American Terms/European Terms American Terms When the USD is the numerator European Terms When the USD is the denominator. → NOTE: In a ratio, the numerator number before the backslash, and the denominator is the number after the backslash, i.e. numerator/denominator. → EXAMPLE: USD/CHF (American terms) EUR/USD (European terms Base/Quote/Terms/Secondary Currency Base Currency In Forex markets, the base currency is the first currency in a currency pair (a quotation of two different currencies, depicting how many units of the counter currency are needed to buy one unit of the base currency). Quote Currency The quote currency is the second currency quoted in a currency pair. In a direct quote, the quote currency is the domestic currency. In an indirect quote, the quote currency is the domestic currency. Terms Currency Terms currency is another way to refer to a quote currency—a currency quotation shows how many units of the terms currency will equal 1 unit of the base currency. Secondary Currency
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American Terms/European Terms
American Terms
When the USD is the numerator
European Terms
When the USD is the denominator.
→ NOTE:
In a ratio, the numerator number before the backslash, and the denominator is the number after
the backslash, i.e. numerator/denominator.
→ EXAMPLE:
USD/CHF (American terms)
EUR/USD (European terms
Base/Quote/Terms/Secondary Currency
Base Currency
In Forex markets, the base currency is the first currency in a currency pair (a quotation of two different
currencies, depicting how many units of the counter currency are needed to buy one unit of the base
currency).
Quote Currency
The quote currency is the second currency quoted in a currency pair. In a direct quote, the quote
currency is the domestic currency. In an indirect quote, the quote currency is the domestic currency.
Terms Currency
Terms currency is another way to refer to a quote currency—a currency quotation shows how many
units of the terms currency will equal 1 unit of the base currency.
Secondary Currency
Also known as ‘variable currency’ or ‘counter currency’, the secondary currency is the currency that the
investor trades the base currency against (i.e. USD in EUR/USD).
→ EXAMPLES:
(1)
Australian Dollar (AUD) against United States Dollar (USD): AUD/USD 0.6660
Australian Dollars is the base currency, and US Dollars is the terms currency. One Australian Dollar is
equal to 0.666 US Dollar (66.6 US cents).
(2)
EUR/USD = 1.35
EUR = Base Currency
USD = Counter Currency
Price = to buy one Euro you will need to spend $1.35US
If a quotation goes up then it means that the base currency is getting stronger vis-à-vis the counter
currency.
(3)
EUR/USD = 1.6
Now, one euro is exchanges for $1.6US.
If a quotation goes down then it means that the base currency is getting weaker vis-à-vis the counter
currency.
(4)
EUR/USD = 1.2
Now, one euro is exchanges for $1.2US.
Bid/Ask Spread
Bid/Ask Spread
Like in the securities markets, the forex markets have a bid price (the price at which a broker is willing to
buy the base currency) and an ask price (the price at which a broker is willing to sell the base
currency). When you enter into a forex transaction you buy at the ask and you sell at the bid. The
difference between the bid price and the ask price is the spread. Spreads are usually quoted in pips.
Leverage allows the trader to increase the possible ROI on an investment. The amount of the
ROI is expressed as a percentage of the margin amount. For instance, if you gain $200 on a
trade which was initiated with $1,000 on margin, your return on margin is 20%.
Example:
The Trader buys 100,000 GBP at 1.9505 USD (using US$1000 as the margin amount).
The Trader calculates a potential profit and places a limit order of 1.9620 (Potential profit of US$1,115.00)
The Trader calculates a potential loss and places a stop at 1.9475 (Potential loss of US$300) Within the next hour the GBP rallies to 1.9592, stalls and begins to reverse. The Trader decides the limit will not be reached, so he closes his position by selling the GBP at
1.9558 and locks in a profit of US$530.00 The Trader made a profit of US$530 on a margin amount of $1000 = 53% return on margin in an
Transaction costs vary from FDM to FDM. You should consider:
1. Commissions. If there is a commission, add it to the spread to determine total cost. Also, you need to determine whether the commission is calculated on a per side or round trip basis.
2. Spread on currency pairs. This is the value of the pip multiplied by the spread (pip X spread). The spread may fluctuate throughout day, based on the FDM.
3. Rollover rates. These are important for longer term strategies (and are not necessarily important for day traders).
4. Quality of execution, including slippage and the consistency of rates versus other platforms.
Written confirmation provided to customers within one business day of activity.
