factors. Essentially, a weighted MA enables the trader to effectively smooth out a curve while having the average more responsive to current price changes. Exponentially Smoothed Moving Average Among the 3 types of moving averages, exponentially smoothed moving averages (EMA) are the most commonly used. Instead of assigning equal weight to all data, it puts an emphasis on the most recent data. The exponentially smoothed MA considers data in the entire life of the instrument. Since it is mathematically smoothed, it generates a more stable moving average line. The mathematics behind this indicator is relatively more complex than the previous two types of moving averages. The EMA multiplies a percentage of the most recent price by the previous period’s average price.

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TECHNICAL ANALYSIS Application of Moving Averages in Trading 1. Determine entry and exit points Moving averages may be used by combining two averages of distinct time frames. For example, a 5day MA may be paired with a 20-day MA or a 10-day MA with a 40-day MA. A buy signal is indicated when the fast moving average (one with the shorter time frame) crosses and closes above a slow moving average (one with the longer time frame).

Conversely, a sell signal is indicated when the fast moving average crosses and closes below a slow moving average. 2. Determine direction of trend An upward moving average signifies an uptrend. A downward moving average signifies a downtrend. 3. Determine strength of trend The steep slope of a moving average indicates a strong trend. The flat slope of a moving average indicates a weak trend

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TECHNICAL ANALYSIS Most Commonly Used Moving Averages Moving averages are frequently viewed as support or resistance levels that are used in reference points. 200-day, 100-day, 50-day, 20-day, and 10-day moving averages are the most widely used in technical analysis. While a longer term moving average can help to define and support a particular trend, shorter term moving averages can provide lead signals that a trend is ending before prices dip below your longer term moving average line. For this reason, most traders will plot several moving

Bollinger Bands Bollinger Bands is another trend-following indicator used to identify extreme highs or lows in relation to market price. Sometimes currency prices appear to remain in a range for extended periods of time. Some people use an upper boundary and a lower boundary to define the range. The upper boundary is

averages on the same chart. For example, price movements above the 200-day exponentially smoothed MA are perceived as bullish, meaning that the market consists of more buyers than sellers. Conversely, price movements below the same MA would be considered bearish, meaning that there are more sellers than buyers in the market. There are various combinations of moving averages as their time interval matters (days or minutes). The longer the time frame is, the more accurate the trend.

calculated as a moving average of a chosen period plus 5% of the price, and the lower boundary is the moving average minus 5%. These boundaries have the drawback of being too narrow to accommodate price levels when volatility is high, and too wide when volatility is low.

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TECHNICAL ANALYSIS A better solution, Bollinger Bands, establishes trading parameters, or bands, based on the moving average and a set number of standard deviations around this moving average. While the upper boundary is a chosen moving average plus X number of standard deviations, the lower boundary is the moving average minus the same number of standard deviations. Bollinger bands are very similar to moving averages but are correlated with price actions of the currency, rather than a fixed percentage amount. Because standard deviation is a measure of volatility, Bollinger Bands are dynamic indicators that adjust themselves (widen and contract) based on the current levels of volatility in the market being studied. Generally, the higher the volatility, the wider the band is; the lower the volatility, the narrower the band is. John Bollinger, the inventor of the Bollinger Bands, recommends using a simple 20-day moving average and 2 standard deviations. A simple moving average is recommended because the sensitivity is less intense, which equates less market noise. The Bollinger Bands include 3 lines: the upper band, lower band, and the centerline. The centerline is simply the moving average, also known as the pperiod in the Bollinger Bands. The upper and lower bands are, respectively, the center line plus or minus twice the standard deviation; this statistically implies that 95% of price movement should be contained between the two bands. When prices reach the upper or lower boundaries of a given set of Bollinger Bands, this is not necessarily an indication of an imminent trend reversal. It simply means that prices have moved to the limits of the established parameters. Therefore, traders should use another study in combination with Bollinger Bands to help them determine the strength of a trend.

Methods of Interpreting Bollinger Bands 1. Breakouts When the price breaks above the upper band or below the lower band, some traders believe that it is an indication that currency price is in the midst of a breakout. Consequently, these traders would take a position in the direction of the breakout. 2. Overbought & Oversold Indicators When the price touches the upper band, it may be interpreted as a sell signal because it is assumed that the currency pair is overbought, and may revert to the middle of the moving average band. Alternatively, when the price touches the lower band, it is interpreted as a buy signal because it is assumed that the currency pair is oversold and may spring back towards the top of the band. Oscillators Oscillators are derived from the underlying currency to provide signals regarding overbought and oversold conditions. Since the market fluctuates, prices tend to overshoot or overextend. The most common oscillators are described below. Relative Strength Indicator (RSI) The most popular oscillator is the relative strength indicator. It was created by J. Welles Wilder Jr. to measure the strength or momentum of a currency pair. This indicator is calculated by comparing a currency pair’s current performance against its past performance — or its up days versus its down days. RSI is plotted on a vertical scale that measures from 0 to 100. An RSI above 70 indicates an overbought condition, which in turn indicates a sell signal. An RSI below 30 represents an oversold condition, which

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TECHNICAL ANALYSIS implies a buy signal. Moreover, a sell signal is indicated when the market price is high and the RSI value begins declining. Conversely, a buy signal is indicated when market price is low and the RSI value begins to rise. This theory underlying this indicator implies that prices cannot rise or fall forever. By studying the RSI, traders can determine with a reasonable degree of certainty when a reversal will take place. However, be very cautious of trading on RSI values alone. From time to time, an RSI can remain at very high or low values for quite sometime without prices reversing their course. During these times, the RSI is simply illustrating that the market is quite strong or weak but shows no signs of changing its course. The RSI can be adjusted to various levels of time sensitivity. Depending on the style of trading, the RSI can be manipulated to suit the trader’s needs. For instance, a 5-day RSI is very sensitive and tends to give many signals that may not all be sustainable. On the other hand, a 20-day RSI tends to be relatively less choppy and give fewer signals. Long-term or position traders may find that shorter time frames used for an RSI will yield too many signals, and perhaps lead to over-trading. However, shorter time frames are probably ideal for day traders who are seeking to capture the shorter-term price fluctuations. Finally, look for divergences between market prices and the RSI. If the RSI turns up in a slumping market or turns down during a bull run, this could be a good indication that reversal is about to take place. Wait for a confirmation before you act on divergent indications for your RSI studies. A divergence between the RSI oscillator and the current market price trend is an accurate indicator that a market turning point Is imminent. However, to be on the safe side,

wait for confirmation before you act on divergent indications from RSI values. Moving Average Convergence and Divergence (MACD) MACD, developed by Gerald Appel, has become another popular oscillator used in the FX market. It is simply a more detailed method of using moving averages to identify trading signals from price charts. In essence, MACD is the difference between a shorter period exponentially smoothed MA and a longer period exponentially smoothed MA. This indicator is used to confirm trends and to indicate reversals and overbought/oversold conditions. The MACD is composed of two lines on the charts and are displayed as crossovers that give buy and sell signals. The MACD line is usually a solid line that signifies the difference between two MA’s with different time periods. The Signal line is usually a dashed line that represents the MACD smoothed with another exponentially smoothed MA. Generally, the MACD plots the difference between a 26-day exponential MA and a 12-day exponential MA. Application of MACD in Trading 1) Crossovers The most common way to use the MACD is to buy or sell a currency pair when it crosses the signal line or zero. A buy signal is indicated when the MACD rallies above the signal line and a sell signal is denoted when it falls below the signal line. 2) Overbought Whenever the MACD rises, or when the shorter moving average moves away significantly from the longer moving average, the currency pair’s price movements are likely to start slowing down and soon return to more middle-ranged levels. 3) Divergences When the MACD diverges from the trend of the currency price, this may signal a trend reversal. For instance, if the MACD turns positive and makes higher lows while prices are still sinking, this could be

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TECHNICAL ANALYSIS a strong buy signal. Conversely, if the MACD makes lower highs while prices are aspiring, this could signify a strong sell signal Stochastics This popular indicator examines the strength and momentum of a currency pair’s price action by measuring the degree by which a currency is overbought or oversold. Stochastics provide a trader with information about the closing price in the current trading period relative to the prior performance of the market being analyzed. The stochastic formula is established on the basis that prices tend to close near the upper part of the trading range during an uptrend and close near the lower part of the trading range during a downtrend. When using the formula, one attempts to identify the points in the rising market where the closes are grouped nearer to the low prices than high prices, which would signal a trend reversal is in progress. Vice versa, in a falling market, stochastics attempt to identify closes grouped nearer to the high prices, which would also signal a trend reversal in progress. Stochastics are measured and represented by two separate lines. They are both plotted on a scale from o to 100. The different values on this scale suggest different market behaviors. While high values indicate a bullish market, low values imply a bearish market. It is important to note that stochastics do not work well in choppy or sideways markets. When prices are fluctuating in a narrow range, the stochastics value lines may cross too many times, indicating that the market is moving sideways. Furthermore, stochastics are most useful in measuring the strength of a trend. When prices are making new highs or lows and the stochastics are moving in the same direction, the trend is very likely to continue.

Application of Stochastics in Trading 1) Detect overbought and oversold conditions Readings above 80 represent strong upward movements and overbought conditions. On the other hand, readings below 20 indicate strong downward movements and oversold conditions. 2) Divergence Divergence occurs when the stochastic values are flattening out or moving in the opposite direction of prices. Divergences can be used as reliable indicators of possible trend reversals. Therefore, many traders close their current positions and/or enter new positions in the opposite direction from the direction of the current trend that is believed to be terminating. 3) Trade Signals Stochastics can be a very useful indicator for timing the market. One of the most important buy and sell signals for technical analysis is when the stochastics value lines cross. Strong overbought signal is indicated when the currency pair makes a new high and the lines cross the 80 level. Conversely, the currency pair is severely oversold and ready to reverse when it makes a new low and the lines cross below 20 to confirm that low. Rate of Change (ROC) ROC is one of the simplest indicators to utilize, while being as effective as other indicators. It compares the current price (or today’s price) with the price of x time periods ago. The result is displayed as a continuous value that fluctuates below and above the median. Although the jaggedness of the ROC’s appearance makes it difficult to spot trend reversals, it is a useful tool for trend analysis. The 12-day ROC is an excellent short-to-intermediateterm overbought/oversold indicator. The higher the ROC, the more overbought the currency; the lower the ROC, the more likely a rally will take place. However, as with all overbought/over-sold

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TECHNICAL ANALYSIS indicators, it is prudent to wait for the market to begin correcting (i.e., turn up or down) before placing your trade. A market that appears overbought may remain overbought for some time. In fact, extremely overbought/oversold readings usually imply a continuation of the current trend. The 12-day ROC tends to be very cyclical, oscillating back and forth in a fairly regular cycle. Often, price changes can be anticipated by studying the previous cycles of the ROC and relating the previous cycles to the current market. The Basic Theories In addition to the technical indicators, successful traders incorporate basic theories into their trading strategies. These theories enrich a trader’s trading skills, allowing them to make logical and sound decisions. There are two fundamental theories that are commonly used: Fibonacci Retracement Theory and Elliott Wave Theory.

enter and exit positions. The most commonly used levels are 38.2%, 50%, and 61.8%. Application of Fibonacci Retracement Levels in Trading Fibonacci levels are used by drawing a trend line between two significant points — recent top and bottom prices — then inserting retracement levels. For example, the red lines in the chart show the high and low points from which the retracement levels are measured. The blue lines represent the corresponding Fibonacci retracement levels. When price moves to one of the levels and stops, it is likely that the correction may be over and the trend will likely resume. If it is a downtrend, the retracement of the correction would be up. If it is an uptrend, the retracement would be down.

