The Overview of Euro (EUR)

 

The European Union developed as an institutional system for the construction of a unified Europe. The E.U. currently consists of Austria, Belgium, Denmark, Finland, France, Germany, Greece, Ireland, Italy, Luxembourg, Netherlands, Portugal, Spain, Sweden, Hungary, Slovakia, Lithuania, Latvia, Estonia, Slovenia, Cyprus, Bulgaria, Romania, and Croatia (including the United Kingdom). Countries except Denmark, Sweden, the United Kingdom, the Czech Republic, Hungary, Poland, Lithuania, Bulgaria, Romania, and Croatia use the Euro as their common currency.

The 18 countries that use the common currency by organising the European Monetary Union (EMU) and share the single monetary policy required by the European Central Bank (ECB). The EMU is the world’s second-largest economy with a highly developed bond market, stock market and futures market. EMU is becoming the second most attractive investment market for investors both inside and outside the Euro area.

The Euro has taken its place, and more countries participate in the EMU. The importance of the euro as a reserve currency has increased at the same time, thereby increasing the inflow of capital into Europe. Euro’s demand is expected to continue to grow as foreign central banks are expected to increase their euro holdings to diversify their portfolio in the future.

EMU is a trade-driven and capital flow-driven economy. Therefore, trade is significant for each country within the EMU. Unlike most significant economies, EMU does not incur large-scale trade deficit surpluses. Yet, EMU also has considerable trade volume with other countries, so it has great power in international trade. The formation of the EU has also increased its influence in the international community. If individual countries are integrated into a single economic bloc, they can negotiate on an equal footing with the United States, the largest trading partner.

The growing role of the EU in international trade has given significant meaning to the part of the euro as a reserve currency. To reduce exchange risk and transaction costs, countries should have a large amount of reserve currency. Traditionally, most international trade deals have used British pounds, Japanese yen, and U.S. dollars. Before introducing the euro, it was entirely unreasonable for European countries to hold the currencies of other European countries on a large scale. Hence, the bank had the reserve currency in dollars.

 

European Central Bank(ECB)

Determines Monetary Policy

 

ECB is the organisation responsible for determining the monetary policy of the EMU participating countries. The EMU’s executive committee form a policy with central bank governors from each country and implement policies. At bi-weekly meetings, the new monetary policy is usually decided by a majority vote, and if the polls are tied, the president will have the right to choose.

EMU’s primary goals are to stabilise prices and promote growth. Changes in monetary and fiscal policy are made to achieve these goals. The EU enacted the Maastricht Treaty, which established several application criteria for individual countries to achieve that goal. Any country that deviates from these standards will be subject to hefty fines.

Based on these criteria, the ECB has strict membership management rights focused on inflation and deficits. The ECB typically strives to maintain the monthly consumer price index, harmonised Index of consumer prices(HICP),  at less than 2% per year and M3 (currency supply) at 4.5% per year.

 

 

EMU Convergence Criteria

 

The 1992 Treaty of Maastricht defined the following prerequisites for membership in the European Monetary Union (EMU).

1. Inflation should not exceed 1.5% of the average annual inflation before the evaluation date of the three countries with the best economic conditions in the region.

2. Long-term interest rates will not exceed the 12-month average of the three countries with the lowest inflation rate of any country in the region (10 years).

3. The exchange rate will remain within the range of exchange rate fluctuation (15% above and below the benchmark rate) of the ERM (EXCHANGE-RATE MECHANISM) for at least 2 years.

4. General government debt balances should remain within 60% of GDP. If higher than this, allow if it is decreasing sufficiently.

5. General financial deficits should remain within 3% of GDP. Allow temporary or slight excess.

ESCB, ECB and 28 member central banks are independent of governments and other EU agencies and have complete control over monetary policy. Members granted this operational independence under Article 108 of the Treaty of Maastricht. The main content of Article 108 states that members of a decision-making organisation cannot receive instructions from local, government, or any other organisation in the EU. 

 

 

Open Market Manipulation

 

The ECB is operating open markets in four categories to adjust interest rates, manage liquidity and suggest monetary policy stance:

1. Main Refinancing Operation(MRO) 

→ It is a two-week liquidity supply (loan) program implemented every week and is a refinancing transaction to the financial sector.

2. Longer-Term Refinancing Operation(LTRO)

→ Long-term refinancing is provided to the financial sector as a liquidity supply (loan) program with a maturity of more than three months, which is implemented once a month.

3. Fine-Tuning Operation

→ Policies implemented from time to time to manage liquidity in the market and adjust interest rates are implemented to control interest rate fluctuations arising from unforeseen changes in liquidity.

4. Structural Manipulation

→ This includes issuing debt instruments, redemption transactions, and outline transactions. Manipulation occurs when ECB wants to adjust the euro system’s structural position in the financial sector (regular or irregular).

 

ECB Minimum Bid Rate

 

The lowest bid rate for the European Central Bank is an important policy objective. It is directly related to a loan rate provided to the central bank of the various countries. The rate is adjusted every 2weeks, and ECB tends to keep interest rates to the targeted rate to prevent inflation.

The ECB is not reducing its exchange rate target, but it will consider the exchange rate in the policy deliberation process as it affects price stability. Consequently, the ECB implements foreign exchange market intervention in the event of inflation.

As a result, the policy committee members’ remarks draw attention to foreign exchange market participants and trigger euro volatility. The ECB publishes monthly data describing economic growth analysis and changes in perception of economic conditions, which need to be watched because it can detect the change in monetary policy stance.

 

 

Key Characteristics of the Euro

 

 

1. EUR/USD is the most volatile currency, and all major euro-cross currencies are also highly volatile.

 

The euro debuted on 1 January 1999 in the form of electronic currency. At that time, the euro replaced all pre-EMU currencies. As a result, EUR/USD is currently the most fluid currency pair globally, and the movement of EUR/USD is used as a primary measure of European and U.S. economic health. The euro is commonly known as the “anti-dollar” because it was the dollar’s fundamentals that influenced the EUR/USD currency pair movement between 2003 and 2008.

EUR/JPY and EUR/CHF are also highly volatile currencies and are commonly used to determine Japanese and Swiss economies’ health. EUR/USD and EUR/GBP are good pairs of currencies to trade because of their low spread, orderly movement, and infrequent gaps.

 

2. The euro has unique risks.

 

Introduced in 1999, the euro is still a new currency. The euro is not a problem for other currencies, but there are many risks to consider. In other words, 28 countries are exposed to economic, political and social situations. Although the number of countries using the euro is expected to increase, it will affect the stability of the entire eurozone if any country stops using the euro or begins to return to its currency because it does not think the ECB’s policy is in its best interest.

The euro is the only currency in the world that is not used on a national basis. Even if Germany, France, Italy and Spain are the largest and most economically dominant countries in the eurozone, the ECB has the authority and responsibility to determine monetary policy for all 28 member states. The 28 member states frequently verify, criticise and politically press the ECB’s actions. Before the subprime crisis, the ECB was just a new, untested central bank. However, the ECB has wholly changed its reputation for them by responding quickly to the credit crunch and providing ample liquidity.

 

3. The spread of interest rates between 10-year U.S. government bonds and 10-year German government bonds suggests a euro direction.

 

The 10-year government bond is used as an essential indicator of the future euro exchange rate. The difference in interest rates between the 10-year U.S. and 10-year German government bonds is a good sign for the euro. If German government bond interest rates are higher than those of U.S. government bonds, and the difference increases or the spread widens, this suggests a rise in the euro. If the difference in interest rates decreases or the spread narrows, the euro can be predicted to fall. The 10-year German government bond is usually used as the eurozone’s benchmark bond.

 

4. Forecasting the flow of funds in the euro area.

 

Another trading indicator is the Inter-European bank rate (three-month interest rate), a regular deposit rate between large banks. Traders tend to compare the eurodollar futures rate with the three-month interest rate to forecast the movement.

M&A also have significant implications for EUR/USD movements. M&A between EU and US multinational corporations has been increasing in recent years. The large transactions will have a significant short-term impact on EUR/USD.

 

 

An Important Economic Indicator of the Euro

 

The following are all important economic indicators for the euro. It is also essential to be aware of political and economic situations such as GDP, inflation, and unemployment. The leading economies of the European Monetary Union (EMU) are Germany, France and Italy. Therefore, we should note the economic indicators of the above three countries, along with the overall EMU economic indicators.

 

1. GDP

 

GDP is collected and published by Eurostat from many countries. It usually includes France, Germany, and the Netherlands (Italy only added to the final report). The annual total of EU-28 and EMU-18 is a simple sum of national GDP. It is more complicated to add up because some countries (Greece, Ireland, Luxembourg) do not create quarterly national data. Moreover, Portugal produces partial quarterly figures with significant time differences. Thus, quarterly figures across EU-28 and EMU-18 are estimates based on groups of countries that account for more than 95% of the total EU GDP.

 

2. German Industrial Production

 

Industrial production includes a breakdown of four segments (mining, manufacturing, energy and construction) reflecting seasonal factors. Manufacturing production consists of four main product groups: necessary production materials, capital goods, consumer goods and non-durable consumer goods.

Since Germany is the largest economy in the eurozone, industrial production in Germany is significant. However, markets sometimes react to French industrial production. Because industrial production has fewer data samples, modifications using all models are used as valid data. The Treasury often displays the expected direction of the changes in the initial data.

 

3. Harmonized Consumer price index (HICP)

 

The EU HICP, announced by Eurostat, was designed for national comparative analysis based on EU law. Eurostat has published the index since January 1995, and since January 1998, it has published the EMU-18 Regional Detail Index, called the MUICP. Price information provides Euro start with 100 indexes for each national statistical agency to survey and calculate their harmonised consumer price index.

Eurostat aggregates these sub-indexes into weighted averages and publishes each country’s harmonised consumer price index, which is then weighted by country and releases at the end of every month. It is around ten days after the announcement of the national CPI in Spain, France and EMU-5 countries.

Although the market already reflects prices when the harmonised consumer price index is released, it is worth noting that the ECB references the index. The ECB aims to maintain consumer price inflation in the euro area within 0% to 2%.