Written confirmation must include the following information:
1. Date; 2. Transaction type (e.g., new position, offsetting position, rollover, adjustment); 3. Currency pair; 4. Buy or sell (if a new or offsetting position); 5. Size; 6. Price or premium (for new or offsetting positions or price adjustments); 7. Price or premium change (for price adjustments); 8. Monetary adjustments (debit or credit); 9. Net profit or loss for offsetting positions; and 10. Charges for each transaction (e.g., rollover interest and/or fees).
Daily statements must be provided to customers on a daily basis and must show account equity
as of the end of the previous day. They can be provided electronically and can be combined with
confirmations and provided electronically with the customers consents
Monthly statements are required for all accounts that have open positions at the end of the
month or changes in the account balance or equity since the prior statement. Quarterly
statements are required for all other open accounts. The monthly or quarterly statements must
contain the following information regarding the transactions during the reporting period and the
funds in the account:
The account equity at the beginning of the reporting period; All initiating or offsetting transactions, deliveries, option exercises, or option expirations that
occurred during the reporting period, with the following information for each: date, currency pair, buy or sell, size, and price or premium (with any price or premium adjustment noted);
All open positions in the account, with the following information for each position: date initiated, currency pair, long or short, size, price or premium at which it was initiated (with any price or premium adjustment noted), and the unrealized profit or loss;
All deposits and withdrawals during the reporting period; All other monetary adjustments (debits and credits) to the account; The amount of cash in the account (excluding non-cash collateral and unrealized profits and
losses); A breakdown by type of all fees and charges during the period, including commissions and
interest expense or rollover fees; and The account equity at the end of the reporting period.
Promotional Material & Solicitation
Promotional Material
This is quite a nebulous topic which is explored in greater depth elsewhere in the materials. I
provide an overview below.
See generally NFA rule 2-36(h) Filing Promotional Materials with NFA:
The Compliance Director may require any Forex Dealer Member for any specified period to file
copies of all promotional material with NFA for its review and approval at least 10 days prior to
its first use or such shorter period as NFA may allow. The Compliance Director may also require
a Forex Dealer Member to file for review and approval copies of promotional material prepared
or used by some or all of the non-Members it is responsible for under Section (d).
The Forex Transactions Guide states:
Communications with the Public and Promotional Material - No Member or Associate shall
make any communication with potential or current customers that operates as a fraud or deceit;
uses a high-pressure approach; or implies that forex transactions are appropriate for all persons.
Promotional material used by the Member or Associate shall not:
Deceive the public or contain any material misstatement of fact or omit a fact that makes the promotional material misleading;
Include any statements of opinion unless they are clearly identified as such and have a reasonable basis in fact;
Mention the possibility of profit unless accompanied by an equally prominent statement of the risk of loss;
Include any reference to actual past trading profits without mentioning that past results are not necessarily indicative of future results;
Include any statistical or numerical information about past performance of actual accounts unless the Member can demonstrate that the performance is representative of actual performance of all reasonably comparable accounts for the same period (calculated in accordance with the formula in CFTC Regulation 4.35(a)(6) and NFA Compliance Rule 2-34); or
Include testimonials unless they are representative of all reasonably comparable accounts, the material prominently states that the testimonial is not indicative of future performance or success, and the material prominently states that they are paid testimonials (if applicable).
No Member or Associate may represent that forex funds deposited with a Forex Dealer Member
are given special protection under the bankruptcy laws. No Member or Associate may represent
or imply that any assets necessary to satisfy its obligations to customers are more secure because
the Member keeps some or all of those assets at a regulated entity in the United States or a
money center country.
No Member or Associate may represent that its services are commission free without
prominently disclosing how it is compensated in near proximity to that representation.
No Member or Associate may represent that it offers trading with “no-slippage” or that it
guarantees the price at which a transaction will be executed or filled, unless:
It can demonstrate that all orders for all customers have been executed and fulfilled at the price initially quoted on the trading platform when the order was placed;9 and
No authority exists, pursuant to a contract, agreement, or otherwise, to adjust customer accounts in a manner that would have the direct or indirect effect of changing the price at which an order was executed.
Members and Associates may not solicit customers based on the leverage available unless they
balance any discussion regarding the advantages of leverage with an equally prominent
contemporaneous disclosure that increasing leverage increases risk.
No Member shall use or directly benefit from any radio or television advertisement that
recommends specific forex transactions or describes the extent of any profit obtained in the past
or that can be obtained in the future unless the member submits the advertisement to NFA’s
Promotional Material Review Team for its review and approval at least 10 days prior to its first
use or such shorter period as NFA may allow.