Fibonacci Retracement Fibonacci retracement levels are a sequence of numbers discovered by the noted mathematician Leonardo da Pisa during the twelfth century. These numbers describe cycles found throughout nature and when applied to technical analysis, can be used to find pullbacks in the FX market. Fibonacci retracement involves anticipating changes in trends as prices near the lines created by the Fibonacci studies. After a significant price move (either up or down), prices will often retrace a significant portion (if not all) of the original move. As prices retrace, support and resistance levels often occur at or near the Fibonacci Retracement levels. Fibonacci retracement levels can easily be displayed by drawing a trend line between a perceived high point to a perceived low point. By taking the difference between the high and low, the user can insert the percentage ratios to achieve the desired pullbacks. These levels represent areas where the pullback may subside; thus, signaling opportunities to

Typically, these levels can be used to signal the prices at which traders should exit and enter positions. For example, an uptrend began to develop at the price of 1.1050 for EUR/USD. Fibonacci retracement levels were applied and the 38.2%, 50%, and 61.8% appeared at 1.1410, 1.1607, and 1.1806. The market continued in an uptrend and pulled back a little at the retracement levels. It is the perfect timing to exit a position when the market retraces at these levels. After the market retraces slightly, it resumes to its uptrend. Once the trend broke the 61.8% level, a trader would anticipate that the price will now move towards the 50% and enter another long position. Theoretically, a trader could

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TECHNICAL ANALYSIS exit before retracement occurs and enter new positions once the currency pair resumes its uptrend.

Factors to consider when using the Fibonacci Levels: • The longer the time frame, the more significant the retracement level. • If there are two different levels that are close together, such as a 50% of a monthly chart and a 61.8% of a daily chart, this enhances the importance of that level. • Rates must close well beyond these retracement levels to signify that the levels have been broken. • If there is a confirmation of the support or resistance in other studies, such as RSI or MACD, this increases the probability that the correction will end at these levels.

Elliott Wave Theory Ralph Nelson Elliott, an engineer from the 1930’s, claimed that the Dow Jones Index along with other related markets, move in rhythms or waves similar to the ocean tides which moves from low tide to high tide. According to Elliott’s 5-wave theory, market trends often develop in five identifiable waves. Waves number 1, 3, and 5, move in the direction of the current trend and waves number 2 and 4 move counter-trend. In addition, Elliott asserted that under normal circumstances, wave number 5 appears similar to wave number 1. He observed that wave number 3 is usually the longest wave. Finally, he stated that wave number 4 should not touch the top of wave number I in an uptrend.

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TECHNICAL ANALYSIS crucial to determine the role of a wave in relation to the greater wave structure. Thus, the key to Elliot Waves is to be able to identify the wave context in question. Ellioticians also use Fibonacci retracements to predict the tops and bottoms of future waves. The diagram of the Impulse Wave is the basic building block of the Elliott wave structure. Elliott classified price movements in patterned waves that can indicate future targets and reversals. Waves moving with the trend are called impulse waves, whereas waves moving against the trend are called corrective waves. The Elliott Wave Theory breaks down impulse waves and corrective waves into five primary and three secondary movements respectively. The eight movements comprise a complete wave cycle. Time frames of wave cycles can range from 15 minutes to years and decades. The challenging part of Elliott Wave Theory is figuring out the relativity of the wave structure. A corrective wave, for instance, could be composed of sub-impulsive and corrective waves. It is therefore

The diagram below shows the corrective patterns that consist of various wave sequences.

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TECHNICAL ANALYSIS The diagram below shows a unique type of corrective patterns.

Part VII. Tips for Using Technical Analysis As in all other aspects of trading, be disciplined when utilizing technical analysis. Too often, a trader will fail to sell or buy into a market even after it has reached a price that his or her technical studies identified as an entry or exit point. This is because it is hard to screen out the fundamental realities that led to the price movement in the first place. For example, you are long USD/JPY and have established your stop loss at 30 pips below your entry point. However, an unanticipated factor causes the USD to depreciate in value; subsequently, the USD/JPY pair goes past your stop loss level. You might be inclined to hold this position just a bit longer, in the hopes that it turns back into a winning trade. It is very hard to make the decision to cut your losses and even harder to resist the temptation to book profits too early on a winning trade. Leaving your position open will only increase your risk of losing more. A common mistake is to ride a loser too long in the hopes it comes back and to cut a winner way too early. If you use technical analysis to establish entry and exit levels, be very disciplined in following through on your original trading plan.

This is not to say that you should go to the other extreme. Do not get too caught up in the mathematics involved in putting together each study. It is much more important to understand how and why studies can and should be manipulated based on the time periods and sensitivities that you determine are ideal for the currency you are trading. These ideal levels can only be determined after applying several different parameters to each study until the charts and studies begin to reveal the “details behind the details”.

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I. What is Money Management

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Principle 1: Always Start with a Demo Account Principle 2: Trade with Sufficient Risk Capital Principle 3: Establish Maximum Exposure

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II. Trading Psychology

Principle 4: Limit Your Losses - Use A Stop Loss Principle 5: Let the Profits Run Principle 6: Maintain Proper Risk vs. Reward Ratio Principle 7: Don’t Fight the Trend Principle 8: Add to Winning Trades and Never Add to Losing Positions

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Losing Attitudes Attitude #1: Fear Attitude #2: Greed Attitude #3: Revenge Attitude #4: Carelessness

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Winning Attitudes Attitude #1: Confidence Attitude #2: Determination

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Principle 9: 78 Understand the Market Discount Mechanism Principle 10: 78 Diversify With Multiple Currency Pairs Principle 11: 78 Never Chase Trades Principle 12: Know When to Leave a Trade Principle 13: Approach Trading as a Business Business/Trading Plan Research the Market Record Activities with Trading Journals

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III. Demo Account to Real Trading Account

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Part I. What is Money Management? When you first begin to trade, you will most likely start with short-term day trading methods and eventually work towards becoming a sound technical trader. Shortterm trading can be a lot like hitting singles and doubles and stealing bases to win a baseball game. You can win a lot of games with this method, but only if you have good defense. In trading, good defense is good money management. Money management is the implementation of financial policies that attempt to preserve trading capital while protecting profits. Seasoned traders know that proper money management must be the cornerstone of any trading system. Without it, you are destined to lose most, if not all, of your trading capital. A superior money management plan is based on sound economic and mathematical principles. There are 13 time-tested principles that may help you establish and master good money management techniques.

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Principle 1: Always Start with a Demo Account It is always tempting to start implementing your trading system once you have finished or even while you are still reviewing this course. However, it requires time and skills to take full advantage of all your tools supplied by the company. As a novice trader, we highly recommend practicing and honing your skills before using real cash. We are all familiar with the saying, “Practice makes perfect”. Allow yourself enough time to digest and absorb the various trading strategies and concepts before risking real money. You can maximize your profit potential so much more if you spend some time to exercise your trading principles in a demo account. It is highly beneficial for all novice traders to begin trading with a demo account. The only difference between a demo account and a real trading account is the fact that the figures in the demo account do not represent real cash. In other words, you do not have to deposit real cash to act as a trading capital. Besides the

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cash factor, there really is no difference between the two accounts. In fact, real live data are used for the trading account as well as for the demo account. For instance, Trader A and Trader B are both trading online. Trader A is trading with a demo account and Trader B with a regular trading account. The executable prices that Trader A would see on the trading platform with the demo account are exactly identical to the prices of Trader B’s trading platform with the real account. Both accounts are developed a strong trading system that works in a demo account, it is bound to succeed in a real account. Brokers provide all traders a free demo account to practice. During this time, familiarize yourself with the setup of the trading platform. Make sure you master the skills to open and close a position, to enter various types of orders (stop-loss and limit orders), and to execute all basic functions in the trading platform. Using a demo account may buy you time to practice. all the other 12 principles of money management and learn how to take advantage of the charts. Principle 2: Trade with Sufficient Risk Capital When establishing a trading account, never use funds that you cannot afford to lose. In other words, ensure that the money you might lose will not affect your life. This means that you should not borrow funds to trade. Currency trading involves risk — the possibility of loss. Losses are part of the game for all traders, but even more so for newer traders as they tend to experience higher percentages of losing trades. If you use essential or borrowed funds, you will find yourself changing your entire trading system, especially after a small floating or an actual loss. Traders with insufficient risk capital cannot afford to lose; therefore, they frequently change their risk-to-reward ratios of good trades and find themselves making unnecessary stops. To avoid the above scenarios from happening to you, it is important to seriously consider how much capital you will need. This component — to determine the amount of initial trade capital required for a trading system to operate effectively — is perhaps the most important and

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the most overlooked application of risk and money management. Most often traders fail when they are misled by the false belief that a winning trading strategy will always produce a net profit. What these traders fail to consider are the two parameters which most often consume a trader’s capital: consecutive losing trades and maximum drawdown. Let’s consider an example of two traders, A and B, both using the same trade system. When determining the percentage of the initial trading capital to risk on trades, the two traders differ; Trader A only risks 1 percent on every new position while Trader B risks 5 percent. Let’s assume that both traders begin trading simultaneously and both generate 20 consecutive losses immediately. Trader A would have only lost 20 percent of his/her trading capital while Trader B’s initial trading capital would have been wiped out. Even if the subsequent trades are highly profitable, Trader B would be left with an empty account but Trader A may pretty well regain his/her full trading capital and perhaps generate a profit.

This table illustrates how many consecutive losing trades (CL) it takes to completely empty an account, based on the percentage of capital risked per trade (R), which is assumed to be constant for all trades. There is always a probability that any trading system will generate as many consecutive losing trades or percent drawdown as required to completely exhaust any amount of trading capital. The mathematical equations that arrive at this conclusion are relatively complex. The important thing is that however small the chance of experiencing such drawdown is, this probability exists.

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FX traders can start a mini account with as low as $300; however, to fully capitalize on trading, it is desirable to apply the 6 % test. The 6 1/2 test is a useful tool to decide how much to start trading. The test poses a simple question: if you experience a 50% drawdown after 6 months of trading, will you have enough left to continue trading? If the answer is yes, you probably have enough to begin trading; if the answer is no, you should probably wait. For instance, a novice trader wants to open a mini account with $500. The math is simple. After experiencing a 50% drawdown, the trader would be left with $250 in the account. Is $250 sufficient to trade? Even if the trader is very modest and only opens one lot at a time, he/she is already risking 40% of the capital in one trade. For a novice trader, $250 is too small of a trading capital and the trader would easily be margined out. Therefore, we recommend that novice traders should invest more than $300 dollars as their initial trading capital in mini accounts. Principle 3: Establish Maximum Exposure It is vital to establish a daily, weekly, and even monthly maximum exposure amount that you are willing to accept. It is highly recommended that traders working with limited risk capital should never exceed more than 5-10% of their total risk capital as their daily maximum exposure. For traders working with larger amounts of risk capital, especially professional Forex fund managers, the daily maximum exposure should never exceed more than 2-5% of their total risk capital. Principle 4: Limit Your Losses — Use A Stop Loss Limiting losses is essential to becoming a successful FX trader. Way too often, traders say they will exit a trade when it goes 200 pips against them, then when they are down 200 pips, they say they will exit when it goes down another 100 pips. Before you know it, they are down 1000 pips, or even worse, get margined out. Unfortunately, the scenario mentioned above is extremely common amongst novice traders, especially since FX spot trading is such highly margined. In order to keep this from happening to you, you must develop and implement strict disciplinary measures that ensure

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you exit losing positions before they turn into disasters. Allowing losses to get out of hand is one of the biggest reasons why traders fail. An effective way of limiting losses is to enter a stop loss. When you place your trade, you may choose to enter a stop loss that protects you from losing too much. Determine how many pips you are willing to risk for that trade. Enter the amount into the system and you are set. If the market price moves in the direction that is unfavorable to you, the stop loss will kick in and exit the position if the specified rate is reached. In the diagram below, the current market price for the USD/JPY is 109.87. Because it is a shorting position, the stop loss must be greater than the current exchange rate. For day traders, an average of 30 pips is recommended for stop loss orders because it accommodates short-term price fluctuations but is effective when a strong trend develops in the opposite direction. In this example, the rate that is 30 pips above 109.87 is 110.17. If the market price for USD/JPY were to reach 110.17, the position would be stopped out.