 

4. M3

 

M3 is a broad money supply indicator that includes both bonds and bank deposits. The ECB closely observes M3 inflation as its primary measure. In December 1998, the ECB’s Policy Committee set the M3 target at 4.5%, achieving the inflation target of 2%, the growth target of 2 to 2.5%, and the long-term monetary rate target of 0.5 to 1%. Growth rates are observed on a three-month moving average basis to avoid possible information distortions in monthly variability.

The ECB’s approach to monetary goals has room for manipulation and intervention. As the German central bank did, the ECB does not set the scope of M3, so there will be no action even if M3 is outside the set range. Furthermore, although the ECB considers M3 an important indicator, it will also refer to other changes in the direction of currency circulation.

 

5. German Unemployment Rate

 

The unemployment rate announced by the Federal Labor Office in Germany both seasonally adjusted (SA) and non-seasonally adjusted (NSA) figures, including information on the unemployed population. Unseasonably adjusted unemployment rates are announced along with vacancies, short-term shifts, and the number of employees.

Germany’s central bank announces seasonally adjusted unemployment within an hour of the Federal Labor Office announcement. A day before the announcement, official data is often leaked from the labour union, when the number of unseasonably adjusted unemployed is almost millions.

When sources in Reuters report the offensive numbers of unseasonably adjusted unemployment, the leaked figures usually reflect official statistics. Rumours are sometimes circulated a week before the official announcement, but they are wildly inaccurate. Furthermore, German statements have been misinterpreted through foreign media so far, so caution is needed in interpreting rumours.

 

6. Each Country’s Fiscal Deficit

 

The stability and growth pact sets the upper limit of the fiscal deficit below 3% GDP. Each country also has goals to reduce its fiscal deficit. Market participants keep an eye on whether they fall short of the target.

 

7. IFO Survey

 

Germany, which accounts for more than 30% of the eurozone’s GDP, is Europe’s largest economy. Thus, an understanding of the status of German companies is regarded as this issue for the whole of Europe. IFO investigates the German corporate environment and short-term planning for 7,000 German companies every month.

Traders need to pay attention to the difference between expectations and actual values of economic indicators. This is the most crucial part of interpreting news because it influences the foreign exchange market depending on market expectations and actual values.

This is called a market discount mechanism, showing the relationship between the forex market and the news are significant. If the information or economic indicators are closer to expectations, there is less impact on monetary movement. Therefore, short-term traders should look carefully at market expectations.

 

The Overview of US Dollar (USD)

 

The U.S. is the world’s leading and largest economy. Based on the purchasing power evaluation model, it is three times the production of Japan, five times the output of Germany, and seven times the production of Britain. The United States is a service-oriented country where real estate, transportation, finance, medical services, and business services account for about 80% of GDP.

Foreign investors have continued to increase their purchases of U.S. assets because the U.S. has the world’s most liquid stock and bond markets. According to the International Monetary Fund (IMF), the number of foreigners directly investing in the United States amounts to 40 per cent of the world’s funds flowing into the United States. The United States also absorbs 71 per cent of all overseas savings.

This means that if foreign investors withdraw their funds in the U.S. asset market, the asset value and the U.S. dollar will be significantly affected. More specifically, if foreign investors dispose of dollar-denominated assets to purchase other high-yield investments, this would result in a decline in the value of U.S. assets as well as U.S. dollars.

The size of U.S. imports and exports also exceeds that of other countries. This is due to the size of the United States itself, and the actual size of U.S. imports and exports is only 12% of GDP. Despite this massive trade activity, the United States recorded a current account deficit. This is a problem that the U.S. economy has been troubled with for more than a decade.

And over the last decade,  the U.S. has weakened its overseas funding capacity as foreign central banks have considered diversifying their reserve assets from the dollar to the euro, making the current account deficit a bigger problem. The U.S. dollar is susceptible to changes in capital flows due to its massive current account deficit.

The United States is also the largest trading partner in many countries, with U.S. trade accounting for 20 per cent of the world’s trade. The changes in dollar-value and volatility affect trade activities with U.S. trading partners. More specifically, a weak dollar will boost exports of U.S. products, but a strong dollar will reduce overseas demand for U.S. products.

 

FED Regulate Monetary Policy

 

The Federal Reserve is a U.S. monetary policy authority. The FED determines and implements monetary policy through the FOMC. The FOMC’s voting members are seven members of the FED and five of the 12 regional Federal Reserve governors. The FOMC holds regular meetings eight times a year, widely watched as it decides whether to adjust interest rates or presents economic growth forecasts.

The FED has an entirely independent monetary policy authority and less political influence. This is because most board members can serve a very long term (14 years), even if the ruling party of the president and Congress changes.

The FED will issue monetary policy reports for the first half of February and July, followed by Humphrey-Hawkins testimony. The Federal Reserve Chairman answers questions from Congress and the Banking Committee regarding the report. It is worth noting that the report includes the FOMC’s outlook on GDP, inflation and unemployment.

Unlike other central banks, the FED has the authority to achieve its long-term goal of price stability and sustainable economic growth. To achieve this goal, the FED must control inflation and unemployment and implement monetary policies for balanced growth. The most common means used by FEDs to control monetary policy are open market manipulation and federal funding rates.

 

 

1. Open Market Manipulation

 

Open market manipulation involves FED buying state bonds, including treasury bills, treasury notes, and treasury bonds. This is one of the most common means of FED to suggest and implement policy changes.

In general, if FED increases the purchase of state bonds, liquidity is supplied to the market, which lowers interest rates. When FED sells state bonds, it absorbs market liquidity and increases interest rates.

 

2. Federal Funding Goals

 

The federal funding target rate is a key policy objective of the Federal Reserve and refers to the interest rate that the FED applies to loans to member banks. FED drive growth and consumption by raising federal funds rates to lower inflation or lower federal funds rates. Changes in federal funding rates are closely observed in the marketplace, meaning significant policy changes, which have a broad impact on bond and stock markets worldwide. The market pays particular attention to the fed statement, as it provides clues to the future direction of monetary policy.

In terms of fiscal policy, the U.S. Treasury Department has the right to determine the federal funds rate. Determination of fiscal policy involves determining appropriate levels of tax and government expenditure. The market is paying more attention to the FED, but the real government agency that determines the dollar policy is the U.S. Treasury Department.

In other words, if the dollar is judged to be undervalued or overvalued in the foreign exchange market, the Treasury Department grants or directs the New York Federal Reserve to sell or buy U.S. dollars by allowing it to intervene in the foreign exchange market. Therefore, changes in the Treasury’s dollar policy and its policies are critical to the currency market.

 

Key Characteristics of the Dollar

 

1. More than 90% of all currency transactions are dollar related.

 

The most volatile currencies in the foreign exchange market are EUR/USD, USD/JPY, GBP/USD and USD/CHF. These currencies are the most actively traded globally and are related to the U.S. dollar. More than 90% of all currency transactions are related to the U.S. dollar, so the dollar is significant for foreign exchange traders. Therefore, the most important economic indicator that drives the market is the fundamentals of the United States.

Before the September 11 attacks, the dollar was the world’s best safe currency.

The U.S. dollar was considered the world’s highest safe currency because the U.S. stability was very high before September 11, 2001. The United States was known as one of the safest and most advanced markets in the world. The dollar’s status as a safe asset allowed the United States to attract investment at a low rate of return, and 76% of the world’s monetary reserves were dollar-denominated assets.

Another reason for holding monetary reserves in U.S. dollars is that the dollar is the world’s key currency. The dollar’s position as a safe asset has played an essential role in choosing a reserve currency for foreign central banks. However, foreigners, including central banks, have had less U.S. assets since September 11, as uncertainties about the U.S. increased and interest rates have fallen.

The emergence of the euro also threatened the dollar’s status as the world’s top reserve currency. Many of the world’s central banks have already begun to diversify their reserve currencies by reducing their dollar reserves and increasing their euro reserves. This trend is an essential thing for all traders to watch in the future.

 

2. The U.S. dollar moves in the opposite direction to the price of gold.

 

Historically, the gold prices and the U.S. dollar shows conflicting mirror images. This means that the dollar falls when gold prices rise and vice versa. This inverse correlation stems from the fact that the value of gold is measured in dollars.

Gold has long been recognized as the ultimate form of currency, so the depreciation of the dollar due to global uncertainty has been the main reason for the rise in gold prices. Also, because gold is considered the best safe asset, investors will flock to gold if it highlighted geopolitical uncertainty. This inherently undermines the value of the dollar.

 

3. Many emerging countries link their currency values to the dollar.

 

Interlocking the dollar has to do with the basic idea that the government will agree to keep the U.S. dollar as a reserve currency by buying or selling its currency at a fixed exchange rate for the reserve currency. These governments should promise to have at least the same amount of national currency and reserve currency in general circulation.

Therefore, these central banks, which have held large amounts of U.S. dollars and are actively interested in managing fixed or variable exchange rates, are critical. Currently, Hong Kong has a fixed exchange rate system linked to the dollar, and China has also maintained a fixed exchange rate system linked to the dollar until July 2005.

China is a very active participant in the currency market. This is because China’s maximum daily fluctuation is controlled within a very narrow range based on the closing exchange rate of the U.S. dollar the previous day. If it goes beyond this within a day, the central bank will buy or sell dollars through foreign exchange market intervention.

Before July 21, 2005, China implemented a peg system that fixed its exchange rate at 8.3 yuan to the dollar. Under pressure to appreciate the currency for many years, China adjusted its currency rate to 8.11 yuan and adjusted it to the closing price of the currency every day. Since then, China has shifted to a management-varying exchange rate system based on the currency basket exchange rate.

Over the past one or two years, the market has noted the asset acquisition patterns of these central banks. The need for U.S. dollars and dollar-denominated assets is gradually decreasing for central banks as the diversification of the reserve currency, and the flexibility of the exchange rate system in Asian countries progresses. If this is true, it could be a very negative factor for the U.S. dollar in the long run.