Every Member should adopt and enforce written procedures to supervise communications with
potential and current customers and promotional material. A supervisory employee that is, or is
under the ultimate supervision of, a listed principal who is also an NFA Associate should review
and approve all promotional material and make a written record of such review and approval.12
All promotional material should be maintained by each Member and be available for
examination for the periods specified in the recordkeeping section of this notice, measured from
the date of last use.
See also Notice I-08-15:
(i) Hypothetical Results
Any Member who uses promotional material that includes a measurement or description or
makes any reference to hypothetical forex transaction performance results that could have been
achieved had a particular trading system of the Member or Associate been employed in the past
must comply with Compliance Rule 2-29(c) and the related Interpretive Notice as if the
performance results were for transactions in on-exchange futures contracts.
Solicitation
See NFA Rule 2-39 at www.nfa.futures.org/nfamanual/NFAManual.aspx?RuleID=RULE%202-
Forex Dealer Member (FDM) is an NFA member who acts a counterparty to forex transaction. It is a self-
executing title, meaning that an NFA member is an FDM solely by nature of acting as a counterparty to
forex transactions. No applications or approvals are required to be considered an FDM. If you do not act
as a counterparty to a forex transaction (IB, CTA, or CPO), then you are not considered an FDM, but you
may be subject to parts of NFA Rule 2-36 pursuant to NFA Rule 2-39.
The following are not FDMs and not subject to NFA Rule 2-36:
financial institutions (e.g., banks and savings associations); certain insurance companies and their regulated subsidiaries or affiliates; financial holding companies; investment bank holding companies; registered broker-dealers that are members of FINRA; and Material Associated Persons of registered broker-dealers that are members of FINRA.
→ General Disclosures:
Disclosure of characteristics and risks of forex transactions (members and associates should know what information has been provided to the customer)
→ Specific Disclosures:
disclaimer regarding non-protection under the Bankruptcy Code manner in which member will be compensated for services 2 paragraph uppercase disclaimer re: trading not conducted on exchange, conflict of interest,
trading exposure disclose bid and offer when customer enters an order duty to update information if a material change would make prior information misleading
Reporting: NFA is concerned that the customer receives timely and accurate notice of account status:
Confirmations: Written confirmation must be submitted within one business day of any account activity (including offsetting transactions, rollovers, deliveries, etc.). Information should include all costs, fees, commission, third party fees, etc.
Monthly/Quarterly Summaries: If (1) there has been activity in an account during the month or (2) there are any open positions in the account at the end of the month, the FDM will need to provide a monthly summary of all forex transactions and other account activity to the customer. For customer accounts not fitting within the above, summaries should be provided quarterly.
Delivery: both confirmation and summaries may be transmitted by electronic means.
Supervision:
NFA Notice to Members: Supervision of Forex Promotional
Materials
NFANotice to Members – Supervision of Forex Promotional Materials (Notice I-08-15;
March 27, 2008) - there are three main parts to this notice.
Supervisory employee responsible for reviewing FDM promotional materials must be under the
ultimate supervision of a principal of the FDM who is also an AP (means that an individual
principal of a FDM will ultimately be held liable for fraudulent or midleading promotional
materials)
FDM must have policies on reviewing the activities of non-Members with which they do
business, including:
Regular review of trading
Procedures for customer complaints
Review of promotional materials
Review of activites of non-Members must also be done by an AP under the ultimate
supervision of an FDM principal/AP
Gross National Product (GNP)
Gross National Product (GNP)
The market value of all goods and services produced by US residents in the US or abroad (i.e. regardless
of where they were produced) over a period of time (typically a year).
World Trade Organization
World Trade Organization
The World Trade Organization (WTO) is an international organization designed by its founders
to supervise and liberalize international trade. The organization officially commenced on January
1, 1995 under the Marrakesh Agreement, succeeding the 1947 General Agreement on Tariffs and
Trade (GATT).
The World Trade Organization deals with regulation of trade between participating countries; it
provides a framework for negotiating and formalizing trade agreements, and a dispute resolution
process aimed at enforcing participants’ adherence to WTO agreements which are signed by
representatives of member governments and ratified by their parliaments.
Among the various functions of the WTO, these are regarded by analysts as the most important:
It oversees the implementation, administration and operation of the covered agreements.
It provides a forum for negotiations and for settling disputes.