The stop loss order is a highly effective tool for limiting losses because it does not let your emotions get in the way. Rather than allowing you to have the leeway to make irrational decisions when the market rate is moving in the unfavorable direction, it exits the position

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immediately, thereby, limiting the maximum loss that you may experience for that trade. For more information regarding stop loss orders, refer to section two: Currency Trading Basics. Principle 5: Let the Profits Run Many traders have no problems limiting their losses, but have difficulty letting their profits run. They insist on exiting trades at the first sign of profits. As time passes, they see that their small profit could have been substantially larger had they held on longer to their position. Early exits can be problematic for traders and is a leading cause of mediocre results.

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position at 1.6700 instead, he would have made a profit of 800 pips or $8000, which is more than 5 times the original amount gained. Therefore, when strong trends are identified in charts and when the favorable price movements are supported by strong economic data, let your profits run. Principle 6: Maintain Proper Risk vs. Reward Ratio A good risk vs. reward ratio is an essential part of any trade process. A major problem for novice traders is simply the fact that they do not take this into account. Risk is the maximum value you are willing to lose and reward is the amount of profit that you will be content with. Does it make sense to risk $400 in order to gain $200? Many beginners seem to think so, but let’s do the math. Even if your trade method is 60% successful, you will still lose more than you gain. You have to be more successful, at least 70%, to show a profit. Generally, the minimum risk vs. reward ratio should be 1:2, 1:3, 1:4, or even 1:5, meaning that for every dollar you risk in a trade, you expect to make 2, 3, 4, or even 5 dollars in return. Poor traders will often take 3:1 or worse and wonder why they are not making money. When you have such a low risk/reward, you may have many successful trades but your first string of losses will eat up your capital.

Consider the example above. The GBP/USD has begun an uptrend in early September, 2003. Let’s say a position trader bought one lot at 1.5900. At the first sign of a slight downturn, he closed the position at 1.6050 to pocket his profit. On the surface, the 150 pips or $1500 (150 pips x $10) profit seems to be marvelous; however, if he had held on to his position for a couple more weeks and exited at the rate of 1.6700, he would have made a much larger profit. If he had closed his

Principle 7: Don’t Fight the Trend You have probably heard the saying “The trend is your friend” a thousand times, but do you actually follow it? You would be amazed by how many new traders fail because they insist on trading against the trend. When you think about it, short-term trading really is a simple game. If there are more buyers than sellers, you buy; if there are more sellers than buyers, you sell. In essence, trending markets are depicting who is in control and fighting the trend is almost always a loser’s game.

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Principle 8: Add To Winning Trades and Never Add to Losing Positions Another important aspect of a good money management plan is adding to open trades. Only add to a winning position and to do so with no more than half the number of lots currently being traded. Do not add equal or more lots than you originally started with to maximize your profit. Of course, if your original position started out with the lowest number of lot size possible, you may add the equal amount. However, do not be tempted to add 5 lots to an original 2 lot position, even if it is a winning one. One of the biggest mistakes novice traders make is the continual buying of a losing position. Why do traders do this? It is usually due to a belief that the market is about to reverse or has already reversed and is now moving in the direction they originally anticipated. Many traders will justify it by saying they are just averaging down and getting a more favorable price, but in reality they are dooming themselves to failure. As short-term traders, capital preservation is most important and putting too much at risk jeopardizes success. If you are right, the market should prove you correct within a reasonable short amount of time. If you are wrong, you should absorb the loss and move on. So, we repeat: never add to a losing trade. Principle 9: Understand the Market Discount Mechanism A key concept that novice traders have a hard time grasping is the fact that markets are forward looking and have a discount mechanism in place. Traders who do not understand this concept often become discouraged and quit because “the market doesn’t make any sense”. How many times have you seen market participants expecting some sort of good economic number that comes in as expected and the market sells off? Novice traders get burned trading these situations because they do not understand that the market already knew it was coming. Understanding that all markets are forward looking is crucial to trading success and will help you demystify markets and their movements.

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Principle 10: Diversify With Multiple Currency Pairs Always limit your rise by diversification. You can diversify your trading by opening positions in different currency pains. Diversification accomplishes two investment goals: spreading of rise and increasing profit potential. If one currency trade in another currency pair can recover the first loss and leave you with additional profit. However, not all currency pairs give us true diversification. Some pairs mirror each other so often that, in essence, you are merely working twice as hard on the same basic trade strategy with no real diversification. For example, the USD/CHF moves in a very similar fashion to the EUR/USD. Therefore, make sure the currency pairs you choose to diversify with have economies that are fundamentally different from each other.

Principle 11: Never Chase Trades It is 1:00 am and you see a nice trade setting up on your charts. You mark it down in your notebook and decide to trade it tomorrow If it sets up. When you wake up the next morning, you see the trade did exactly what you thought it would; the pair is now 150 pips past your entry. What do you do? Poor traders cannot stand the fact that they have missed the trade and will enter the market regardless of the fact that it has gone many points past their entry point. The result is typical. They end up getting in just as momentum changes and incur large losses. Markets are always moving especially in foreign exchange. Missing trades is a part of trading; accepting it and having the discipline not to chase will save you grief and money.

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Principle 12: Know When to Leave a Trade If the reason you entered a trade disappears, there is no reason to stay in the trade. Many novice traders will see their reason evaporate and stay in the position until they are stopped out. Poor traders do not like to admit they are wrong and continually trading their way out of it. This repeated behavior is obviously detrimental to their profit/loss and often results in catastrophes. On the other hand, good traders condition themselves to get out by implementing smart trading strategies. If their reason reappears, they can always reenter the trade at a more appropriate time without having to be exposed while they wait. Principle 13: Approach Trading as a Business Trading is a business and should be taken seriously. Like any other business, always start with a business plan, a thorough research of the market, and records of business activities.

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Research the Market To become a successful trader, you will require forking out some time and effort to study the history, markets, and new trading techniques. This will enable you to increase your market comprehension and rapidly advance your trading techniques and skills. Knowledge is power; the more knowledge you have, the more successful you will become. Record Activities with Trading Journals Trading journals are tremendous assets to any successful traders. A good trading journal should include: thoughts at the moment of trade, trade logic, and price and outcome information. When reviewed periodically (monthly or quarterly), the journal will give you insights into your trading habits and will allow you to quickly pinpoint problematic areas and address them before they become detrimental.

Business/Trading Plan Trading is not a hobby or a quick scheme to get rich. It is a serious business for people who are willing to devote the time, effort, and capital necessary for success Successful trading requires constant planning. Good traders are always mindful how their positions are holding. Generally, we recommend traders to begin their trading career with a trading plan that outlines: what you plan to trade, how you plan to trade, what style to trade, what strategies to trade, how to handle winningllosing trades, and goals for the day, the week, and the month. Writing down these key questions and answers will benefit you in many ways as it will help solidify these concepts and should make you a more disciplined trader.

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their trading system which, in turn, will lead to greater success.

Part II. Trading Psychology

Attitude #2: Greed The FX market offers the potential for making huge profits in a relatively short period of time without the appearance of performing much work. Vast fortunes seem to be only moments away! This is where greed enters the picture. Traders begin to envision unrealistic returns from their trading. Greed can emerge when you are in a winning trade. You simply want more and so you convince yourself that the market will keep on going in your favor, It can also surface when you are in a losing trade and convince you that the market will turn around anytime to give you your profits. Trading is definitely one of the most challenging tasks a person can undertake as it requires constant mental toughness in the face of a constantly changing emotional environment. To be successful, a trader has to achieve a mental state of total control. Traders can do this by focusing on winning and losing attitudes. Losing Attitudes Attitude #1: Fear Traders must first identify and confront their fear. The most common anxiety is the fear of failure, which distorts our perception. It narrows the amount of information we can process and drastically limits the choices that we perceive are available. It is the main reason why the majority of traders cut their profits short and let their losses run. How can this paralyzing emotion be controlled? First, focus on applying your trade system, mentally practicing the mechanics of the trade. Second, always remember that trading is not about proving anything to anybody. Third, give yourself permission from the very beginning to make some mistakes as you develop your trading skills. Fourth, truly accept the reality that all good trading systems have losses and temporary drawdown periods. Finally, you must learn to completely trust your ability to respond to whatever information the market offers you. Traders who take these proactive steps toward controlling their fears will be more apt to stick to

To exterminate greed, first and foremost, you must always be on the lookout. First, never think that you are immune; consider putting notes near your trade station to remind you. Second, periodically review your trading performance and see how often you altered or abandoned your trading system as each variant signifies greed. Third, be careful that you never think in terms of what you can buy with a certain number of pips or amount of profit which will lead you away from your original trading system. Attitude #3: Revenge At times, a trader can lose more than he/she intended to risk. You may be willing to take responsibility for what you originally intended to risk on a trade. However, you may not want to take responsibility for losing more. When the market took more than you agreed because you have deviated from you original trading system, you may be compelled to get it back. The best way to overcome this negative attitude is to remember that the market does not have feelings nor can it pre-determine its actions. Take responsibility for all of your trading decisions, even those decisions that seem to be irrational afterwards. In addition, refuse to succumb to feelings of anger towards yourself or the market when things do not go your way.

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Attitude #4: Carelessness Traders are most vulnerable to carelessness after experiencing a large profit or a large loss. After a large profit, especially when this profit is a series of winning trades, you may feel invincible. When you feel that you have figured out how the market usually works and where it will most likely move next, you will become careless about your trading system. Being overconfident leads you to pay less attention to details and eventually become careless. A large loss can be just as problematic. The negative emotions generated by a series of losing trades can easily lead to carelessness and a loss of motivation. This often leads to further losses instead of regaining your loss capital and additional profit. Therefore, be extra careful during times of large profits and large losses. During these periods, try to take a break from trading and reenter the market with your original trading system.

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Attitude #2: Determination Traders must possess the intensity to do whatever it takes to win at trading. This will include continual studying, practicing, and applying proven concepts. It also means sticking to your trading system and not allowing a momentary impulse, based on fear or greed, to control or alter your decisions. All trading, especially day trading requires the ability to continue trading even when results have not been good. Due to the dynamic nature of markets and trading systems, bad times are frequently followed by good times. Conversely, good times are frequently followed by bad. Some of a trader’s greatest winners will follow a string of losers. This is why it is extremely important for traders to be determined to apply their methods and stick to their system. Ultimately, with persistent determination, one can overcome all obstacles.

Winning Attitudes: Attitude #1: Confidence The first attitude required for successful trading is confidence. We are not referring to being arrogant or cocky like many traders can be. The confidence we are referring to is the mental state of anticipating good results based on a proven system, hard work, and discipline. New traders can begin to develop this healthy confidence by taking enough time to correctly practice trade their system, thereby proving to themselves that their system really works. The easiest method to build your confidence is to use the free demo account provided by a broker. During this time, you can practice placing orders and following the rules of your system while the market is open so you can watch the prices change. Additionally, records of your winning and losing trades will also be provided. When you achieve consistent profit in this manner for at least three to four weeks, you would have built the confidence to begin live trading with real money.

Part III. Demo Account to Real Trading Account After you have practiced and mastered the 13 principles of money management in a demo account, you have reached the halfway point in becoming an FX Trader. Throughout your time trading with the demo account, you might have identified times at which you have experienced the losing and winning attitudes mentioned above. Again, be mindful of these concepts in order to maximize your trading skills. Once you feel very confident while trading with the demo account, you may open up a real trading account and begin making real profits. Remember, the real account is identical to the demo account, except it is trading with real money. There is nothing to be anxious about as long as you exercise your established trading system in a disciplined manner. The next section will help you set up your trade station, be it your demo or real trading account.