 

4. Interest rate differences between U.S. government bonds and overseas bonds are strongly followed.

 

The difference in interest rates between U.S. government bonds and overseas bonds is an essential relationship that professional FX traders follow. This could be a strong indicator of potential currency movements, as the U.S. bond market is one of the world’s largest bond markets, and investors are very sensitive to the return of unsold assets.

Large investors are always looking for assets that offer high returns. Investors will sell U.S. assets and buy overseas assets if the yield on U.S. bonds decreases or increases foreign bonds. Selling U.S. bonds or stocks will affect the currency market, as it involves selling U.S. dollars and buying foreign currencies. If the yield on U.S. bonds increases or the yield on overseas bonds decreases, investors will eventually buy U.S. assets, resulting in a strong U.S. dollar.

 

5. Keep an eye on the dollar index.

 

Market participants closely observe the US DOLLAR INDEX (USDX) to measure overall dollar strength or weakness. USDX is a futures contract traded on the New York Exchange, which is determined by the weight of trade volume in six major countries worldwide.

It is essential to share the index because market participants refer to the general index when discussing a general weakening of the dollar or a fall in the trade-weighted dollar. Besides, even if the dollar fluctuates significantly against individual currencies, USDX may not move significantly because it is based on trade weights.

The index is important because some central banks focus on the trade price index rather than the individual currency pair movement against the dollar.

 

6. The U.S. Dollar is affected by the stock market and bond market

 

There is a strong correlation between a country’s stock and bond markets and its currency. In general, a rise in the stock market will bring in foreign funds to gain investment opportunities. If the stock market falls, local investors will sell local stocks to seize overseas investment opportunities.

For the bond market, a more robust economy would prompt the inflow of foreign capital. Changes in exchange rates and developments in these markets result in changes in foreign portfolio investment, requiring foreign exchange transactions.

M&As between countries are also an essential part of FX traders’ watch. Large-scale M&A involving significant cash transactions have a substantial impact on the currency market. Because the buyer must buy or sell dollars to secure cross-border mergers and acquisitions funds.

 

Important U.S. Economic Indicators

 

The following economic indicators are all critical indicators for the U.S. dollar. Since the U.S. economy is a service-oriented country,  the service sector’s indicators should be taken into account.

 

1. Employment-Non-Farm

 

U.S. employment indicators are the most important and highly watched economic indicators. This is due to the Federal Reserve’s political influence under intense pressure to control unemployment. As a result, interest rate policies are directly affected by employment conditions.

It includes two surveys: a monthly reporting business survey and a household survey. Business survey results in non-agricultural employment, average weekly working hours per hour, total working hours index, and household survey results in information about the working population, household employment, and unemployment rate.

Forex traders watch for significant changes in the monthly unemployment rate and the number of non-agricultural workers who have undergone a seasonally adjusted period.

 

2. Consumer Price Index

 

The Consumer Price Index (CPI) is a crucial measure of inflation and the price of a basket of consumer goods. Economists focus more on source inflation, except for CPI-Utility or highly volatile foodstuffs and energy items. The consumer price index is observed with interest in the foreign exchange market because it can lead to various economic and social changes.

 

3. Producer Price Index

 

The PPI is an index that measures the average change in sales prices released by domestic producers. The PPI tracks price changes in almost all production industries in the country like agriculture, electricity, natural gas, forestry, fishing, manufacturing, and mining. The foreign exchange market traders should watch how the PPI index reacts monthly, quarterly, and annually along with the seasonally adjusted PPI.

 

4. Gross Domestic Product

 

Gross domestic product (GDP) is a measure of the total amount of goods and services produced and consumed in the United States. The Bureau of Economic Analysis (BEA) comprises two complementary components: income-based data and expenditure-based data.

The reserve of GDP released a month after the end of each minute is the most important indicator that includes estimates of inventories and trade balances that have not yet been disclosed. Other announcements of GDP are not necessary unless they are significantly revised.

 

5. Trade Balance

 

The balance of trade represents the difference between imports and exports of goods and services. It provides detailed information on trade with all countries and individual goods and trade with specific countries and regions. Traders judge the monthly benchmark figure to be low in reliability and focus on the three-month seasonally adjusted trade balance.

 

6. Employment Cost Index

 

The ECI is a measure of employees’ remuneration at the end of each quarter’s third monthly pay cycle. The survey measures the probability of approximately 3,600 private company employees and 700 state and local governments, public schools, and public hospitals.

A significant advantage of the Employment Cost Index is that it includes non-wage expenses that account for more than 30% of the total employment cost. It is necessary to pay close attention because it is an indicator that the Fed is watching.

 

7. Institute for Supply Management

 

The ISM publishes monthly composite indices calculated by surveys from 20 industries and 300 manufacturers nationwide. An index greater than 50 indicates an expansion of the competition or a contraction for less than 50. It is widely seen as one indicator that Alan Greenspan, former chairman of the Fed, watched very closely.

 

8. Industrial Production Index

 

The Industrial Production Index is an index that measures the performance of U.S. manufacturing, mining, and utility production. It is possible to identify production activities for each industry and item. The foreign exchange market mainly focuses on the total number of seasonal changes. An increase in the index usually causes a strong dollar.

 

9. Consumer Confidence Index

 

The Consumer Confidence Index is calculated based on consumers’ individual economic perceptions. The survey is based on a sample of 5,000 households nationwide, usually calculated with 3,500 responses. It’s a total of five questions.

– Local business conditions.

– Regional Economic Outlook in 6 Months.

– Employment situation in the region.

– Prospects for employment in 6 months.

– Forecast of household income in 6 months.

The survey responses shall be individually indexed after seasonal adjustment and then made into a composite index. Market participants perceive the rise in the consumer confidence index as a signal of increased consumer spending. Increasing consumer spending is often seen as a catalyst for accelerating inflation.

 

10. Retail Sales

 

The Retail Sales Index measures monthly gross sales by selecting a retailer sample. It represents a measure of consumer spending and consumer confidence. The index excluding car sales is the most important because of the large monthly fluctuations in automobile sales. Retail sales are very volatile due to seasonal factors, but they are an essential indicator of economic status.

 

11. Treasury Department International Capital Outflow Data (TIC Data)

 

The TIC data is a monthly measure of the total amount of capital inflows into the United States. The data has grown in importance over the years as the U.S. trade/financial deficit has deepened.

It becomes a more significant issue as a way to resolve the U.S. trade deficit, and the market pays attention to the capital flow of the public sector, which represents the demand for U.S. bonds by foreign central banks.

As the Forex market opens 24hours a day, it is not easy for traders to participate in all of the time zones and respond immediately every time. Therefore, timing is the most essential thing in foreign exchange trading.

To develop the most effective and time-efficient trading strategy, it is crucial to know how active market movements depending on the time zones. Only then you get as many trading opportunities as possible in the time zone you participate in.

In addition to liquidity, the extent of fluctuations in currency pairs also depends mainly on each country’s geopolitical locations and macroeconomic conditions. Thus, by finding out when the currency pair moves the most and when the least, the trader can increase his or her investment efficiency through efficient asset allocation. Let get started!

 

Asian Market (Tokyo FX Market)

 

19:00 – 04:00 (Eastern Time)

 

In Asian markets, foreign exchange trading is mainly carried out in certain financial centres. The Tokyo foreign exchange market, which accounts for a larger portion of the Asian time zone, is followed by Hong Kong and Singapore. Japan’s central bank’s influence in the foreign exchange market is gradually weakening, but the Tokyo foreign exchange market is still one of Asia’s most important foreign exchange markets.

Since this is the first major market opening among Asian markets, many investors use the Tokyo market as a trading momentum and a benchmark for measuring market dynamics in order to establish trading strategies. Sometimes trading in the Tokyo foreign exchange market is inactive. Still, large investment banks and hedge funds are known to operate important stop orders or options in the Asian market.

For risk-taking traders, USD/JPY, GBP/CHF and GBP/JPY are good choices. These currency pairs usually offer attractive opportunities of 90 per cent on average to traders who trade during short periods of time because of their large fluctuations. Foreign investment banks and institutional investors, mostly holding dollar-denominated assets, generate large amounts of transactions when they participate in the Japanese stock market or bond market. Japan’s central bank, which holds about $800 billion in U.S. bonds, exerts great influence in the foreign exchange market, affecting the demand and supply of USD/JPY by manipulating the open market.

Finally, large Japanese exporters are also known to send their overseas earnings to their home countries during the Tokyo foreign exchange market, which increases the exchange rate fluctuation. Meanwhile, GBP/CHF and GBP/JPY show high volatility in Asian markets for central banks and large investors to adjust their positions in preparation for European market opening.

Traders who do not prefer risk, AUD/JPY, GBP/USD, and USD/CHF are good choices. Usually, these calls are because mid-to-long-term traders may take into account the fundamentals of decision-making. Traders can protect their investment strategies from abnormal market movements due to speculative day traders by choosing currencies with low fluctuations.

 

US market (New York FX market)

 

8:00 to 17:00 (Eastern Time)

 

The New York market is the second largest in the foreign exchange market and it serves as the last market of the day. Forex trading activities are minimized during the afternoon market until the start of the Tokyo forex market the next day. Many of the time zones in which the US market opens are still in the European market, so they overlap, indicating very high liquidity.

If you prefer risk, we recommend trading GBP/USD, USD/CHF, GBP/JPY, GBP/CHF. This is because the average range of variation during the day is about 120 pips. The above-mentioned currencies are particularly active during this time because they directly include the dollar.

To be more specific, as the U.S. forex market opens during the U.S. foreign exchange market’s opening hours, foreign investors convert their currencies (such as the Yen, Euro, and Swiss Franc) into dollar-denominated assets in the U.S. market for stock and bond investments. Also, this time zone is the time zone where GBP/JPY and GBP/CHF show the largest daily fluctuations as the European and U.S. markets overlap.

In the foreign exchange market, the exchange rate for most currencies is denominated in dollars because the currency pair must exchange it for dollars before it changes to another currency. For example, GBP/JPY does not change directly from Yen to Pound but is eventually converted to Yen once converted to Dollar.