Additionally, it is the WTO’s duty to review and propagate the national trade policies,
and to ensure the coherence and transparency of trade policies through surveillance in
global economic policy-making.
Another priority of the WTO is the assistance of developing, least-developed and low-
income countries in transition to adjust to WTO rules and disciplines through technical
cooperation and training.
The WTO is also a center of economic research and analysis: regular assessments of the
global trade picture in its annual publications and research reports on specific topics are
produced by the organization.
Finally, the WTO cooperates closely with the two other components of the Bretton
Woods system, the IMF and the World Bank.
Theory of Elasticities
Theory of Elasticities
The theory of elasticities holds that the exchange rate is simply the price of foreign exchange that
maintains the balance of payments in equilibrium. In other words, the degree to which the exchange
rate responds to a change in the trade balance depends entirely on the elasticity of demand to a change
in price.
For instance, if the imports of country A are strong, then the trade balance is weak. Consequently, the
exchange rate rises, leading to the growth of country A’s exports, and triggers in turn a rise in its
domestic income, along with a decrease in its foreign income.
Whereas a rise in the domestic income (in country A) will trigger an increase in the domestic
consumption of both domestic and foreign goods and, therefore, more demand for foreign
currencies, a decrease in the foreign income (in country B) will trigger a decrease in the domestic
consumption of both country B’s domestic and foreign goods, and therefore less demand for its
own currency. The elasticities approach is not problem-free because in the short term the
exchange rate is more inelastic than it is in the long term and additional forex rate variables arise
continuously, changing the rules of the game.
Source: http://www.iforex.org
Central Bank Activities
Central Bank Activities
A central bank, reserve bank, or monetary authority is the entity responsible for the monetary policy of
a country or of a group of member states. It is a bank that can lend money to other banks in times of
need. Its primary responsibility is to maintain the stability of the national currency and money supply,
but more active duties include controlling subsidized-loan interest rates, and acting as a lender of last
resort to the banking sector during times of financial crisis (private banks often being integral to the
national financial system). It may also have supervisory powers, to ensure that banks and other financial
institutions do not behave recklessly or fraudulently.
Intervention
Official intervention in the foreign exchange market means that the central bank or other agent of the
government buys or sells foreign currency in an attempt to influence the exchange rate value. Purchases
of foreign exchange usually are intended to push down the home currency value of the exchange rate,
and sales usually are intended to push it up.
Sterilized Intervention
In a sterilized intervention, the central bank offsets the purchase or sale of foreign exchange by selling
or purchasing domestic securities so as to keep the domestic interest rate at its target. Since the
domestic interest rate usually is considered the main determinant of the value of the domestic currency,
many argue, it must change in order to influence the exchange rate. Sterilized intervention may be
especially useful when the exchange rate is under speculative attack (that is, when a change in the
exchange rate is not justified by fundamentals) or to help coordinate private sector expectations
Role of Central Banks
Role of Central Banks
The role of central banks in microfinance is related to their broader role in the financial system
and in the economy more generally.
Central banks have a number of objectives:
tactical or macroeconomic objectives (relating primarily to the domestic price level and
the exchange rate);
long-term strategic objectives of financial sector development (including the
development of an effective payments system and other forms of financial infrastructure);
and
sectoral or microeconomic objectives (such as prudential supervision and deposit
insurance).
Portfolio Balance
Portfolio Balance
One of the problems stock investors have is losing their balance in an investment portfolio spread. This
balancing problem can occur in a rising market or in a falling market. The balance is the ratio in your
portfolio of stocks, bonds and cash. Investors should have a ratio in mind (some leave out cash) of how
they want their investments to be in proportion to their total portfolio.
International Monetary Fund (IMF)
International Monetary Fund (IMF)
The IMF promotes international monetary cooperation and exchange rate stability, facilitates the
balanced growth of international trade, and provides resources to help members in balance of
payments difficulties or to assist with poverty reduction.
Through its economic surveillance, the IMF keeps track of the economic health of its member
countries, alerting them to risks on the horizon and providing policy advice. It also lends to
countries in difficulty, and provides technical assistance and training to help countries improve
economic management. This work is backed by IMF research and statistics.
The IMF supports its membership by providing:
policy advice to governments and central banks based on analysis of economic trends and
cross-country experiences;
research, statistics, forecasts, and analysis based on tracking of global, regional, and
individual economies and markets;
loans to help countries overcome economic difficulties;
concessional loans to fight poverty in developing countries; and
technical assistance and training to help countries improve the management of their
economies.