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TOOLS & RESOURCES Account: A record of transactions of goods and services owed to one person by another.

American options. Sometimes also refer to as Average Rate Option.

Adjustable Peg: An exchange rate system where a country’s exchange rate is “pegged” (i.e. fixed) in relation to another currency. The official rate may be changed from time to time.

Ask Rate: The lowest price that shares will be offered for sale, such as the bid/ask spread in the foreign exchange market.

ADX (Average Directional Index): Unlike most oscillators, ADX does not attempt to gauge the direction of the trend; instead, it works to gauge the strength of the trend. ADX operates on a scale of 0 to 100; the higher the oscillator, the stronger the trend. Agent: An intermediary or person hired to carry out transactions on behalf of another person. Aggregate Demand: Total demand in an economy, consisting of government spending, private/consumer and business investment. Aggregate Risk: Total amount of exposure a bank has with a customer for both spot and forward contracts. All or None: Refers to requests for a broker to fill an order completely at a predetermined price or not at all. Refers to both buy and sell orders. American Option: An option that can be exercised anytime during its life. The majority of exchange-traded options are American. Anonymous trading: Visible bids and offers on the market without the identity of the bidder and seller being revealed. Anonymous trades allow the high profile investors to execute transactions without the scrutiny and speculation of the market. Appreciation: A currency is said to ‘appreciate’ when it strengthens in price in response to market demand. Arbitrage: When a price differential arises, creating an opportunity to profit through buying and selling. Arbitrage is a “riskless” opportunity to profit, as there is no uncertainty involved. In regards to the foreign exchange market, arbitrage arises when a profit can be made through differentials in exchange rates. Arbitrage opportunities in the foreign exchange market are rare.

Ask Size: The number of shares a seller is willing to sell at his/her ask rate. Asset Allocation: The diversification of one’s assets into different sectors, such as real estate, stocks, bonds, and forex, to optimize growth potential and minimize risk. Asset Swap: An interest rate swap used to alter the cash flow characteristics of an institution’s assets in order to provide a better match with its liabilities. At Best: An instruction given to a dealer to buy or sell at the best rate that is currently available in the market. At Par Forward Spread: When the forward price is equivalent to the spot price. At the Price Stop-Loss Order: A stop-loss order that must be executed at the requested level regardless of market conditions. Attorney in Fact: A person given the right or authority to act on behalf of another to carryout business transactions and implement documents. Authorized Dealer: A financial institution or bank authorized to deal in foreign exchange. Automatic Exercise: A procedure implemented to protect an option holder where the Option Clearing Corporation will automatically exercise an “in the money” option for the holder. Away From the Market: When the bid on an order is lower (or the ask price is higher) than the current market price for the security. Back Testing: The process of designing a trading strategy based on historical data. It is then applied to fresh data to see if and how well the strategy works. Most technical analysis is tested with this approach.

Ascending Triangles: A bullish continuation pattern that is shaped like a right triangle consisting of two or more equal highs forming a horizontal line at the top.

Balance/Account Balance: The net value of an account.

Asian Option: An option whose payoff depends on the average price of the underlying asset over a certain period of time. These types of option contracts are attractive because they tend to cost less than regular

Balance of Payments: A record of all transactions made by one particular country with others during a certain time period, It compares the amount of economic transactions between a country and all other

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TOOLS & RESOURCES countries. This includes trade balance, foreign investments, and investments by foreigners.

changes so infrequently that dealers often omit them in quotes.

Balance of Trade: Net flow of goods (exports minus its imports) between two countries.

Bilateral Grid: An exchange rate system which links all of the central rates of the EMS currencies in terms of the ECU.

Back Office: Refers to the administrative arm of financial service companies, who carry out and confirm financial transactions. Duties include: accounting, settlements, clearances, regulatory compliance and record maintenance. Balance of Payments: Record of all transactions, such as trade balances and capital flows, carried out by a country with the rest of the world within a certain period. Bank Notes: Paper issued by the central bank, redeemable as money and considered to be full legal tender. Bar Chart: On a daily bar chart, each bar represents one day’s activity. The vertical bar is drawn from the day’s highest price to the day’s lowest price. Closing price and opening price are represented by ticks on the bar. Base Currency: In general terms, the base currency is the currency in which an investor or issuer maintains its book of accounts. In the FX markets, the US Dollar is normally considered the ‘base’ currency for quotes, meaning that quotes are expressed as a unit of $1 USD per the other currency quoted in the pair. The primary exceptions to this rule are the British Pound, the Euro and the Australian Dollar. Basis Point: Measure of a bond’s yield equal to 1/100th. A 1% change in yield is equal to 100 basis points and 0.01% is equal to one basis point. Bear Market: Any market that exhibits a declining trend. In the long run they have a down turn of 20% or more. Bear Trap: A bear trap occurs when prices break below a significant level and generate a sell signal, but then reverses direction and hence invalidate the sell signal. Bear traps serve as opportunities for reversal traders, whereas trend/momentum traders will suffer losses due to the change in direction.

Bollinger Bands: An indicator that allows users to compare volatility and relative price levels over a period time. This indicator consists of three bands designed to encompass the majority of a security’s price action: a simple moving average in the middle; an upper band 2 standard deviations away from the simple moving average (usually set to a time frame of 20); and a corresponding lower band that is also 2 standard deviations away from the moving average. Since the band width is a function of standard deviation, assets with greater volatility will have wider bands. Bonds: Bonds are debt instruments used to raise capital, which are issued for periods greater than one year. Bondholders are loaning money (investing in debt) to companies and governments, at the end of which they will be paid a specified interest rate. Bond prices are inversely related to interest rates, as interest rates rise, bond prices fall. There are numerous types of bonds, including treasury bonds, notes, and bills; municipal bonds and corporate bonds. Breakaway Gap: A price gap which occurs in the beginning of a new trend, many times at the end of a long consolidation period. It may also appear after the completion of major chart formations. Break-Even Point: The price of a financial instrument at which the option buyer recovers the premium. Bretton Woods Accord (1944): This accord established a fixed exchange rate regime, whose aim was to provide stability in the world economy after the Great Depression and WWII. This accord fixed the exchange rates of major currencies to the US dollar and set the price of gold to $35. The accord required central bank intervention to maintain the fixed exchange rates. The US Central Bank was required to exchange dollars for gold, which eventually led to the demise of this system, when the demand for the dollar declined, as well as the gold reserves, forcing Nixon to stop the exchange of dollars for gold, effectively ending the system in 1971.

Bid: The price an investor is willing to pay for an asset. Bid/Ask Spread: The difference between the bid and the ask price. Big Figure: Refers to the first number to the left of the decimal point in an exchange rate quote, which

Broken Dates: Deals that are undertaken for value dates that are not standard periods, e.g. 1 month. The standard periods are 1 week, 2 weeks, 1,2,3,6, and 12 months. Terms also used are odd dates, or cock dates, or broken period.

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TOOLS & RESOURCES Broker: Individual or firm acting as an intermediary to bring together buyers and sellers typically for a commission or fee. Bull Market: A market where prices are rising or are expected to rise. Bull Trap: The opposite of a bear trap; occurs when indicators suggest an uptrend, but the market reverses its momentum and begins to fall again.

The rest of the range is marked by two “shadows” the upper shadow and the lower shadow. The candlestick encapsulates the open, high, low and close of the trading period in a single candle. *lf the close is above the open, the actual candle is either hollow or blue in color. *lf the close is below the open, the actual candle is filled in or red in color. Capital Markets: Markets in which capital (stocks, bonds, etc.) are traded. Usually for medium or long term investing.

Bundesbank: Germany’s Central Bank. Buy a Bounce: A recommendation to instigate a long trade if the price bounces from a certain level. Buy Break: A recommendation to buy the currency pair if it breaks the current level specified. Buying Rate: Rate at which a bank is prepared to buy foreign exchange. Also known as the Bid Rate. Buying/Selling FX: Buying and selling in the foreign exchange market always happens in the currency which is quoted first. “Buy dollar/mark” means buy the dollar/sell the mark. Traders buy when they expect a currency’s value to rise and sell when they expect a currency to fall. Buy Stops Above: A recommendation to enter the market when the exchange rate breaks through a specific level. The client placing a stop entry order believes that when the market’s momentum breaks through a specified level, the rate will continue in that direction. Cable: Term used to describe the exchange rate between the US dollar and the British Pound. Call: (1) An option that gives the holder the right to buy the underlying instrument at a specified price during a fixed period. (2) A period of trading. (3) The right of a bond issuer to pre-pay debt and demand the surrender of its bonds. Calendar Spread: An option position comprised of purchase and sale of two option contracts of the same type with different expiration dates at the same exercise price. Candlestick Charts: Identical to a bar chart in the information conveyed, but presented in an entirely different visual context. A type of chart which consists of four major prices: high, low, open, close. The body of the candlestick bar is formed by the opening and closing prices. To indicate that the opening was lower than the closing, the body of the bar is left blank. If the currency closes below its opening, the body is filled.

Carry: The interest cost of financing securities or other financial instruments held. Carry Trade: An investment position of buying a higher yielding currency with the capital of a lower yielding currency to gain an interest rate differential. Cash Settlement: A procedure for settling futures contracts where the cash difference between the future and the market price is paid instead of physical delivery. Central Bank: A banking organization, usually independent of government, responsible for implementing a country’s monetary policy and for printing money. Central Rate: Exchange rates against the ECU adopted for each currency within the EMS. Currencies have limited movement from the central rate according to the relevant band. Channel: An upwards or downwards trend whose boundaries are marked by two straight lines. A break above/below the channel lines signals a potential change in the trend. Clearing: Refers to the settlements/confirmations of trades. Close a Position (Position Squaring): Refers to getting rid of a position, either by buying back a short position or selling a long position. Closing Purchase Transaction: The purchase of an option identical to one already sold to liquidate a position. Commission: A fee charged by broker or agent for carrying out transactions/orders. Confirmation: A written document verifying the completion of a trade/transaction to include such things as date, fees or commissions, settlement terms and the price.

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TOOLS & RESOURCES Confirmation on a Chart: A subsequent indicator or chart pattern, following an initial alert to a trade opportunity, which serves to legitimize the initial alert. Confirmation of a trade is believed to reduce the risk associated with that trade. Contagion: Term used to describe the spread of economic crises from one country’s market to other countries within close geographic proximity. This term was first used following the Asian Financial Crisis in 1997, which began in Thailand and soon spread to other East Asian economies. It now is used to refer to the recent crisis in Argentina and its effects on other Latin American countries.

exchanging it for currency B, investing currency B for the duration of the loan, and, after taking off the forward cover on maturity, showing a profit on the entire set of deals. Cover on a Bounce: A recommendation to exit trades on a bounce out of a support level. Cover on Approach: A recommendation to exit trades for profit on approach to a support level.

Continuation: Represents an extension of the trend. The trend continues to have momentum, and hence it moves onwards without reversal.

Credit Checking: Before making a large financial transaction, it is imperative to check whether the counterparty has enough available credit to carry out/honor the transaction. Credit checking refers to the process of verifying that the counterparty has enough credit. The check is initiated after the price has been determined.

Contract (unit or lot): The standard trading unit on certain exchanges. A standard lot in the forex market is $100,000.

Credit Netting: Agreements that are made having to continually re-check credit, established between large banks and institutions.

Convertible Currency: Currencies that can be exchanged for other currencies or gold.

Cross Rate: Refers to the exchange rate between two countries’ currencies. Cross rates usually refer to pairs quoted that do not include the domestic currency. For example, in the U.S., the EUR/JPY rate would be called a cross rate.