Thus, trading GBP/JPY also depends on the two aforementioned currency pairs’ correlation, including two different currency pairs: GBP/USD and USD/JPY. GBP/USD and USD/JPY are negatively correlated because they move in opposite directions, amplifying volatility.

The movement of USD/CHF can also explain similar methods, but the intensity of volatility is greater. Although currency trading with high volatility may be attractive somehow, we should remember that the inherent risks are also greater. Traders always have to continuously modify their strategies to suit market conditions, as sudden changes in exchange rates can disrupt orders or invalidate their long-term strategies.

Traders who do not prefer risk are usually recommended to choose USD/JPY, EUR/USD, and USD/CAD because the above currency pairs show moderate fluctuations to allow traders to take small risks and earn attractive returns. These currency pairs are rich in liquidity, allowing investors to quickly and efficiently realize losses or profits. These currencies are also not very volatile, which is advantageous for traders using long-term strategies.

 

European market (London FX market)

 

2 pm to noon (Eastern Time)

 

London’s foreign exchange market is the largest and most important market in the world. According to a BIS survey, it accounts for more than 30 per cent of the world’s trading volume. Dealing desks for large banks are usually located in London, and the major currency transactions are operating in London due to their high liquidity and efficiency. London’s foreign exchange market is the most volatile compare to other markets due to the larger number of market participants and huge trading volume.

GBP/JPY and GBP/CHF are suitable for risk-loving traders. The pairs represent an average daily variation of more than 140pips which can generate large profits in a short period of time. These two currency pairs have a large fluctuation because large participants increase trading volume in the European market.

The European market directly connects the U.S. market to the Asian market. Large banks and institutional investors will complete rebalancing of their portfolios at this time and begin to convert their European currency assets into U.S. dollar-denominated assets in preparation for an opening in the U.S. market. These currency pairs show extreme volatility in the European market from the large market participants.

Investors who can tolerate more risks have a wide range of choices. EUR/USD, USD/CAD, GBP/USD and USD/CHF (which have an average of 100 pips of volatility) are good currency pairs to choose from because of their high volatility and many opportunities to enter the market. 

Investors who do not prefer risk may choose NZD/USD, AUD/USD, EUR/CHF, and AUD/JPY with an average variation of around 50 pips. These currency pairs tend to move according to fundamentals and are less likely to lose money due to speculative daily traders.

 

Overlapping Time Zone,

US and European Markets.

 

8 o’clock to noon (Eastern US time)

 

The foreign exchange market tends to move most actively during times when the U.S. and European markets overlap. The volatility between 10 p.m. and 2 a.m. takes about 70% of the average fluctuation of the exchange rate traded in the European market and 80% of the average fluctuation in the U.S. If traders can’t trade all they long, but expecting price fluctuations and volatility to be high, this is the most appropriate trading time when the time zones of the U.S. and Europe overlap.

 

Overlapping Time Zone,

European and Asian Markets.

 

2 to 4 o’clock (Eastern Time)

 

Since the time zone where Asia and Europe overlap is the morning time in Europe, there are not many transactions, so the volume of trading is minimal compared to other times. Also, the actual overlapping time is short. Because trading volume is not high during this time, risk-loving traders may spend time waiting for breakthroughs in the European market, taking a nap until the U.S. market opens, or formulating position strategies (a type of trading strategy that makes a profit from long-term buying or selling).

Technical analysis and fundamental analysis are mainly used methods to analyze financial markets. The fundamental analysis predicts future price movements based on fundamental economic conditions, but technical analysis uses past price data and chart.

Controversy has continued over which methodologies are more successful since technological analysis began to be used. Traders who focus on short-term trading prefer to use technical analysis because the main strategy focuses on prices. Traders who focus on medium-term tradings, on the other hand, tend to use fundamental analysis to evaluate the future value of any currency as well as its appropriate value.

Before implementing successful trading strategies, it is important to understand what causes currency movements in the foreign exchange market. The best strategies may be a mixture of fundamental and technical analysis. This situation occurs in both technical patterns and fundamentals.

There can be drastic changes in price movements, especially with economic news releases. Therefore, technical traders should be aware of important economic indicators and situations in which the announcement is scheduled, and fundamentals traders should be aware of the critical technical levels that the market is largely focused on.

 

Using Fundamentals Analysis

 

Fundamental analysis focuses on analyzing economic, social and political influences that drive demand and supply. Using fundamental analysis as a trading tool implies to take account of various macroeconomic indicators such as growth rates, interest rates, infrastructure, and unemployment. Fundamental analysts will combine all of this information to evaluate current and future price movement sand combining all the information requires a lot of work and analysis.

Traders using fundamental analysis should be constantly aware of news and announcements that could lead to potential economic, social, and political changes. All traders must be thoroughly familiar with the overall economic conditions before trading, which is particularly important for traders making trading decisions based on news events. Although the Federal Reserve’s monetary policy decisions are always important, the impact on EUR/USD may not be significant if the movement of interest rates is already fully reflected in the market.

The exchange rate is basically driven by supply and demand. In other words, most fundamentally strong currencies are due to demands. Regardless of whether demand is for hedging, speculation, or currency conversion, the exchange rate’s actual movement is based on the currency’s need. When the supply exceeds, the value of the currency decreases. Supply and demand are the real determinants in predicting future price movements.

However, predicting supply and demand is not as simple as many people think. Many factors affect the net demand and supply of a currency, such as capital flows, trade flows, speculations, and hedgings. For example, from 1999 to 2001, the Internet and stock market boom in the United States led to foreign investors’ inflow, and the U.S. dollar strengthened against the euro. Depending on the demand for U.S. assets, foreign investors would sell their currencies and buy U.S. dollars.

When geopolitical uncertainties rose since late 2001, the U.S. began to cut interest rates, and foreign investors sold U.S. assets to move toward higher yields. As a result, the dollar’s supply increased, while the dollar’s value fell compared to other major currencies.

The intention to buy a currency or the possibility of funding for that currency is a major factor that could affect the direction of that currency’s value. These were the main determinants of the U.S. dollar value between 2002 and 2005. The capital outflow trend announced by the U.S. Treasury Department is one of the most important economic indicators for market forecasts.

 

The Factors to Consider!

 

1. The Flow of Capital and Trade

 

Capital and trade flows form the balance of payments, which allows entities to measure the size of demand for a currency over a period of time. Theoretically, the international balance of payments must be zero for a currency’s current value to remain the same. A negative balance of payments indicates that capital outflows from a country’s economy are faster than inflows, so its currency value should theoretically fall.

This is especially important in the current situation where the U.S. continues to record a huge trade deficit without sufficient foreign capital inflow to bridge the trade deficit. The Japanese yen could be another good example.

Japan is one of the largest exporters in the world that has a huge trade surplus. As a result, despite the zero interest rate policy, which hinders the increase in capital inflows, the yen tends to remain strong on the other side due to the trade surplus.

Capital Flows measure the net size of the currency purchased or sold on an equity investment. Capital account surplus means that foreign capital inflows of real investment or portfolio investment in a country exceed outflows. The capital account deficit indicates that real investment or portfolio investment into overseas assets by domestic investors outweighs capital inflows by foreign investors.

The Flow of Real Investment is a corporate investment in real estate and manufacturing. It also includes foreign direct investments, such as local business acquisitions. These factors are causing foreign companies to sell their own currencies and buy foreign currencies, resulting in changes in the foreign exchange market.

This is particularly important in global acquisitions because it has more cash flow than stocks. The real investment flow represents a fundamental change in actual direct investment activities. And direct flows can change each country’s financial health and growth potential.

Changes in local laws to attract foreign investment can also accelerate the flow of real investment. For example, China’s entry into the World Trade Organization eased laws on foreign investment. Global companies are flooding into China,  seeing China’s cheap labour and attractive investment revenue opportunities. From the foreign exchange market perspective, it is recommended that foreign companies sell their currencies and buy Chinese yuan to raise funds for Chinese investment.

 

2. A Comparative Measure of Exports and Imports

 

Trade flows are the base of all international trade. A country’s investment environment is the main determinant of its currency value, and its net trade balance is calculated according to its trade flow. Net exporters whose exports exceed imports will have a net trade surplus.

The currency value of net exporters is likely to rise because the demand for their currencies is higher than the demand for selling in terms of international trade. Overseas customers interested in purchasing exported products and services must first purchase the currency, which increases the demand for the exporting country’s currency.

Countries with imports exceeding exports will show a trade deficit, which serves as a potential factor in lowering the currency’s value. For import purposes, the importing countries must sell their own currencies to buy the countries’ currencies that sell goods or services. For this reason, if the size of imports increases, this can serve as a factor that leads to a fall in the value of the currency.

 

3. The Stock market

 

With the development of technology, capital movement has become very easy, making it possible to invest in stock markets worldwide.

Therefore, the stock market, which is strong anywhere globally, offers ideal investment opportunities for everyone regardless of their geographical location. As a result, a country’s stock market and its currency have a strong correlation. If the stock market rises, investment funds will flow in. On the contrary, a fall in the stock market would allow local investors to seek overseas investment opportunities by disposing of their domestic investments.

However, this correlation has changed since the Tech Bubble burst in the United States. The reason is that the correlation between the U.S. stock market and the U.S. dollar has decreased as foreign investors continue to be relatively hedging. Nevertheless, because these correlations still exist, all traders continue to monitor the global market’s performance and find cross-market revenue opportunities.

 

4. The Bond Market

 

Just as the stock market correlates with the foreign exchange market, the bond market also correlates with the foreign exchange market. In times of high uncertainty worldwide, the bond investment can be beautiful due to bonds’ inherent safety. As a result, foreign investment will be made into a country with attractive bond investment opportunities, leading to its currency appreciation.

A valid way for recognizing capital flows to the bond market is the short-term/medium-term return on government bonds. It may need to keep an eye on the spread difference between the yield on U.S. 10-year government bonds and foreign bonds yield. This is because international investors tend to invest their capital in assets in countries with the highest return. If U.S. assets were one of the highest-yielding assets, more investment would occur in U.S. financial instruments, which would soon result in a rise in the U.S. dollar. Investors may also use short-term returns, such as a two-year national spread, to measure the short-term flow of international capital.