International Fisher Effect (IFE)
International Fisher Effect (IFE)
An economic theory that states that an expected change in the current exchange rate between any two
currencies is approximately equivalent to the difference between the two countries’ nominal interest
rates for that time.
→ CALCULATE:
% change in the exchange rate =
(country A’s interest rate - country B’s interest rate)/(1 + country B’s interest rate)
≈ (country A’s interest rate - country B’s interest rate)
→ EXAMPLE:
If country A’s interest rate is 10% and country B’s interest rate is 5%, country B’s currency
should appreciate roughly 5% compared to country A’s currency.
The rational for the IFE is that a country with a higher interest rate will also tend to have a higher
inflation rate. This increased amount of inflation should cause the currency in the country with the high
interest rate to depreciate against a country with lower interest rates.
Interbank Funds Transfers & Settlement System
Interbank Funds Transfers & Settlement System
In the United States, payment and securities settlement systems consist of numerous financial
intermediaries, financial services firms, and non-bank businesses that create, distribute, and process
large-value payments. The bulk of the dollar value of these payments are processed electronically and
are generally used to purchase, sell, or finance securities transactions; disburse or repay loans; settle
real estate transactions; and make large-value, time-critical payments, such as payments for the
settlement of interbank purchases and sales of federal funds, settlement of foreign exchange
transactions, or other financial market transactions.
There are two primary networks for interbank, or large-value, domestic, funds transfer payment orders.
The first, Fedwire® Funds Service, is operated by the Federal Reserve Banks and is an important
participant in providing interbank payment services, as well as safekeeping and transfer services for U.S.
government and agency securities and mortgage-backed securities. In addition, Fedwire Funds Service
and the Federal Reserve’s National Settlement Service (NSS) are critical components used in other
payment systems’ settlement processes. The Clearing House Interbank Payments Company L.L.C. (CHIP
Co.) operates the second, the Clearing House Interbank Payments System (CHIPS).
Processing large-value funds transfers involves two key elements: clearing and settlement. Clearing is
the transfer and confirmation of information between the payer (sending financial institution) and
payee (receiving financial institution). Settlement is the actual transfer of funds between the payer’s
financial institution and the payee’s financial institution. Settlement discharges the obligation of the
payer financial institution to the payee financial institution with respect to the payment order. Final
settlement is irrevocable and unconditional. The finality of the payment is determined by that system’s
rules and applicable law.
In general, payment messages may be credit transfers or debit transfers. Most large-value funds transfer
systems are credit transfer systems in which both payment messages and funds move from the payer
financial institution to the payee financial institution. An institution initiates a funds transfer by
transmitting a payment order (a message that requests the transfer of funds to the payee). Payment
order processing follows the predefined rules and operating procedures of the large-value payment
system used. Typically, large-value payment system operating procedures include identification,
reconciliation, and confirmation procedures necessary to process the payment orders. In some systems,
financial institutions may contract with one or more third parties to help perform clearing and
settlement activities on behalf of the institution.
The legal framework governing payment activity and the regulatory structure for financial
institutions that provide payment services is complex. There are rules for large-value payments
that are distinct from retail payments. Large-value funds transfer systems differ from retail
electronic funds transfer (EFT) systems, which generally handle a large volume of low value
payments including automated clearinghouse (ACH) and debit and credit card transactions at the
point of sale.
Source: www.ffiec.gov
Balance of Trade
Balance of Trade
The value of a country’s exports minus its imports. A nation’s balance of trade is favorable when the
exports of goods exceed imports, and is said to be unfavorable if imports exceed exports.
Economic Indicators
Economic Indicators
Employment
Consumer Spending
Income
Industrial and Inflation Indicators
Foreign Investment Indicators
Foreign Investment Indicators
The forex market is sensitive to changes in the economy and will react accordingly. As the
economy is affected by investment performance, the expected returns may change due to the
influence of inflation or deflation. Thus, it’s important to consider foreign economy trends while
planning investment strategies.
→ EXAMPLE:
Foreign Investment Indicators
The Business Cycle has 4 stages: 1) recovery (also known as expansion); 2) peak; 3) contraction (also
known as recession); and 4) trough. The growth of business activity, increase of demand and production,
as well as expansion of employment should also be observed.
Gross National Product (GNP) is one of the key indicators of the economic activity. All the services
provided and the goods produced within the US economy form the GNP. There are 4 components
included in the GNP. They are: 1) consumer spending; 2) government spending; 3) investments; and 4)