Correction: The term used for the rationale that a directional movement would have a partial reversal due to the fact that momentum tends to “overshoot” itself; hence there will be a “correction” of the trend to bring the asset back to a fairer market valuation. Correlation: A statistical measure referring to the relationship between two or more variables (events, occurrences etc.). A correlation between two variables suggests some causal relationship between these variables. Typically, the Swiss Franc is closely correlated with the German Mark. Cost of Carry: When an investor borrows money to sustain a position. There is a cost for borrowing derived from the interest parity condition, which is used to determine the forward price. Counterparty: A participant, either a person or an institution, involved in one side of a financial transaction. With such transaction there is an associated risk (counterparty risk) involved that the counterparty will not be able to meet the terms outlined in the contract. This risk is usually default risk. Country Risk: The risk that a government might default on its financial commitments/contracts, which typically causes harm to other areas of the financial sector, as well as those in other countries.

Cup with Handle: Named after the resemblance the formation on the chart bears to a cup and handle; this pattern offers explanation into where a bullish trend can begin. Once the pattern begins to curve upward and reaches the cup line, the asset is believed to be bullish and set for a rise. Currency: Notes and coins issued by the central bank or government, serving as legal tender for trade. Currency (Exchange Rate) Risk: Risk associated with drastic changes/fluctuations in exchange rates in which one could incur a major loss. Daily Charts: Charts that encapsulate the daily price movement for the currency pair traded. Since the currency market operates 24 hours a day, the daily chart typically runs from 5 PM New York time to the same time on the following day. Day Trading: Refers to the process of entering and closing out trades within the same day or trading session. Dealer: One who places the order to buy or sell. A dealer differs from an agent in that it takes ownership of the asset, and thereby is exposed to some risk.

Covered Interest Rate Arbitrage: An arbitrage approach which consists of borrowing currency A,

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TOOLS & RESOURCES Dealing Systems: On-line computers which link the contributing banks around the world on a one-on-one basis Declaration Date: The latest day or time by which the buyer of an option must indicate to the seller his intention to the option. Delivery Date: The date of maturity of the contract, when the exchange of the currencies is made. This date is more commonly known as the value date in the FX or Money markets. Deficit: An excess of liabilities over assets, of losses over profits, or of expenditure over income. Deposit: Refers to the process of borrowing and lending money. The deposit rate is the rate at which money can be borrowed or lent. Depreciation: The decline in the value of an asset or currency. Derivative: A security derived from another and whose value is dependent on the underlying security from which it is derived. Examples of derivatives are futures contracts, forward contracts and options. Underlying securities can include stocks, bonds or currencies. Derivatives can be traded and are usually used to hedge portfolio risk. Descending Triangles: A bearish continuation pattern indicating distribution consisting of two or more comparable lows forming a horizontal line at the bottom. Descending triangles are bearish patterns that indicate distribution. The definitive bearish signal of a descending triangle is when support on the lower rung of the triangle is broken. Devaluation: When the value of a currency is lowered against the other, i.e. it takes more units of the domestic currency to purchase a foreign currency. This differs from depreciation in that depreciation occurs through changes in demand in the foreign exchange market, whereas devaluation typically arises from government policy. A currency is usually devalued to improve the balance of trade, as exports become cheaper for the rest of the world and imports more expensive to domestic consumers.

through changes in the interest rate to attract/detract capital flows or through the buying and selling of the currency. This system is contrasted with a Pure Float in which there is no central bank intervention and the exchange rate is entirely determined by the market and speculation. Double Top and Bottom: A double top and bottom implies an upper limit - the top - and a lower limit - the bottom - which the currency pair has touched twice but has failed to penetrate. Accordingly, the asset can be expected to trade within this range, or, if there is a breakout, the movement is expected to be substantial. Dow Theory: One of the first ideas that formed the beginnings of technical analysis, the Dow Theory holds that all major trends can be sub-divided into three phases: entrance, whereby savvy market participants enter the market; acceleration, whereby a slew of additional participants see the trend and enter the market, thereby accelerating the trend; and consolidation, a period characterized by the initial participants exiting their trade. Durable Goods Order: An economic indicator which measures the changes in sales of products with a life span in excess of three years. Economic Indicator: An economic statistic used to indicate the overall health of an economy, such as GDP, unemployment rates, and trade balances. These are used in fundamental analysis of foreign exchange markets to speculate against the direction of an exchange rate. Economic Exposure: When the cash flow of a country is vulnerable to changes in the exchange rate. Economic and Monetary Union (EMU): The irrevocable fixing of exchange rates between member currencies and their replacement by a single European currency, the euro. The euro is to be issued by a future European central bank, to be independent of political control and federal in nature. All countries which fulfill the five convergence criteria in 1998 will proceed to EMU in 2000. The UK and Denmark have secured optouts from EMU. Sweden’s joining is subject to ratification by parliament.

Direct Quotation: Quoting in fixed units of foreign currency against variable amounts of the domestic currency.

Efficient Markets: Markets where assets are traded in which the price is indicative of all current and relevant information and thus it is impossible to have undervalued assets.

Dirty Float (Managed Float): An exchange rate system in which the currency is not pegged, but is “managed” by the central bank to prevent extreme fluctuations in the exchange rate. The exchange rate is managed

Elliot Wave Theory: A theory based on the notion that the market moves in waves, which consist of trends followed by partial corrections. The Elliot Wave Theory stated that there are 5 waves within an overall trend.

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TOOLS & RESOURCES Envelopes: While Bollinger Bands place boundary lines based on standard deviation, envelopes place lines at fixed percentage points above and below a moving average line. The upper and lower limits specify entry and exit points for traders. End of the Day (Mark to Market): Accounting measure, referring to the way traders record their positions. There are two ways that a trader can record his positions: the accrual system in which only cash flows are recorded and the mark to market method, in which the value of an asset is recorded at the end of each trading day at the closing rate or value. Equilibrium: A price region that suggests a balance between demand and supply for a currency pair in the marketplace. Euro:The new monetary unit of the European Monetary Union used by twelve countries in the European Union. It is now the legal tender of those countries as of January 2002. Those countries include Germany, France, Belgium, The Netherlands, Luxembourg, Spain, Portugal, Italy, Austria, Ireland, Finland and Greece. European Monetary Union: An institution of the EU, whose primary goal is to establish a single currency (the euro) for the entire EU. European Monetary System: A system designed to stabilize if not eliminate exchange risk between member states of the EMS as part of the economic convergence policy of the EU. It permits currencies to move in a measured fashion (divergence indicator) within agreed bands (the parity grid) with respect to the ECU and consequently with each other. Italy and the UK are currently not part of the system. Only Germany and the Benelux are within the current narrow band. Exercise Notice: A formal notification that the holder of an option wishes to exercise it by buying or selling the underlying stock at the exercise price. Exercise Price (Strike Price): The price at which an option may be exercised. Expiry Date: The last day on which the holder of an option can exercise his right to buy or sell the underlying security. Exposure: The total amount of money loaned to a borrower or country. Banks set rules to prevent overexposure to any single borrower. In trading operations, it is the potential for running a profit or loss from fluctuations in market prices.

Exponentially Weighted Moving Average (EMA): While the simple moving average distributes weight equally across the data series, exponentially weighted moving averages place greater weight to more recent data. As a result, they are more recent asset movement, as opposed to assuming an unbiased view. Factory Orders: An economic indicator which refers to the total orders of durable and non-durable goods. The non-durable goods orders consist of food, clothing, light industrial products and products designed for the maintenance of the durable goods. Federal Deposit Insurance Corporation: A regulatory agency of the U.S. created to oversee that bank deposits are insured against bank failures. It was created in 1933 to restore confidence in the banking system. It insures up to US $100,000 per banking institution. Federal Reserve/Fed: The central bank of the United States, responsible for monetary policy. Fibonacci Numbers: Derived from a sequence of numbers in which each successive number is the sum of the two previous numbers, Fibonacci numbers are used frequently in hypothesizing which rates assets will gravitate towards. Namely, there are four popular Fibonacci studies: arcs, fans, retracements, and time zones. The use of Fibonacci numbers is widespread in the currency market. The red lines may be used as short-term support and resistance levels, while the blue lines represent long- term levels. Fill or Kill: An order which must be entered for trading, normally in a pit three times, if not filled is immediately cancelled. Fixed Exchange Rate: When the exchange rate of a currency is not allowed to fluctuate against another, i.e. the exchange rate remains constant. Typically, under fixed exchange rate regimes, currencies are allowed to fluctuate within a small margin. Fixed exchange rate regimes require central bank intervention to maintain the fixed rate. Fixed Interest Rate: An interest rate used for loans, mortgages and bonds that remains at the same rate throughout the period. Flag and Pennant: Shaped like a flagpole with a pennant, this formation is characterized by an upward movement with a large slope followed by a period of consolidation. It is considered a bullish pattern overall, as the pattern is expected to continue rising. Flat/Square: To either have no positions or positions that cancel each other out.

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TOOLS & RESOURCES Floating Rate Interest: An interest rate that is allowed to adjust with the market; the opposite of a fixed interest rate. Foreign Currency Effect: Refers to how changes in the exchange rate affect the return on foreign investment. Forward Contract: A deal in which the price for the future delivery of a commodity is set in advance of the delivery. The forward rate is obtained by adding the margin to the spot rate. It is used to hedge against adverse fluctuations in the exchange rate that can affect the amount of profit or loss at that future date. Forward Rate: Forward rates are quoted in terms of forward points, which represent the difference between the forward and spot rates. In order to obtain the forward rate from the actual exchange rate the forward points are either added or subtracted from the exchange rate. The decision to subtract or add points is determined by the differential between the deposit rates for both currencies concerned in the transaction. The base currency with the higher interest rate is said to be at a discount to the lower interest rate quoted currency in the forward market. Therefore the forward points are subtracted from the spot rate. Similarly, the lower interest rate base currency is said to be at a premium, and the forward points are added to the spot rate to obtain the forward rate. Forward Spread (forward points or forward pips): Forward price used to adjust a spot price to calculate a forward price. It is based on the current spot exchange rate, interest rate differential, and the number of days to delivery. Front Office: Refers to the sales personnel (trading and other business personnel) in a financial company. Fundamental Analysis: The analysis of economic indicators and political and current events that could affect the future direction of financial markets. In the foreign exchange market, fundamental analysis is based primarily on macroeconomic events. G7: The seven leading industrial countries: The United States, Germany, Japan, France, United Kingdom, Canada, and Italy. Gap: The price gap between consecutive trading ranges (i.e. the low of the current range is higher than the high of the previous range). Gold Standard: The original system for supporting the value of currency issued. The way that the price of gold is fixed against the currency means that the increased supply of gold does not lower the price of gold, but causes prices to increase.