In addition to the yield on long-term government bonds, short-term government bond futures prices can also be used to predict the movement of U.S. funds. This is because short-term government bond futures reflect expectations for the Fed’s interest rate policy in the future. Meanwhile, the Euro Interbank Offered Rate (EURIBOR) interest rate futures indicate future policy movements as well.

 

5. PPP, Purchasing Power Parity

 

Relative prices determine the exchange rate by constructing a similar basket of goods between the two countries. On the very basis of this idea, the theory of purchasing power assessment is established. Changes in the country’s inflation rate should be balanced by the opposite change in the country’s exchange rate. Therefore, according to this theory, if a country’s prices rise due to inflation, its exchange rate must fall.

The basket of goods and services priced for purchasing power assessment is a sample of all goods and services included in gross domestic product. These goods and services include consumer goods and consumer services, government services, facilities and construction projects.

To take a closer look, consumer goods include food, beverages, tobacco, clothes, shoes, monthly rent, water supply, gas, electricity, medicine and services, furniture, home appliances, personal transportation equipment, fuel, transportation services, entertainment and cultural services, telephone services, home appliances and repair services.

One of the most famous examples of PPP is the Economist’s Big Mac Index. The Big Mac PPP is an exchange rate calculated by assuming that the Big Mac hamburger’s price in the United States is the same as that of other countries. The comparison between the PPI exchange rate and other countries’ actual exchange rate indicates whether the country’s currency value is undervalued or highly valued.

The OECD releases a more formal index. The OECD issues a table showing the price levels of major developed countries. Each column represents the number of monetary units required by each country on the list specified to purchase the same representative consumer goods and service basket. The cost of purchasing 100 units of each representative bundle in a country is stated in that country’s currency.

It publishes a chart that compares a country’s PPP with its actual exchange rate on a weekly bases to reflect the current exchange rate. Also, it reveals predictions in PPP approximately twice a year. Although PPP forecasts come from studies conducted by the OECD, they should not be considered conclusive. Due to differences in different computational methods, the PPP exchange rate will be different among various entities.

 

6. Interest Rate Evaluation

 

The theory of interest rate evaluation says that if there is a difference in interest rates between the two countries, the difference is reflected in premium or discount on the leading exchange rate to prevent risk-free trade.

For example, if U.S. interest rates are 3 per cent and Japanese interest rates are 1 per cent, the U.S. dollar should fall 2 per cent against the Japanese yen in calculating the forward exchange rate to prevent risk-free trading.

This future exchange rate is reflected in the forward exchange rate calculated today. The forward exchange rate of the dollar is called the discount. This is because buying the yen at the leading U.S. dollar exchange rate can buy the Japanese yen less than buying it at the spot exchange rate. This state of the yen is called the premium.

The theory of interest rate evaluation has not been working well lately. This is because high-interest currencies have frequently risen due to the central bank’s decision to slow economic activity through interest rate hikes, regardless of risk-free profit-taking.

 

7. Real Interest Rate Difference Model

 

In the theory of real interest rate differences, the movement of exchange rates is determined by a country’s interest rate. The currencies of countries that maintain high-interest rates should remain strong, while those that maintain low-interest rates should remain weak.

If a country raises interest rates, foreign investors will be attracted to the currency in terms of return and buy the country’s currency. One of the key factors in determining the strength of the exchange rate’s response to changes in interest rates in the model is the expectation of the continuation of changes in interest rates. When the interest rate hikes, which is expected to last for the next five years, has a greater impact on the exchange rate than it is expected to last for a year.

There has been debate among international economists over whether there is a strong and statistically significant link between a country’s interest rate change and currency prices. The main weakness of this model is that it does not take into account a country’s current account and instead relies on capital flows through its capital account.

The interest rate model tends to overemphasize capital flows at the expense of numerous other factors such as political stability, inflation, and economic growth. Assuming that these factors are absent, the interest rate model can be very useful. This is because there is an extremely logical reason that investors will naturally be attracted to invest that pay higher rewards.

 

8. Currency Model

 

The Currency Model is the theory that the country’s monetary policy determines the exchange rate. According to the model, the currencies of countries that have been implementing stable monetary policies for a certain period of time are strong and the currencies of countries with inconsistent or excessive expansionist policies show a decline in value.

1. The volume of money in a country’s currency.

2. The nation’s future monetary volume.

3. The growth rate of the country’s monetary volume.

These factors are key to understanding currency trends that can change the exchange rate. For example, Japan’s economy has been in recession for the past decade. The interest rate level was almost zero, and the fiscal deficit prevented the government from increasing spending to get out of the recession. As a result, there was only one way that the Japanese government could revive Japan’s economy. It’s printing more money! By buying stocks and bonds, Japan’s central bank increased its currency volume, resulting in inflation that caused the exchange rate to change!

This is an example of implementing an excessive policy of increasing the money supply that the currency model can most successfully be applied. One of several ways a country can prevent a sharp decline in its currency value is by implementing a monetary tightening policy.

Another example is when the Hong Kong dollar was under attack by speculators during the Asian financial crisis. Hong Kong authorities have raised interest rates to 300 per cent to keep the U.S. dollar-linked. This method worked perfectly. Skyrocketing interest rates have allowed speculators to be kicked out. On the other hand, the downside was the risk that the Hong Kong economy could fall into a recession. Eventually, however, the U.S. dollar peg system was maintained, and the currency model worked.

 

9. Currency Substitution Model

 

The currency replacement model should be considered an extension of the currency model because it considers the investment flow of a country. It is assumed that the movement of the private and public sector portfolios from one country to another has a significant impact on the exchange rate. The act of individuals changing assets from their own and foreign currencies is called currency replacement.

Combining this model and currency model shows evidence that changes in expectations for a country’s currency volume can have a decisive impact on its exchange rate. Investors will be looking at the currency model data carefully and expect changes in the flow of funds, resulting in changes in the exchange rate, which results in investment execution, making the currency model predictable on its own. Investors who support this theory use a currency replacement model as a complement to the currency model.

 

Conclusion

 

The importance of economic indicators, for both fundamental and technical traders, should never be underestimated. There are many people who claim to be technical analysts, but in the foreign exchange market,  almost every pro-traders has included economic indicators as an important factor in their trading strategies.

For example, a good technical analyst who focuses only on range trading (a strategy to buy at a low price and sell at a high price) will probably choose to leave the market without trading on the day of the release of economic indicators that trigger a very large movement in the market, such as Nonfarm payrolls (NFP).

Traders who focus on technical breakouts (a strategy to trade on top or bottom breakthroughs) will, on the contrary, want to trade only on the day when important economic indicators that trigger price movements are released. For those who trade in automated systems, it is especially important to add a fundamental analysis.

This is because turning on or turning off their strategies based on the economic indicators to be released could potentially have a significant impact on the overall performance of their trading strategies. Fundamental traders tend to perform better when economic indicators are released. The economic indicators that have the greatest impact on the exchange rate are, of course, the U.S. economic indicators. Nearly 90% of all currency tradings are made in exchange for US dollars.

In other words, the U.S. dollar is the benchmark or relative currency for most transactions. However, not all economic indicators affect it. Some economic indicators are very important and may have a lasting effect on the exchange rate, while others may not be of general importance.

Before starting trading forex, every trader must understand some of the key events that happened in the past. These events are repeatedly mentioned by many professional foreign-exchange traders even today.

 

Bretton Woods

Dollar as the world’s key currency.

 

In July 1944, a new treaty was needed to control the international economy after World War II. Representatives from 44 countries gathered in Breton Woods, New Hampshire, the United States. Many agreed that instability in the global economy was one of the leading causes of the war and that the international community should prevent such instability in the future.

The treaty, drafted by renowned economists John Maynard Keynes and Harry Dexter White, was proposed to support Britain before and after the war as part of the United States’ Lend-Lease Act.

The Lend-Lease Act of the United States was enacted in March 1941 to provide supplies to the United Kingdom, the Soviet Union, France, and China, where the United States was allied. After several rounds of negotiations, the Bretton Woods Agreement was signed, with the following essential details:

1. To promote fair trade and harmonization of the international economy, an international organization shall be established.

2. Adopt a fixed exchange rate system between currencies.

3. Designate the U.S. dollar as the world’s key currency by allowing a convertible between gold and the U.S. dollar.

Only the first of the above three are valid to this day. Organisations formed as a direct result of Bretton Woods, including the International Monetary Fund, the World Bank, and the General Agreement on Tariffs and Trade (GATT), remain to this day to play an essential role in the development and regulation of the international economy. For example, with the Brenton Woods system’s implementation, the IMF fixed the gold at $35 per ounce and introduced a fixed exchange rate system based on a fixed exchange rate system between each currency.

Even after the Bretton Woods system’s end, the IMF worked closely with the World Bank (established under the Bretton Woods system). These two organisations regularly contribute funds to developing countries, helping developing countries develop their public infrastructure. They are now operating to support a sound commercial economy that can contribute to the international stage. The World Bank and the IMF are also working closely with GATT to ensure these developing countries’ opportunities to trade equally and fairly with their industrialised counterparts.

GATT was initially established as a temporary organisation but is now operating to encourage the dismantling of trade barriers such as tariffs and quotas. The Bretton Woods Agreement took effect from 1944 to 1971, but to secure the Bretton Woods system’s flaws, President Nixon proposed the Smithsonian Agreement.

However, the Smithsonian Agreement had the same critical weakness as the Bretton Woods Agreement. It had maintained a fixed exchange rate system without acknowledging the gold against the U.S. dollar. This fixed exchange rate system failed to accommodate international demands for a sustained U.S. trade deficit and a weak dollar. As a result, the Smithsonian Agreement did not last long.

Ultimately, the exchange rate system evolved into a free-floating exchange rate market where demand and supply determined its value. However, this has led to several currency crises and increased volatility between currencies. As a result, the market is automatically controlled, and the appropriate value of the currency is formed in the market without any special restrictions.