Golden Cross: An intersection of two consecutive moving averages which move in the same direction and suggest that the currency will move in the same direction. Good Until Cancelled: An instruction to a broker that unlike normal practice, the order does not expire at the end of the trading day, although normally terminates at the end of the trading month. Gross Settlement: A process where full payment of each transaction is made, rather than clearing a group of transactions as currently occurs in the FX market. A method designed to eliminate capital risk. Gross Domestic Product: Total value of a country’s output, income or expenditure produced within the country’s physical borders. Gross National Product: Gross domestic product plus “factor income from abroad” - income earned from investment or work abroad. GTC (Good-till-Cancelled): Refers to an order given by an investor to a dealer to buy or sell a security at a fixed price that is considered “good” until the investor cancels it. Hard Currency: A currency whose value is expected to remain stable or increase in terms of other currencies. Head and Shoulders Pattern: A pattern resembling two peaks (the shoulders) with a higher peak between the two shoulders (the head). The neckline, or the bottom boundary that both shoulders reach, is regarded as a key point traders can use to enter/exit positions. Hedge/Hedging: Strategy to reduce the risk of adverse price movements on one’s portfolio and to protect against the volatility of the market. Hedging typically involves selling or buying at the forward price or taking a position in a related security. Hedging becomes more prevalent with increased uncertainty about current market conditions. High/Low: Refers to the daily traded high and low price. Historical Volatility: A measure of the change in price over a specified time frame. Higher volatility suggests that the asset is more likely to trade within a wider range, while reduced volatility suggests the asset will trade in a tighter range. IMF: International Monetary Fund, established in I 946 to provide international liquidity on a short and medium

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TOOLS & RESOURCES term and encourage liberalization of exchange rates. The IMF supports countries with balance of payments problems with the provision of loans. IMM: International Monetary Market, part of the Chicago Mercantile Exchange, that lists a number of currency and financial futures. Implied Volatility: A measurement of the market’s expected price range of the underlying currency futures based on the traded option premiums. Implied Rates: The interest rate determined by calculating the difference between spot and forward rates. In-the-Money: A call option is in-the-money if the price of the underlying instrument is higher than the exercise/strike price. A put option is in-the-money if the price of the underlying instrument is below the exercise/strike price. Inconvertible Currency: Currency which cannot be exchanged for other currencies because this is forbidden by the foreign exchange regulations. Index Linking: The process of linking wages, social benefits payments, prices, interest rates or loan values to an economic index, usually of prices. Indicative Quote: A market-maker’s price which is not firm. Industrial Production Index: A coincident indicator measuring physical output of manufacturing, mining and utilities. Inflation: Refers to the increase in prices (price level) and wages over time that decrease purchasing power. It is calculated from changes in the price index, usually a consumer price index, or a GDP deflator. Initial Margin: The percentage of the price of a security that is required for the initial deposit to enter into a position. The Federal Reserve Board requires a minimum of 50% initial margin. For futures contracts, the market determines the initial margin. Interbank Rate: The rate at which the major banks (Deutsche, Citibank, Bank of Tokyo) trade in foreign exchange. Interest Parity: Theory that says that the difference in interest rates across countries should be equal to the difference between the forward and spot rate. Inter-dealer Broker: A specialist broker who acts as an intermediary between market-makers who wish to buy

or sell securities to improve their book positions, without revealing their identities to other market-makers. Interest Arbitrage: Switching into another currency by buying spot and selling forward, and investing proceeds in order to obtain a higher interest yield. Interest arbitrage can be inward, i.e. from foreign currency into the local one or outward, i.e. from the local currency to the foreign one. Sometimes better results can be obtained by not selling the forward interest amount. In that case some treat it as no longer being a complete arbitrage, as if the exchange rate moved against the arbitrageur, the profit on the transaction may create a loss. Interest Parity: One currency is in interest parity with another when the difference in the interest rates is equalized by the forward exchange margins. For instance, if the operative interest rate in Japan is 3% and in the UK 6%, a forward premium of 3% for the Japanese Yen against sterling would bring about interest parity. Interest Rate Options: An agreement permitting a party to obtain a particular interest rate, issued both OTC and by exchanges. Interest Rate Cap: An agreement that provides the buyer of a cap with a maximum interest rate for future borrowing requirements. Interest Rate Collar: A combination of a cap and a floor to provide maximum and minimum interest rates for borrowing or lending. Interest-Rate Swaps: The process of changing the form of debts held by banks or companies, in which they trade debt’s/loan’s fixed rates for floating rates (or vice versa) in another country. Intervention: Action by a central bank to enter the market and affect the value of its currency. Concerted intervention refers to action by a number of central banks to control exchange rates. lntra-Day limit: Limit set by bank management on the size of each dealer’s Intra Day Position. Intra-Day Position: Open positions run by a dealer within the day, usually squared by the close. Inverted Market: Where short term instruments are trading at premiums to long term instruments. J Curve: A term describing the expected effect of devaluation on a country’s trade balance. It is anticipated that import bills rise before export orders and receipts increase.

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TOOLS & RESOURCES Jawbone: Announcements and statements by politicians or monetary authorities to influence decisions by business, consumer, or trade union sectors, often associated with forecasts and policy implications. Jurisdiction Risk: (1) The risk inherent in placing funds in the Centre where they will be under the jurisdiction of a foreign legal authority. (2) The risk in making a loan subject to the laws of another country. Kappa: A measure of the sensitivity of the price of an option to a change in its implied volatility. Key currency: Small countries, which are highly dependent on exports, orientate their currencies to their major trading partners, the constituents of a currency basket.

date or in respect of an un-matured forward or spot transaction. LIBOR: Stands for the London Interbank Offer Rate, and is the rate at which major international banks lend to one another. It is widely used as the benchmark for short-term interest rates. Life of Contract: The period between the beginning of trading in a particular future and the expiration of trading. Limit Down: The maximum price decline from the previous trading day’s settlement price permitted in one trading session. Limit Move: A price that has advanced or declined the permissible limit permitted during one trading session.

Kiwi: Slang for the New Zealand dollar. Ladder: Dealers analysis of the forward book or deposit book showing every existing deal by maturity date, and the net position at each future date arising. Lagging Indicator: A measure of economic activity which tends to change after change has occurred in the overall economy, e.g. CPI. Last Trading Day: The day on which trading ceases for an expiring contract. Lay Off: To carry out a transaction in the market to offset a previous transaction and return to a square position. Leading Indicators: Such statistics as unemployment rates, CPI, Federal Funds Rate, retail sales, personal income, discount rate and the prime rate, that are used to predict economic activity. Leads and Lags: The effect on foreign trade payments of an anticipated move in the exchange rate, normally devaluation. Then payment of imports is faster and export receipts is slowed down. Left-hand Side: Taking the left hand side of a two way quote i.e. selling the quoted currency. See Right-hand Side. Leverage: In options terminology, this expresses the disproportionately large change in the premium in terms of the relative price movement of the underlying instrument. Liability: In terms of foreign exchange, the obligation to deliver to a counterparty an amount of currency either in respect of a balance sheet holding at a specified future

Limit order: An order with restrictions on the maximum price to be paid or the minimum price to be received. As an example, if the current price of USD/YEN is 102.00/05, then a limit order to buy USD would be at a price below 102. (i.e. 101.50) Liquid and Illiquid Markets: A liquid market is one in which changes in supply and demand have little impact on the asset’s price. It is characterized by many bids, offers and players/traders, low volatility and tight spreads. Illiquid markets have less players and larger spreads. Liquidation: The process of closing out long or short positions by offsetting transactions. Also refers to the process of selling all assets of a bankrupt company to pay off first, creditors, and then shareholders. Liquidity: The ability of a market to accept large transactions with minimal to no impact on price stability. Local: A futures trader who normally trades on an exchange on his/her own account. Locked Market: A market is locked when the bid price equals the asked price. Long (Position): Refers to the ownership of securities, commodities or currencies, in which there is no intent to sell due to speculation that the price will rise. Ml: Cash in circulation plus demand deposits at commercial banks. There are variations between the precise definitions used by national financial authorities. M2: Includes demand deposits, time deposits, and money market mutual funds excluding large CDs.

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TOOLS & RESOURCES M3: In the UK it is M1 plus public and private sector time deposits and sight deposits held by the public sector.

Matching: The process of ensuring that purchases and sales in each currency, and deposits given and taken in each currency, are in balance by amount and maturity.

M4: In the US it is M2 plus negotiable CDs.

Maturity: The date that the security is due to be redeemed or repaid.

MACD (Moving Averages Difference Oscillator): The MACD indicator relies primarily on plotting two moving average lines - typically 12 and 26 day EMAs - and plots the rate of change between the two. If the signal line - the line used to denote the rate of change - is rising upward, this suggests that momentum is bullish; if downward, the indication is that momentum is bearish.

Mid-price or Middle Rate: The price half way between the two prices, or the average of both buying and selling prices offered by the market makers. Mine and Yours: Terms used to signal when a trader wants to buy (mine) and sell (yours).

Maintenance Margin: The minimum margin which an investor must keep on deposit in a margin account at all times in respect of each open contract.

Minimum Price Fluctuation: The smallest increment of market price movement possible in a given futures contract.

Make a Market: A dealer is said to make a market when he or she quotes bid and offer prices at which he or she stands ready to buy and sell.

Minimum Reserve: Reserves required to be deposited at central banks by commercial banks and other financial institutions; sometimes referred to as Registered Reserves.

Managed Float: When the monetary authorities intervene regularly in the market to stabilize the rates or to aim the exchange rate in a required direction. Margin: A percentage of the total value of a transaction that a trader is required to deposit as collateral. Buying on margin refers to investing with borrowed funds, and the margin requirement insures against heavy losses. Margin Call: This is a call by a broker or dealer to raise the margin requirement of an account. The call is typically made after the value of a security (securities) has significantly declined in value. Marginal Risk: The risk that a customer goes bankrupt after entering into a forward contract. In such an event the issuer must close the commitment, running the risk of having to pay the marginal movement on the contract. Market Amount: The minimum amount conventionally dealt for between banks. Market Maker: A broker-dealer firm that owns shares of a security and is willing to buy and sell at the quoted bid and ask prices. The firm lists buy and sell prices to attract customers. Market Order: An order to buy or sell a stock at the best available price. Market Risk: The risk associated with investing in the market that cannot be hedged or avoided. Marry: Where a dealer is able to match two customer deals which off set one another.

MITI: Japanese Ministry of International Trade & Industry. Momentum: The term has two meanings: (I) a trading style by which traders go with the direction of the current trend; and (2) a technical indicator which measures the rate of change of an asset over a given time frame. Monetarism: A school of economics which believes that strict control of money supply is the principal tool for implementing monetary policy, especially against inflation. Policies include cuts in public spending and high interest rates. Monetary Base: Currency in circulation plus banks’ required and excess deposits at the central bank. Monetary Easing: A modest loosening of monetary constraint by changing interest rate, money supply, and deposit ratios. Monetary Policy: A central bank’s management of a country’s money supply. Economic theory underlying monetary policy suggests that controlling the growth of the amount of money in the economy is the key to controlling prices and therefore inflation. However, central banks’ monetary capability is severely limited by global money movements. This forces them to use the indirect tool of exchange rate manipulation. Monetary Union: An agreement between countries to maintain a fixed exchange rate between their currencies. This is a process which the EMS is intended to lead to, especially after the Maastricht Treaty.

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TOOLS & RESOURCES Money Market: Highly liquid markets for short-term investing in monetary instruments and debts, typically maturing in less than one year. Because of large transaction cost relative to potential interest, transactions occur in large amounts and thus participants are mainly banks and other large financial institutions. Money Supply: The amount of money in the economy, which can be measured in a number of ways. See definitions of M1-M4. Moving Averages: An average of a number of specified historical time periods from the point on the chart. Moving averages offer an indication of the clear direction and slope of the trend in the market. Since moving averages measure historical data, they are a lagging indicator; in other words, the information they reveal is not predictive, but rather can be used to gauge momentum in the marketplace. Exponential moving averages (EMAs) work to reduce the lag of the overall moving average by placing a greater premium on more recent data when calculating the average. Naked Intervention: A central bank type of intervention in the foreign exchange market which consists solely of the foreign exchange activity. This type of intervention has a monetary effect on the money supply and a long term effect on foreign exchange. Narrow Money: Limited definition of money to include cash or near cash, i.e. Ml or MO. Nearby Contracts: The closest active futures contracts, i.e. those that expire the soonest. Negative or Bearish Divergence: Occurs when two or more indicators or chart patterns do not yield the same analysis. Netting: A process which enables institutions to settle only the net positions with one another at the end of the day, in a single transaction, not trade by trade. Net Position: The number of futures contracts bought or sold which have not yet been offset by opposite transactions. Net Worth: The difference between the values of assets and liabilities. For public companies this is referred to as shareholder equity. Next Best Price Stop-loss Order: A stop-loss Order which must be executed after the request level was reached. Nominee Name: Name in which a security is registered and held in trust on behalf of the beneficial owner.

Note: A financial instrument consisting of a promise to pay rather than an order to pay or a certificate of indebtedness. Odd Lot: A non standard amount for a transaction. Off-Balance Sheet: Financing or the raising of money by a company that does not appear on the company’s balance sheet, such as Interest Rate Swaps and Forward Rate Agreements. Offer: The price (or rate) at which a seller is willing to sell at. Offsetting Transaction: When a trader enters an equivalent but opposite position to an already existing position, thereby balancing his positions. An offsetting transaction to an initial purchase would be a sale. One Cancels Other Order (O.C.O. Order): An order that thrOugh its execution cancels the other part of the same order. Open Interest: The total number of outstanding option or futures contracts that have not been closed out by offset or fulfilled by delivery. Open Outcry: A public auction method of trading conducted by calling out bids and offers across a trading ring or pit and having them accepted. Open Market Operations: Central Bank operations in the markets to influence exchange and interest rates. Open/Open Position: An order that has yet to be executed and is still valid. An open position puts a trader at risk if the market prices rise or fall, i.e. the trader is vulnerable to movements in the exchange rate. Open Order: An order to buy or sell that remains valid until it is executed or canceled by the customer. An order that is executed when the price of a share or currency reaches a pre-determined price. Options: These are tradable contracts giving the right, but not obligation, to buy or sell commodities, securities or currencies at a future date and at a pre-arranged price. Options are used to hedge against adverse price movements or to speculate against price rises or falls. Holding options is riskier than holding shares, but offers potentially higher returns. Order: An instruction by a customer to a broker/trader to buy or sell at a certain price or market price. The order remains valid until executed or cancelled by the customer.

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TOOLS & RESOURCES Overbought: A term used to characterize a market in which asset prices have risen at a pace that is above typical market acceleration, and hence is due for a retracement. Overnight: A position that remains open until the start of the next business day. Oversold: The opposite of overbought; exists when the price of a market decelerates at an abnormally fast rate, and hence is due for an upwards reversal. OTC (Over-the-Counter): A market conducted directly between dealers and principals via a telephone and computer network rather than a regulated exchange trading floor. These markets have not been very popular. They were never part of the Stock Exchange since they were seen as “unofficial”. Each OTC firm operates a market in the shares of a restricted list of (generally small and little-known) companies. Sometimes the dealer simply puts would-be buyers and sellers together but does not take a position in the shares himself. These days OTC trading is seen as “consumer-friendly,” meaning that it is interested in getting the buyer and seller the best possible price. Some see this as what share-trading is all. about. However, market makers, many of whom create market movements purposefully, feel they are being elbowed out by OTC, and that speculation, arbitrage and “smarttrading” are undermined by the new market. Out-of-the-Money: A put option is out-of-the-money if the exercise/strike price is below the price of the underlying instrument. A call option is out-of-the money if the exercise/strike price is higher than the price of the underlying instrument. Outright Deal: A forward deal that is not part of a swap operation. Overhang: A holding of foreign exchange that is temporarily unable to be converted from the reserve currency into other reserve assets. Overheated (Economy): Is an economy where highgrowth rates are placing pressure on production capacity resulting in increased inflationary pressures and higher interest rates. Overnight Limit: Net long or short position in one or more currencies that a dealer can carry over into the next dealing day. Passing the book to other bank dealing rooms in the next trading time zone reduces the need for dealers to maintain these unmonitored exposures.

Oscillators: Quantitative methods designed to provide signals regarding the overbought and oversold conditions. Package Deal: When a number of exchange and br deposit orders have to be fulfilled simultaneously. Parabolic SAR (Stop and Reversal): Functioning best in trending markets, Parabolic SAR specifies where traders should place their stops. If Parabolic SAR is above the market rate, the recommendation is to short; if it is below, the recommendation is to go long. Paris: A term for USD FRF Spot Rate. Parities: The value of one currency in terms of another. Parity Grid: A term used in the context of the European Monetary System which consists of the upper, central and lower intervention points between member currencies. Payment Date: A system where a currency moves in tine with another currency, some pegs are strict while others have bands of movement. Pegging: When a country fixes the exchange rate to another country’s currency, usually to achieve price stability. Most countries that peg their currencies do so against the US dollar or the Euro. Pip (Points): The smallest amount an exchange rate can move, typically .0001. Point & Figure (“P&F”): Unlike conventional bar, candlestick, and line charts, Point & Figure charts completely disregard the passage of time, opting only to display changes in prices. The chart instead emphasizes on illustrating (1) reversals in trends and (2) solid support and resistance lines. Put/Call Ratio: Calculated by dividing the number of put options traded by the number of call options traded for a particular asset, the put/call ratio offers explanation into expectations of the options market. Position: The amount of currency or security owned or owed by an investor. Position Clerk: A clerk who assists the dealer in recording a dealer’s position and ensures that all deal tickets are completed and transferred to the back office or input into the books in a position keeping system. Position Limit: The maximum position, either net long or net short, in one future or in all futures of one currency or instrument combined, which may be held or controlled by one person.

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TOOLS & RESOURCES Pre-Spot Dates: Quoted standard periods that fall between the transaction date and the current spot value date. Price Transparency: Refers to the degree of access to information regarding bids and offers and respective prices. Ideally, every investor/trader would have equal access to all information.

Ratio Spread: Buying a specific quantity of options and selling a larger quantity of out of the money options. Ratio Calendar Spread: Selling more near-term options than longer maturity options at the same strike price. Reaction: A decline in prices following an advance.

Primary Reserves: Gold related monetary reserves, being gold, SDR, etc.

Real: A price, interest rate or statistic that has been adjusted to eliminate the effect of inflation.

Prime Rate: (1) The rate from which lending rates by banks are calculated in the U.S. (2) The rate of discount of prime bank bills in the UK.

Realignment: Simultaneous and mutually coordinated revaluation and devaluation of the currencies of several countries. An activity that mostly refers to EMS activity.

Principal: A dealer who buys or sells stock for his/her own account.

Realized and Unrealized Profit: Unrealized profit is a gain from an increase in the price of an asset that has not been cashed in. Realized profits are made from the cashing in of the unrealized gain.

Producer Price Index: An economic indicator which gauges the average changes on prices received by domestic producers for their output at all stages of processing. Profit Taking: The unwinding of a position to realize profits.

Reciprocal Currency: A currency that is normally quoted, as dollars per unit of currency rather than the normal quote method of units of currency per dollar. Sterling is the most common example.

Proxy Hedge: A term to describe when it is necessary to hedge against a currency where there is no market but it follows a major currency, the hedge is entered against the major currency.

Rectangle: Similar to the consolidation portion of a flag pattern, a rectangle is a continuation pattern denoting a trading range characterized by strong support and resistance lines. Unsurprisingly, rectangles are often known as trading ranges, consolidation zones, or congestion areas.

Purchasing Power Parity: Model of exchange rate determination stating that the price of a good in one country should equal the price of the same good in another country, exchanged at the current rate. Also known as the law of one price.

Reinvestment Rate: The rate at which interest earned on a loan can be reinvested. The rate may not attract the same level of interest as the principal amount.

Put Option: A put option confers the right but not the obligation to sell currencies, instruments or futures at the option exercise price within a predetermined time period. Put Call Parity: The equilibrium relationship between premiums of call and put options of the same strike and expiry.

Repurchase Agreement: Agreements by a borrower where they sell securities with a commitment to repurchase them at the same rate with a specified interest rate. Repurchase (REPO): Repos are short-term money market instruments. The trader sells a security (government security) and buys it back only after a short period of time, typically only overnight. Repos are primarily used to raise short-term capital.

Quote: The offer price of a security. Rally: A recovery in price after a period of decline. Range: The difference between the highest and lowest price of a future recorded during a given trading session. Rate: The price of one currency in terms of another (exchange rate).

Reserve Currency: A currency held by a central bank on a permanent basis as a store of international liquidity, these are normally Dollar, Deutschemark, and Sterling. Reserves: Funds held against future contingencies; normally a combination of convertible foreign currency, gold, and SDRs. Official reserves are to ensure that a government can meet near term obligations. They are an asset in the balance of payments.

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TOOLS & RESOURCES Reserve Requirement: The ratio of reserves to deposits, expressed as a fraction prescribed by national banking authorities, including the United States. Resistance: A price level at which a currency pair has had trouble breaking, and hence consolidation is expected. If the resistance line holds and the currency pair retraces, the sellers have outnumbered the buyers; on the other hand, buyers have outnumbered sellers if the resistance level is broken, and momentum may allow for a strong continuation of the trend. Retail Price Index: Measurement of the monthly change in the average level of prices at retail, normally of a defined group of goods. Retracements: Synonymous with the term correction; used to denote a temporary reversal in the overall trend of the market to accommodate for excessive acceleration or deceleration of asset price movement. Reversal: Process of changing a call into a put. Revaluation: An increase in the exchange rate for a currency as a result of central bank intervention. Opposite of Devaluation Revaluation Rates: The market rates that are used by traders in the evaluation of the gains and losses in their accounts each day. Reversal: A pattern that suggests a potential shift or deceleration of the current trend. A reversal of an up move will be reflected in a downward price movement. Right-hand Side: To do a deal on the right hand, side of a two way quote, normally to buy the currency and sell dollars. See Left-hand Side. Ring: An area on a trading floor where futures or equities are traded. Risks: Uncertainty in the possible outcomes’ of an action, i.e. possible returns on an investment. Risk is most commonly measured from the variance of possible outcomes. Higher risks are associated with higher rates of returns, typically in order to induce investment in riskier ventures. Risk/Return: The relationship between the risk and return on an investment. Usually, the more risk you are prepared to take, the higher the return you can expect. Depositing your money in a bank is safe and therefore a low return is regarded as sufficient. Investing in the stock market exposes you to more risk (from, capital losses) and so investors will expect a higher return.

Risk Capital: The capital that an investor does not need to maintain his/her living standard. Risk Factor: The risk factor (delta) indicates the risk of an option position relative to that of the related futures contract. Risk Management: Term to describe when a trader will use analysis and other trading techniques to avoid substantial risks to his portfolio. Rollover: Refers to a process of reinvesting in which at the expiry, the settlement is postponed until a later date. The cost of the process is measured by the interest rate differential between the two currencies. Rounding Top and Bottom: Similar to a Cup and Handle pattern, a rounding top signifies a rounded resistance line and a bearish overall trend. Alternatively, a rounding bottom is a bullish for which the bottom curve can serve as a support line. Both patterns are best-suited to longer-term analyses. Round Trip: Buying and selling of a futures or options contract. RSI (Relative Strength Index): An oscillator that measures the size of recent upward trends against the size of downward trends within the specified time frame. High RSI scores - above 70 or perhaps 80 - indicate that the currency is overbought, and hence due for a reversal. Alternatively, low RSI scores indicate that the currency is oversold, and hence due for a fall in price. Same Day Transaction: A transaction that matures on the day the transaction takes place. Scalping: A strategy of buying at the bid and selling at the offer as soon as possible. SDR: Special Drawing Right. A standard basket of five major currencies in fixed amounts as defined by the IMF. Selling Rate: Rate at which a bank is willing to sell foreign currency. Seller/Grantor: Also known as the option writer. Serial Expiration: Options on the same underlying futures contract which expire in more than one month. Series: All options of the same class which share a common strike price and expiration date. Settlement: The actual finalization of a contract in which the goods, securities or currencies are paid for or delivered and the transaction is entered in the books.

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TOOLS & RESOURCES Settlement Risk: Risk associated with the nonsettlement of the transaction by the counter party. Short: The selling of a borrowed security, commodity or currency. Traders sell when prices are expected to fall. Short Contracts: Contracts with up to six months to delivery. Short Covering: Buying to unwind a shortage of a particular currency or asset. Short Forward Date/Rate: The term ‘short forward’ refers to a period up to two months, although it is more commonly used with respect to maturities of less than one month. Short Position: A contract to sell securities, commodities or currencies at a future date and at a prearranged price. At the expiry date, if the spot price is below the contract price, the holder of the contract will make a profit and if the spot price is above the contract price, then there is the potential to make a huge loss.