The Bretton Woods has significantly contributed to changing the U.S. dollar’s perceptions on the international economical stage. While the British Pound is still showing considerable strength and the Euro is under the new spotlight for international trade as an innovative currency, the dollar has been chosen as the world’s key currency for the time being. This can be attributed mainly to the Brenton Woods Agreement, which guaranteed its credibility and accessibility based on the dollar to gold transition system. The Bretton Woods system is a policy of the past, but the impact on the U.S. dollar and the international economy remains significant to this day.

 

 

 

The End of Bretton Woods

The Birth of Free Market Capitalism

 

 

On August 15, 1971, the Brenton Woods system officially ceased to fix the currency’s value to gold prices. A new form of system emerged for a while before the Brenton Woods system disappeared, but the Brenton Woods system officially came to an end. The value of currencies is fixed at the price of gold, and the structure of a limited exchange rate fluctuation in the range of only one per cent disappears. Instead, the fair value of currency1 is determined by free-market economic behaviour such as trade and direct foreign investment.

U.S. President Nixon was confident that the end of the Bretton Woods system would bring a better new era for the international economy. However, he was not a free market believer who believed that the market could value the currency legally and freely. Like most economists, President Nixon also determined that a completely unorganised foreign exchange market would lead to a competitive devaluation, an obstacle to international trade and investment. The outcome predicted by President Nixon and his economic advisory committee was a global economic slowdown.

A few months later, the committee signed the Smithsonian Agreement. The Smithsonian Convention, praised by President Nixon as the “Greatest monetary agreement in the world’s history”, sought to maintain a fixed exchange rate system without gold. The Bretton Woods system’s key difference is that the dollar’s value can fluctuate within the range of 2.25% (which allows only within 1% of the Brenton Woods system).

Eventually, the Smithsonian Agreement turned out to be an intricate system to implement. Gold prices surged to $215 an ounce in the free market, as the exchange rate did not fix gold prices. Moreover, the U.S. trade deficit continued to grow, and from a fundamentals perspective, the U.S. dollar needed to depreciate its currency beyond the 2.25% limit set out in the Smithsonian. Due to the exposure of these problems, the foreign exchange market was forcibly closed in February 1972.

The foreign exchange market reopened in March 1973, and the Smithsonian Agreement was no longer valid. Since then, the U.S. dollar has not been fixed by any commodity and changes in the exchange rate are not limited to a specific limit, so the U.S. dollar exchange rate has been determined entirely in the market. This naturally provided the U.S. dollar and other currencies with the agility to adapt to a new and rapidly evolving international trade environment. However, it also served as a springboard for unprecedented infrastructure. Crude oil prices soared as conflicts grew in the Middle East. The Brenton Woods and Smithsonian Agreement created stagflation represented by unemployment and inflation in the United States.

The stagflation lasted until the early 1980s, when Federal Reserve Governor Paul Volker initiated new economic policies. President Ronald Reagan introduced a new financial plan to help the U.S. dollar return to an average value. Fortunately, the foreign exchange market has made significant progress and achieved various goals. As the U.S. eased regulations for free international trade, investors who wanted to participate in the market showing abundant liquidity and continuous growth flowed into the foreign exchange market. Consequently, the end of the Bretton Woods system in 1971 marked the beginning of a new economic era, represented by international tradings’ liberalisation and the surge in speculative capital influx.

 

 

Plaza Accord

Devaluation of the U.S. dollar (1985)

 

 

After the end of the 20th century, the currency market remained completely unregulated except for the ‘invisible hand’ that sought an economic balance by the demand and supply of free-market capitalism, unfortunately, due to unforeseen economic events (OPEC oil crisis, stagflation in the 1970s), supply and demand have become inefficient means to control the currency market on their own.

It has already been proven that pegging currency values to commodities such as gold, or setting maximum exchange rate fluctuations, is too inflexible to entice economic development. A balance between the system and strict rules has plagued the currency market for the 20th century, and the countries still needed a final solution while progress was being made.

Therefore, in 1985, finance ministers and central bank governors of the world’s largest economies (France, Germany, Japan, United Kingdom, and the United States) held a meeting in New York in the hope of reaching a diplomatic agreement to maximise the economic efficiency of the foreign exchange market.

In a rare meeting at the Plaza Hotel, international leaders reached an absolute consensus on a particular country and the entire global economy. Inflation was at a shallow level throughout the world. Stagflation in the 1970s was represented by high inflation and low growth, but in contrast, in 1985, the global economy showed low inflation and high growth, moving in a 180-degree turnaround.

Despite substantial economic growth, low inflation continued to lead to low-interest rates favouring developing countries, but risks of protectionist policies such as tariff barriers were becoming visible. Japan and Germany had substantial current account surpluses, while the U.S. had a growing current account deficit. Realistically, this fundamental imbalance could cause severe economic imbalances, leading to a distortion of the foreign exchange market and the international economy.

With the current account imbalance and the resulting protectionist policies emerging, countermeasures were required. Eventually, these led to the conviction that the value of the U.S. dollar was rising more than 80 per cent faster than significant trading partner currencies. As the value of the U.S. dollar rose, the U.S. showed a considerable trade deficit. On the contrary, the depreciation of the U.S. dollar automatically brought about a balance between exports and imports of all other countries, helping to stabilize the international economy more efficiently.

At the Plaza Hotel conference, the United States persuaded other participants to coordinate multilateral intervention, and the Plaza Accord was reached on September 22, 1985. The agreement was designed to allow the depreciation of the dollar and the appreciation of significant counter-currency.

Countries have agreed to intervene in the currency market to revise their economic policies and induce the dollar to depreciate. The U.S. agreed to reduce its budget deficit and cut interest rates, while France, Britain, Germany and Japan agreed to raise interest rates. Germany also agreed to implement the tax cut, while Japan decided that the yen’s value would fully reflect the Japanese economy’s fundamental strength.

But the real problem with the actual implementation of the Plaza Accords is that not all countries stuck to their promises. In particular, the U.S. did not fulfil its initial commitment to reduce the budget deficit. Japan has been hit hard by the yen’s rapid appreciation. Japanese exporters have lost competitiveness in overseas markets, which eventually led to a decade of economic stagnation in Japan. On the contrary, the United States achieved significant economic growth and price stability due to the Plaza Accord.

The multilateral intervention effect was immediate, and within two years, the dollar fell 46 per cent against the German DEM and 50 per cent against the Japanese YEN. As a result, the U.S. economy has become much more export-driven, while industrial countries such as Germany and Japan have become importing countries. This phenomenon gradually resolved the current account deficit problem, and the international community minimised protectionist policies to the extent that they did not pose a risk to the global economy.

But most importantly, the Plaza Accord has shown the significance of central banks’ role to control exchange rate movements. Since the exchange rate was not fixed, the exchange rate was primarily determined by supply and demand in the market. However, these invisible hands by demand and supply alone were insufficient. The central banks worldwide are responsible for intervening in the foreign exchange market on behalf of the international economy.

 

 

George Soros

The man who surrendered the Bank of England.

 

 

When George Soros won a $10 billion speculative bet against the British pound, he was known by everyone as the “Man who brought down the Bank of England.” Whether people like or dislike George Soros, he is involved in one of the most exciting events in the history of currency transactions.

 

1. Britain Applied Exchange Rate Adjustment Mechanism

 

In 1979, the European Monetary System was established, led by France and Germany, to stabilise exchange rates, curb inflation, and prepare for currency integration. One of the critical elements of the European monetary system, the exchange rate adjustment mechanism, established a benchmark exchange rate against the European monetary unit, a basket of currencies for participating countries.

The system kept the participating countries’ exchange rates within the range of 2.25% up and down each benchmark exchange rate. The ERM was a fixed, adjustable exchange rate system, and nine reporting of the benchmark exchange rate were made between 1979 and 1987. The UK was not the first to join the ERM in 1990, with a pound-to-German mark benchmark exchange rate of 2.95 and a +/- 6 per cent fluctuation.

Until mid-1992, the ERM appeared to be successful, with diminished inflation in Europe due to the German Central Bank’s leadership’s regulatory effect. However, the initial stability did not last long as international investors began to feel the value of some currencies in the ERM was inadequate.

When Germany was unified in 1989, government spending increased, and the central bank had to print more money. This boosted inflation and left the German central bank unable to do anything but raise interest rates. Germany’s interest rate hike has further affected ERM by putting upward pressure on the German mark’s value.

Consequently, to maintain a fixed exchange rate within the ERM, Irving Fisher’s interest rate equilibrium theory led other central banks to raise their interest rates. It was at this time that George Soros began to take action. Considering Britain’s weak economy and high unemployment, he judged that the British government would not maintain a fixed exchange rate policy.

 

2. Soros bet on Britain’s failure to join ERM.

 

Soros, a Quantum hedge fund manager, thought the UK had no choice but to devalue the pound or withdraw from ERM and determined to bet on the pound’s depreciation. During the ERM period, capital regulations were continuously removed, making it easier for international investors to recognise imbalances, and they were able to make these imbalances an opportunity.

Soros built a short position against the pound and an extended position against the mark by borrowing the pound and investing in the Mark-marked assets. Soros also utilised huge options and futures contracts. His positions totalled $10 billion. Soros was not alone, of course. Many investors soon followed him. Everyone sold the pound, which acted as a substantial downward pressure on the pound.

Initially, the Bank of England attempted to defend the fixed exchange rate by buying an enormous reserve asset of £15 billion. However, their involvement in the foreign exchange market was not enough. Market participants traded the pound very close to the bottom of the fixed exchange rate fluctuation range.

On September 16, 1992, the day it was later called Black Wednesday, the central bank announced a 2 per cent increase in interest rates (10 per cent to 12 per cent) to support the pound. A few hours later, he promised to raise interest rates by an additional 15 per cent. Still, Soros and other international investors remained unmoved when they learned that the opportunity to realise huge profits was close. Traders continued to sell the pound on a large scale, but the Bank of England continued to buy the pound.

At 7 p.m. on the same day, when Treasury Secretary Norman Lamont declared, “The U.K. is leaving the ERM.”, and interest rates returned to the first level of 10 per cent. Chaotic Black Wednesday was a prelude to the pound’s steep depreciation.