Spread: The difference between the bid and offer price that is offered by a market maker. (1) The difference between the bid and ask price of a currency. (2) The difference between the prices of two related futures contracts. (3) For options, transactions involving two or more option series on the same underlying currency. Square: Purchase and sales are in balance and thus the dealer has no open position. Squawk Box: A speaker connected to a phone often used in broker trading desks. Squeeze: Action by a central bank to reduce supply in order to increase the price of money. Stable Market: An active market which can absorb large sale or purchases of currency without major moves. Standard: A term referring to certain normal amounts and maturities for dealing.

Sidelined: A major currency that is lightly traded due to major market interest being in another currency pair.

Stand by Credit: An arrangement with the IMF for draw downs on a “need” basis. The term is sometimes more generally used.

SITC: Standard International Trade Classification, a system for reporting trade statistics in a common manner.

Sterilization: Central Bank activity in the domestic money market to reduce the impact on money supply of its intervention activities in the FX market.

SOFFEX: Swiss Options and Financial Futures Exchange, a fully automated and integrated trading and clearing system.

Sterling Index: An index based on the movement of sterling against the major currency. Sterling: Refers to the UK currency, the Pound.

Soft Market: More potential sellers than buyers, which creates an environment where rapid price falls are likely. Sovereign Immunity: Legal doctrine which means that the state cannot be sued or have its assets seized. Spike (high or low): A significantly lower low or higher high within a data series. Points where currency spikes often signify a potential reversal in the direction of the trend, and hence can be valuable tools in analyzing a chart. Spot: (1) The most common foreign exchange transaction. (2) Spot or Spot date refers to the spot transaction value date that requires settlement within two business days, subject to value date calculation. Spot Market: A market in which commodities, securities or currencies are immediately delivered. Spot Price/Rate: The current market price.

Stochastic: Like RSI, stochastics is a momentum indicator that indicates overbought/oversold levels. High levels (above 70 or 80) are indications to enter short orders; low levels (below 30 or 20) are indications to buy. Like all oscillators, stochastics work best as a momentum indicator that measures the price of a security relative to its high/low range over a set period of time. The indicator fluctuates between 0 and 100, with readings below 20 considered overbought (bearish) and readings above 80 considered oversold (bullish) Stop Order (Stop-Loss Order): An order used to hedge against excessive loss in which a position is liquidated at a specific, prearranged price. Straddle: The simultaneous purchase/sale of both call and put options for the same share, exercise/strike price and expiry date. Stagflation: Recession or low growth in conjunction with high inflation rates.

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TOOLS & RESOURCES Strap: A combination of two calls and one put. Strike Price: Also called exercise price; the price at which an options holder can buy or sell the underlying instrument.

volume levels. It examines charts and historical performance. Technical Correction: An adjustment to price not based on market sentiment but technical factors such as volume and charting.

Strip: A combination of two puts and one call. Supply Side Economics: The concept is that tax cuts will boost investment leading to an increase in the supply of goods in the economy. To be compared with demand led Keynesian economics. Support: The opposite of support; a point in a chart where a currency pair has repeatedly had trouble falling beneath. When a currency pair “tests” support but does not break it, buyers have outnumbered sellers; alternatively, sellers have gained control of momentum if support is broken and the currency pair continues to plunge downward. Support Levels: When an exchange rate depreciates or appreciates to a level where (1) technical analysis techniques suggest that the currency will rebound, or not go below; (2) the monetary authorities intervene to stop any further downward movement. Swap: When a trader exchanges one currency for another, holding it for only a short period. Swaps are typically used to speculate on interest rate movements. It is calculated using the interest differentials between the two currencies. Swap Price: A price as a differential between two dates of the swap.

Temporal Accounting: Method of determining accounting exposure which translates all balance sheet items at the current rate of exchange, not the one at the time the cost was incurred. Terms of Trade: The ratio between export and import price indices. Threshold of Divergence: A safety feature for the EMS which creates an emergency exit for currencies which become the singular focus of various adverse forces. The threshold of divergence indicates when the specific country with the pressured currency should take additional steps other then simple central bank intervention in the foreign exchange markets. Thin Market: A market in which trading volume is low and in which consequently bid and ask quotes are wide and the liquidity of the instrument traded is low. Thursday/Friday Dollars: A U.S. foreign exchange technicality. If the bank leaves the funds overnight and transfers them on Friday by means of a clearing house cheque, then clearance is not until Monday, the next working day. Higher interest rates for this period are thus available. Tick: A minimum price movement. Ticker: Depicts current or recent history of a currency, usually in the form of a graph or chart.

Swissy: Market slang for Swiss Franc. Symmetrical triangle: Also referred to as a coil, usually forms during a trend as a continuation pattern. It contains at least two lower highs and two higher lows. At the time these points are conjoined, the lines converge as they are extended and the symmetrical triangle takes shape. One can also think of it as a contracting wedge, wide at the beginning and narrowing over time. Synthetics: Options or futures that create a position that is able to be achieved directly but is generated by a combination of options and futures in the relevant market. In foreign exchange, a SAFE combines two forward contracts into a single transaction where settlement only involves the difference in values. Technical Analysis: A technique used to try and predict future movements of a security, commodity or currency, based solely on• past price movements and

Tight Money: A condition where there is a shortage of credit as a result of monetary policy restricting the supply of credit normally through raising interest rates. TIFFE: Tokyo International Financial Futures Exchange. Time Decay: The decline in the time value of an option as the expiry approaches. Time Value: That part of an option premium which reflects the length of time remaining in the option prior to expiration; the longer the time remaining until expiration, the higher the time value. Today/Tomorrow: Simultaneous buying of a currency for delivery the following day and selling for the spot day, or vice versa. Also referred to as overnight.

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TOOLS & RESOURCES Tombstone: Colloquial term for announcement in a publication that a loan or bond has been arranged.

or commodity in which they make a market. This is called a two-sided market.

Trade Date: The date on which a trade occurs.

Two-Tier Market: A dual exchange rate system where normally only one rate is open to market pressure, e.g. South Africa.

Trade Deficit/Surplus: The difference between the value of imports and exports. Often only reported in visible trade terms. Trade-weighted Exchange Rate: The changes in the exchange rate against a trade weighted basket including the currencies of the county’s principal trading partners. Traded Options: Transferable options with the right to buy and sell a standardized amount of a currency at a fixed price within a specified period. Trade Price Response: This term advises that price reaction to a certain level is critical. If this level breaks, then the recommendation would be to run with the market direction (i.e. Buy a break above resistance level; sell a break below a support level). However, if a price stalls at this level and is rejected, then the recommendation is to go with this also (i.e. Sell at a resistance level that is tested and holds, buy at a support level). Transaction: The buying or selling of securities resulting from the execution of an order. Transaction Costs: The costs that are incurred by a trader when buying or selling currencies, stocks or commodities. These costs include broker commissions or spreads. Transaction Exposure: Potential profit and loss generated by current foreign exchange transactions. Trend Lines: A straight line drawn across a chart that indicates the overall trend for the currency pair. In an upward trend, the line is drawn below, and acts as a support line; the opposite holds true for a downward trend. Once the currency breaks the trend line, the trend is considered to be invalid. Triple Top: A pattern in which a currency has reached a price three times previously, yet has been unable to sustain movements beyond those three peaks. A triple top signifies a strong resistance level. Turnover: The number or volume of shares traded over a specific time period. The larger the turnover, the more commissions a broker will be making. Two Way Price: A price that includes both the bid and offer price. The NASD requires that market makers have both bid and ask prices for any security, currency

Two-Way Quotation: When a dealer quotes both buying and selling rates for foreign exchange transactions. Uncovered: Another term for an open position. Under Reference (Order): Before finalizing a transaction, all the details should be submitted for approval to the order giver, who has the right to turn down the proposal. Under-Valuation: An exchange rate is normally considered to be undervalued when it is below its purchasing power parity. Undo: A colloquial term for reversing a transaction, e.g., a spot sale by means of a forward purchase or if done in error, a spot purchase. Unload: Term for sale of assets or unwinding positions either to limit loss or to undermine other market participant’s positions. Unwind: Selling of assets and or instruments to square a position. Uptick: A price quote that is higher than the preceding quote for the same currency. Uptick Rule: A regulation requiring that if a security is to be traded short, the price in the trade prior to the short trade has to be lower than the price of the present short trade. U.S. Prime Rate: The interest rate that the major U.S. banks lend to major clients. USDX: Currency index which consist of the weighted average of the prices of ten foreign currencies against the U.S. dollar. U.S. Quote: Exchange rate quotation on a reciprocal basis. Also known as an American Quote. Value at Risk: The expected loss from an adverse market movement. Value Date: For exchange contracts, it is the day on which the two contracting parties exchange the currencies which are being bought or sold. For a spot transaction, it is two business banking days forward in

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TOOLS & RESOURCES the country of the bank providing quotations which determine the spot value date. The only exception to this general rule is the spot day in the quoting center coinciding with a banking holiday in the country(ies) of the foreign currency(ies). The value date then, moves forward a day. The enquirer is the party who must make sure that his spot day coincides with the one applied by the respondent. The forward month’s maturity must fall on the corresponding date in the relevant calendar month. If the one month date falls on a non-banking day in one of the centers, then the operative date would be the next business day that is common. The adjustment of the maturity for a particular month does not affect the other maturities that will continue to fall on the original corresponding date if they meet the open day requirement. If the last spot date falls on the last business day of a month, the forward dates will match this date by also falling due on the last business day. Also referred to as “Maturity Date”. Variation Margin: A call by a broker to increase the margin requirement of an account during a period of extreme market volatility. Variance: Measures the volatility of a data set/data points from the mean. It is calculated by adding the squares of the standard deviations from the mean and dividing by the number of data points, i.e. taking the average of the standard deviations. Vega: Expresses the price change of an option for a one per cent change in the implied volatility. Velocity of Money: The speed with which money circulates or turnover in the economy. It is calculated as the annual national income: average money stock in the period. Vertical (bear or bull) Spread: The sale of an option with a high exercise price and the purchase (in the case of a bull) or the sale (in the case of a bear) of an option with a lower exercise price. Both options will have the same expiration date. Visible Trade: Trade in merchandise goods as compared with capital flows and invisible trade. Volatility: Refers to the tendency of prices/variables to fluctuate over time. It is most commonly measured using the coefficient of variation (the standard deviation divided by the mean). The higher the volatility, the higher the risk involved. Volume: The number of shares or contracts traded for a certain security or an exchange during a period.

applied to the counterparty’s account from which funds may be paid into or withdrawn, as a result of a transaction. Warrant: It is a right but not obligation, to buy shares in a company at a future date and at a prearranged price. Warrants are tradable options. Weekly Charts: Charts for which each candlestick or bar encapsulates data for the currency pair for the past week. Whipsaw: Term used to describe sharp price movements and reversals in the market. A whipsaw would be if shortly after you bought a stock, the price plummeted. Wholesale Money: Money borrowed in large amounts from banks and institutions rather than from small investors. Wholesale Price Index: It measures changes in prices in the manufacturing and distribution sector of the economy and tends to lead the consumer price index by 60 to 90 days. The index is often quoted separately for food and industrial products. Window-dressing: Where financial institutions or companies raise funds for specific reporting dates such as year ends to give the appearance of high liquidity. Working Balance: Discretionary element in the monetary reserves of a central bank. Working Day: A day on which the banks in a currency’s principal financial centre are open for business. For FX transactions, a working day only occurs if the bank in both (all relevant currency centers in the case of a cross) are open. World Bank: A bank made up of members of the IMF whose aim is to assist in the development of member states by making loans where private capital is not available. Yard: Term for a billion JPY. Yield Curve: The graph showing changes in yield on instruments depending on time to maturity. A system originally developed in the bond markets that is now broadly applied to various financial futures. A positive sloping curve has lower interest rates at the shorter maturities and higher at the longer maturities. A negative sloping curve has higher interest rates at the shorter maturities.

Vostro Account: A local currency account maintained with a bank by another bank. The term is normally

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