Whether the transition to a floating exchange rate was due to Soros’s attack on the pound, or just fundamentals, remains a subject of debate today. However, what is certain is that over the next five weeks, the pound has fallen about 15 per cent against the German mark and has lost 25 per cent against the dollar, giving Soros and other traders huge profits.

Within a month, Quantum Fund earned about $2 billion by selling more expensive German Marks and purchasing cheaper pounds. The case of “The man who brought the Bank of England to its knees” was a representative case of how vulnerable the central bank is too speculative attacks.

 

 

1997-1998 Asian Financial Crisis

 

1. The Emerging Economies

 

Asian Tiger economies collapsed on July 2, 1997. It is a perfect example of the global capital market’s interdependence and the subsequent impact on the currency market. Although several fundamental collapses triggered the crisis, the primary reason stemmed mainly from opaque lending practices, rising trade deficits and immature capital markets.

The combination of such factors made major regional markets incompetent, creating a catastrophic situation that brought highly valued currencies down to a significantly lower level. During this period, the crisis badly influenced the stock and the currency market.

 

2. Bubble

 

By 1997, the increment of asset prices increasingly attracted investors to the prospects of Asian investment focused on real estate development and the stock market. As a result, foreign investment capital has flowed into areas where economic growth is rising due to increased production, such as Malaysia, the Philippines, Indonesia, and Korea.

Thailand saw economic growth of 13% in 1988, which fell to 6.5% in 1996. Thailand implemented a fixed exchange rate system to peg the baht to a reliable U.S. dollar to provide additional loan support for a healthy economy. By pegging the exchange rate to the U.S. dollar, countries like Thailand sought financial stability in their markets and guaranteed a fixed exchange rate for export deals with the U.S. 

 

3. Expansion of Current Account Deficit and Loans

 

However, in early 1997, the sentiment for such fundamentals began to change. Each government found it increasingly difficult to handle the current account deficit, and its lending practices affected the economic structure negatively. In particular, economists were nervous that Thailand’s current account deficit increased to $14.7 billion in 1996.

Although it was relatively smaller than the U.S. current account deficit, Thailand’s deficit gap stood at 8 per cent of GDP. Opaque lending practices have also contributed significantly to this collapse. Senior bank officials and individually close borrowers were given preferential treatment for loans, which, surprisingly, became standard throughout the region. This practice has affected many large Korean companies that rely heavily on debt, with the total amount of bad loans soaring to 7.5 per cent of GDP.

Additional examples of this practice are seen in Japanese financial institutions. In 1994, Japanese authorities announced $136 billion in loans, but a year later revised $400 billion. In addition to the sluggish stock market, the decline of real estate values and the slowing economy allowed investors to expect the Japanese yen to fall, increasing selling pressure on neighbouring currencies.

When Japan’s asset bubble collapsed, asset prices fell the same value as two years’ worth of national production, and property prices accounted for nearly 65 per cent of the total decline.

The drop in asset prices sparked a banking crisis in Japan. The banking crisis began in the early 1990s and spread to the overall system crisis in 1997, leading to several high-profile financial institutions’ bankruptcy. In response, the Japanese currency authorities mentioned a potential increase in the benchmark interest rate to defend its currency value. Unfortunately, Japan\ did not implement these ideas at all, and only a few were empty.

The fall in the exchange rate was snowballing as the central bank’s reserves dried up. The currency’s value was challenging to maintain, considering the downward pressure by currency, based on the announcement of Thailand’s implementation of the floating exchange rate system.

 

4. A Currency Crisis

 

After large-scale short speculation and market intervention, the aforementioned Asian countries suffered disasters and fell into incompetence. Thailand’s baht, once recognised as an investment asset, fell 48 per cent in value. The most affected currency was Indonesia’s Rupia.

Rupia, which had usually been relatively stable with Thai baht before introducing the adjustment exchange rate system, suffered a whopping 28 per cent drop from 12,950 when it was pegged to the U.S. dollar. Among the major currencies, the Japanese yen fell about 23 per cent from a high to a low against the U.S. dollar during 1997 and 1998. The 1997-98 financial crisis shows the interconnection between countries and how it affects the global market. These are examples of how difficult it is for the central bank to successfully intervene when facing enormous market pressure without guaranteeing improvements in economic fundamentals.

Today, Asia’s four small dragons are wiggling thanks to IMF restructuring package support and better implementation of stricter requirements again. Setting inflation standards and rejuvenating export markets, Southeast Asia builds its previously major industrialised economies worldwide.

After experiencing depletion of foreign exchange reserves, the Asian Tigers focus on keeping enough foreign currency reserves to defend speculators’ to attack their currencies again.

 

 

Launch of the Euro (1999)

 

 

The launch of the euro was a monumental event as the most extensive currency conversion ever made. The euro was officially launched on 1 January 1999 as a currency traded only on computer books without any real issues. Belgium, Germany, Spain, France, Ireland, Italy, Luxembourg, the Netherlands, Austria, Portugal, and Finland were the first of the 11 members of the European Monetary Union. Greece became the first countries to use the euro two years later.

Countries pegged their currencies at a specific conversion rate to the euro and adopted a standard currency policy controlled by the European Central Bank. For many economists, the system was ideal for including all 15 European Union countries, but Britain, Sweden and Denmark decided to keep their currencies for the time being.

Euro notes and coins were not in circulation until the first two months of 2002. Officially, the euro notes and coins were introduced from 1 January 2002 to 28 February 2002, after a two-month exchange period, the EU thoroughly used the euro from 1 March 2002. On 1 January 2014, Latvia participated in the euro, expanding the number of countries currently using the euro as their official currency to 18 countries. All EU member states had to weigh the gains and losses in deciding whether to settle the euro.

For EMU citizens, travel convenience may be the most prominent problem, but the euro has also brought many other benefits.

1. The euro provided a more stable environment for trade in Europe by eliminating exchange rate fluctuations between countries in use.

2. Eliminating all exchange rate risk within the eurozone allows companies to plan investment decisions very accurately.

3. Transaction costs have been reduced. Transaction costs refer to the costs associated with foreign exchange management, hedge management, cross-border payments and the operation of multiple currency accounts.

4. Consumers and businesses can more easily compare prices of goods between countries, making them more transparent and competitive.

5. The huge single currency market has become more attractive to foreign investors.

6. The economy and stability of a huge scale boosted confidence, which allowed the European Central Bank to control prices at low-interest rates.

However, the euro also has its limitations. Even if putting political issues aside, the biggest problem is countries that adopt the euro cannot have any independent monetary policy. Because each country’s economy does not have a perfect correlation with the EMU’s, some countries may face a situation where the European Central Bank raises interest rates during the recession.

This happened in many small countries. As a result, governments try to rely more heavily on fiscal policy. Still, the effective fiscal policy’s effectiveness limited if it is not effectively combined with monetary policy. This inefficiency was exacerbated by the EMU’s regulations restrict the budget deficit to 3% of GDP as specified in its Stability and Growth Convention.

There are also some concerns about the validity of the European Central Bank. ECB set inflation target slightly below 2%, but from 2000 to 2002, eurozone’s inflation was slightly above the benchmark and exceeded the target level. By the end of 1999, due to the European Union’s lack of a new currency, the euro’s U.S. dollar exchange rate fell 24% in January 1999 from 1.15 to 0.88.

The Forex market is an over-the-counter(OTC) market without a centralised exchange. Competition among market makers prevents monopoly prices within the market. And they try to distort prices; traders have to find another one.

Market makers do not change trading costs (like ask/bid spreads) because the market participants closely watch them. In contrast, many stock markets operate in entirely different ways. For example, the New York Stock Exchange is the only place where you can trade stocks of companies listed on the exchange.

The centralised market is operating by people called specialists. Prices presented by sellers and buyers arrange as a single top-priority asking price through transactions, and the counterparty becomes an exchange. Since the New York Stock Exchange is a centralised market, stocks traded on the exchange always have only one buy/sell price (single call price).

In decentralised markets, such as foreign exchange markets, several market makers offer prices that can provide different prices. Let’s look at how centralised and decentralised markets work!

 

A Centralized Market

 

An essential feature of the centralised market is that it tends to be proprietary (a single price at every point in time). Since only one specialist controls the market, they can easily distort the offered price from the specialist’s perspective, not from the traders’ standpoint.

For example, suppose a market overflows with sellers, and there are no buyers on the other side. Then specialists will be forced to buy from sellers, and they will not be able to sell shares that are falling in price due to increased selling.

In this situation, specialists will expand the spread widely, increasing transaction costs, which will delay new participants’ entry into the market. Specialists will change the price they offer to protect themselves.

 

A Decentralized Market

 

The foreign exchange market is decentralised, so there are many market makers, not just one specialist. However, participants in the foreign exchange market are composed of several classes, among which those with excellent credit, high trading volume and expertise are given priority.

At the top of the structure is the Interbank market, which trades on the highest scale (mostly G7 currencies). The large banks in the interbank market can directly deal with each other through interbank brokerage firm like EBS and Reuters systems. The Interbank market is a type of credit approval system that relies on credit relationships established between banks and trading parties.

They can see the exchange rate trading record. However, to deal with each bank’s exchange rate, one must have a specific credit relationship with the other bank in advance. Other institutions, such as Online FX Brokers, Hedge Funds, and Corporations, have to trade FX through commercial banks.

However, many banks (small local banks or banks in emerging economies), corporations, and institutional investors cannot trade at these interbank exchange rates because they don’t have a credit relationship with big banks in advance. As a result, small participants have no choice but to make foreign exchange transactions through only one bank. It will inevitably be provided with an uncompetitive exchange rate and become a lower class of market structure. The least competitive exchange rate is the bank’s customers and currency traders.

Recently, due to the development of technology, barriers that existed between end-users of foreign exchange services and the interbank market have been broken down. The development of online trading has opened the door to foreign exchange transactions for retail customers. It has efficiently linked to market makers and market participants at low costs alone.

Essentially, the online trading platform serves as an entrance to the liquidity-rich foreign exchange market. Ordinary traders can now trade orders at prices similar to those of the largest banks in the world. In games controlled and dominated by giant hands, individuals can make profits and enjoy the same opportunities as large institutions.

 

Dealing Station – Interbank Market

 

The majority of FX transactions are mainly through the Interbank market. Large banks worldwide trade with each other through computer platforms such as EBS and Reuters Dealing 3000-Spot Matching. While significant currency pairs are available through these two platforms, specific currency pairs are traded more fluidly or more frequently.

The two companies are continuously competing to increase their market share and introduce the most flexible currency pair in each company.

 

Generally known heterogeneous currency pairs are not traded on either platform but are instead calculated based on the exchange rate of key currency pairs and offset using LEGS (the currency used to create the currency pair’s asking price).

For example, if a customer wants to buy AUD/JPY, the Interbank Trader will buy AUD/USD on REUTERS D3000 systems, and the EBS system will inform the USD/JPY exchange rate.

These heterogeneous currency pairs, known as synthetic currencies, generally explain why the spread of these currencies is broader than that of major currencies.

The foreign exchange market was not originally the most popular in the world. The reason for this is that the foreign exchange market is primarily accessible to hedge funds, CTA and institutions that operate large assets and have not been welcomed by individual traders due to technical requirements, asset conditions and regulations.

Recently, online brokers have opened the foreign exchange market by providing free charts, real-time news, terminals to personal traders and opportunities to make more profits by utilising leverage. As a result, the foreign exchange market has become more popular and has increased its appeal as an alternative investment asset.

Previously, many traders trading stocks or futures began to trade foreign currencies, and some are only trading currencies. This trend started because the foreign exchange has features that are more attractive than stock investments.

 

 

5 Reasons Why Foreign Exchange Is Attractive

 

1. Markets Open 24 Hours

 

The foreign exchange market is so popular that it is the ideal market for traders who trade frequently. Thanks to the Internet’s development, traders can trade around the clock and participate in the market throughout the day. This feature helps traders make decisions more flexible when making trading decisions.

Trading in the foreign exchange market begins at 5 p.m. on Sunday in Sydney, Australia (New York Time). The Tokyo market will then be held at 7 p.m. And at 9 p.m., the Singapore and Hongkong markets will be held, followed by Frankfurt at 2 a.m., and the London market at 3 a.m. European markets remain active until 4 a.m., but Asian markets are closing. The U.S. market opens around 8 a.m. in New York City on Monday, when the European market slowly slows down, and the Sydney market opens again at 5 p.m.

The most active time for trading is when each market overlaps. For example, from 2 a.m. to 4 a.m. Eastern time, when Asian and European markets overlap, and from 8 a.m. to 11 a.m., when European and U.S. markets overlap, from 5 p.m. to 9 p.m., when the U.S. and Asian markets overlap. In times of overlapping New York and London markets, all currency pairs are active, but in Asian markets, GBP/JPY and AUD/JPY are usually the most active.

 

2. Customized leverage

 

I know that high leverage carries high risks, but only a few traders can boldly resist the opportunity to trade with other people’s money because they are human beings! The foreign exchange market is a market that suits traders by providing them with the highest leverage. Most online brokerage firms offer 100x leverage for general-scale accounts and up to 200x leverage for small budgets.

This is compared to providing 100 times as much leverage to ordinary stock investors and 10 times as much leverage to professional stock traders. This is why many traders are turning to the foreign exchange market.

Leverage in the foreign exchange market requires a margin deposit. It is a different concept from the down payment paid for purchasing shares in the stock market. In the foreign exchange market, the margin can be a contract fulfilment deposit or consignment evidence to bear the loss caused by trading. Therefore, this feature of evidence in the foreign exchange market is handy for short-term day traders who need to increase their assets to earn faster returns.

Leverages can be adjusted to any size that customers want. Therefore, if you are a risk-driven investor who uses only 10-20 times leverage or does not want to use leverage, you can choose as much leverage as you want. However, leverage is a double-edged sword. Thus, trading using leverage too high without proper risk management can lead to large losses.

 

3. Able to make a profit in Bear Market.

 

Trading Forex enables a trader to make a profit in both bull and bear markets. Currency trading is always about buying one currency and selling the other, so there is no structural bias in the market. Consequently, potential returns exist equally in markets for upward and downward trends. This is the difference from the stock market. This is because most traders focus on buying instead of selling in the stock market.

 

4. This market fits well with technical analysts.

 

For technical analysts, currencies tend to develop into strong trends rather than staying within narrow trends for a long time. More than 80% of the trading volume is speculative, so the market frequently overheats.

Experience in technical analysis can be frequently applied in the foreign exchange market. Traders can more easily identify new trends that allow them to enter or liquidate the position. The most commonly used indicators, such as Fibonacci Reversal, Moving Average, MACD, RSI, Support and Resistance level, have proven useful in many cases.

 

5. Analyse a nation like stocks.

 

Currency trading is not difficult for fundamentals traders. This is because the currencies are analyzed like stocks. For example, GDP can be used if a country’s growth rate. By analyzing inventory and production ratios, industrial production and durable goods, order data can be analyzed. If you want to analyze sales figures, you can analyze retail sales data.

It is better to invest in the currency of a country that is in a better economic situation or growing faster than other countries like a stock investment. The currency price is determined by the demand and supply of the currency. The two main variables affecting the demand and supply of money are interest rates and overall economic robustness.

Economic indicators such as GDP, national investment, and trade balance reflect the overall economy’s health, thus causing changes in the currency’s demand and supply. Periodically, vast amounts of economic data are published, some of which are more important than other indicators. Among them, data related to interest rates and trade balance should be closely examined.

If the market is uncertain about interest rates, even small news related to interest rates can directly affect the currency market. In general, if a country raises interest rates, its currency will be stronger than other countries’ currencies. This is because investors move the capital to the country to obtain higher interest rates. However, higher interest rates are generally bad news for the stock market.

Some investors will drain funds from the country’s stock market when interest rates rise, which will soon cause the country’s currency to weaken. There is a common opinion in advance regarding the difficulty of determining which effect would be more dominant, but the impact on changes in interest rates.

The indicators that have the greatest impact on interest rates are PPI(producer price index), CPI(consumer price index), and GDP(gross domestic product). Generally, the timing of changing interest rate levels is known in advance. The rate change occurs at regular meetings of the Bank of England(BOE), the Federal Reserve(FED), the European Central Bank(ECB), the Bank of Japan(BOJ), and each country’s central banks.

The trade balance shows the net difference between a country’s exports and imports over a period of time. When a country’s imports exceed its exports, its trade balance represents a deficit and is considered a bad situation. For example, the dollar’s value will fall due to the outflow of dollars outside the United States, where the U.S. dollar will be sold in exchange for other countries’ currencies to pay for imports. Similarly, if the trade balance indicates an increase in exports, the dollar will flow into the United States, and the dollar value will rise. From the perspective of the national economy, the trade deficit itself is not necessarily bad. But if the deficit is greater than the market’s expectation, it will trigger negative price movements.

 

 

Trading is a challenging job, either emotionally or psychologically, but these problems are surprisingly easy to understand and solve. Many traders do not make profits because they lack an understanding of risk management and consider it insignificant. Risk management is identifying the extent to which risks are exposed and what levels of profit are expected. Without a sense of risk management, we may hold loss positions longer than necessary, and liquidation of profit positions occurs too early.

This phenomenon is widespread in actual trading, but in other respects, it is also very paradoxical. An example is when the winning rate is high, but losses are recorded in terms of amount. Due to the absence of risk management, the average amount of failure in the loss position is greater than the average amount of revenue generated in the revenue position.

So what are the ways traders can take a healthy risk management habit into their trading journey? Some guidelines to be followed regardless of the strategies or stocks that traders trade are as follows!

 

1. Set the Risk Compensation Ratio

 

Traders should know the profit-factor of their strategy. In other words, we must know how much loss they can tolerate and how much profit we can expect for repeating the same rules. Generally, the risk compensation ratio should be at least 2 (profit/loss). Setting a healthy balance can prevent entering extreme positions.

 

2. Use Stop Orders

 

Traders have to calculate the maximum losses they can endure and take advantage of the stop-orders. The realisations of profits might limit the profit, but we can prevent cases where losses exceed the total amount of profits. In particular, training stop order to secure profit is a beneficial method. This is a form of order that confirms the profit when the price reaches an expected level.

 

3. Use Stop Loss

 

 

To survive in the FX market, stop-loss orders must be used. The currency market operates 24/5, and it is not possible to limit the loss when we are not monitoring the market. Unexpected events could lead to significant losses if the stop-loss is not set. Plus, limiting the losses is so essential due to the geometric principles. If we lose 10%, we need to win 11% to recover the initial capital. And what if we lose 50%? We need to win 100% to get back to where we started. Stop-loss is powerful to limit the losses!

 

4. Fear and Greed

 

Traders who fail to overcome the market fluctuations are difficult to survive in the market regardless of how aggressively and systematically trained. Therefore, capital management and other techniques are necessary to stay in the market.

 

5.  Separate Work from Emotion

 

One of the essential characteristics of successful traders is to separate emotions. They trade base on their pre-setted strategies without any feelings. Sometimes you have to endure losses and make intelligent investment decisions. 

 

6. Recognise the Moment You Need a Break.

 

 

If you experience a series of failed tradings, it is time to pause and take a break. The best remedy is to stay away from the market for a while and take a few days off to refresh your mind if you experience continuous failure.

Continuing to trade under harsh market conditions can cause more significant losses and often experience psychological panic. Ultimately, if a failure occurs, we should accept it instead of trying to confront the losses.

There is always a possibility of loss in the world of trading, regardless of knowledge, experience, and proficiency. To survive in the market, we must minimise the losses to gain the next chances. 

 

Rememer These Ten Rules!

 

1. Limit your losses.

2. Keep the profit position running.

3. Maintain position scale at a reasonable level.

4. Be aware of your risk compensation ratio.

5. Do it with sufficient capital.

6. Don’t go against the trend.

7. Do not enter the losing position further.

8. Watch out for market expectations.

9. Learn from your mistakes.

10. Set maximum loss or adjust revenue intervals.