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The spot forex market traded over $ trillion a day as of April , including currency options and futures contracts. With this enormous amount of money floating around in an unregulated spot market that trades instantly, over the counter, with no accountability, forex scams offer unscrupulous operators the lure of earning fortunes in limited amounts of time. While many once-popular scams have ceased—thanks to serious enforcement actions by the Commodity Futures Trading Commission (CFTC) and the formation of the self-regulatory National Futures Association (NFA)—some old scams linger, and new ones keep popping up.

Back in the Day: The Point-Spread Scam

An old point-spread forex scam was based on computer manipulation of bid-ask spreads. The point spread between the bid and ask basically reflects the commission of a back-and-forth transaction processed through a broker. These spreads typically differ between currency pairs. The scam occurs when those point spreads differ widely among brokers.

For instance, some brokers do not offer the normal two-point to three-point spread in the EUR/USD but spreads of seven pips or more. (A pip is the smallest price move that a given exchange rate makes based on market convention. Since most major currency pairs are priced to four decimal places, the smallest change is that of the last decimal point.) Factor in four or more additional pips on every trade, and any potential gains resulting from a good trade can be eaten away by commissions, depending on how the forex broker structures their fees for trading.

This scam has quieted down over the last 10 years, but be careful of any offshore retail brokers that are not regulated by the CFTC, NFA, or their nation of origin. These tendencies still exist, and it’s quite easy for firms to pack up and disappear with the money when confronted with actions. Many saw a jail cell for these computer manipulations. But the majority of violators have historically been United States-based companies, not the offshore ones.

The Signal-Seller Scam

A popular modern-day scam is the signal seller. Signal sellers are retail firms, pooled asset managers, managed account companies, or individual traders that offer a system—for a daily, weekly, or monthly fee—that claims to identify favorable times to buy or sell a currency pairbased on professional recommendations that will make anyone wealthy. They tout their long experience and trading abilities, plus testimonials from people who vouch for how great a trader and friend the person is, and the vast wealth that this person has earned for them. All the unsuspecting trader has to do is hand over X amount of dollars for the privilege of trade recommendations.

Many of signal-seller scammers simply collect money from a certain number of traders and disappear. Some will recommend a good trade now and then, to allow the signal money to perpetuate. This new scam is slowly becoming a wider problem. Although there are signal sellers who are honest and perform trade functions as intended, it pays to be skeptical.

"Robot" Scamming in Today’s Market

A persistent scam, old and new, presents itself in some types of forex-developed trading systems. These scammers tout their system’s ability to generate automatic trades that, even while you sleep, earn vast wealth. Today, the new terminology is “robot” because the process is fully automated with computers. Either way, many of these systems have never been submitted for formal review or tested by an independent source.

Examination of a forex robot must include the testing of a trading system’s parameters and optimization codes. If the parameters and optimization codes are invalid, the system will generate random buy and sell signals. This will cause unsuspecting traders to do nothing more than gamble. Although tested systems exist on the market, potential forex traders should do some research before putting money into one of these approaches.

Other Factors to Consider

Traditionally, many trading systems have been quite costly, up to $5, or more. This can be viewed as a scam in eunic-brussels.eu trader should pay more than a few hundred dollars for a proper system today. Be especially careful of system sellers who offer programs at exorbitant prices justified by a guarantee of phenomenal results. Instead, look for legitimate sellers whose systems have been properly tested to potentially earn income.

Another persistent problem is the commingling of funds. Without a record of segregated accounts, individuals cannot track the exact performance of their investments. This makes it easier for retail firms to use an investor’s money to pay exorbitant salaries; buy houses, cars, and planes or just disappear with the funds. Section 4D of the Commodity Futures Modernization Act of addressed the issue of fund segregation; what occurs in other nations is a separate issue.

Other scams and warning signs exist when brokers won’t allow the withdrawal of monies from investor accounts, or when problems exist within the trading platform. For example, can you enter or exit a trade during volatile market action after an economic announcement? If you can’t withdraw money, warning signs should flash. If the trading platform doesn’t operate to your liquidity expectations, warning signs should flash again.

The Bottom Line

Conduct due diligence on the forex broker you’re considering by going to the Background Affiliation Status Information Center (BASIC), created by the NFA. Many changes have driven out the crooks and the old scams and legitimized the system for the many good firms. However, always be wary of new forex scams; the temptation and allure of huge profits will always bring new and more sophisticated scammers to this market.

Global decentralized trading of international currencies

"Forex" and "Foreign exchange" redirect here. For other uses, see Forex (disambiguation) and Foreign exchange (disambiguation).

The foreign exchange market (forex, FX (pronounced "fix"), or currency market) is a global decentralized or over-the-counter (OTC)market for the trading of currencies. This market determines foreign exchange rates for every currency. It includes all aspects of buying, selling and exchanging currencies at current or determined prices. In terms of trading volume, it is by far the largest market in the world, followed by the credit market.^[1]

The main participants in this market are the larger international banks. Financial centers around the world function as anchors of trading between a wide range of multiple types of buyers and sellers around the clock, with the exception of weekends. Since currencies are always traded in pairs, the foreign exchange market does not set a currency's absolute value but rather determines its relative value by setting the market price of one currency if paid for with another. Ex: 1&#;USD is worth X CAD, or CHF, or JPY, etc.

The foreign exchange market works through financial institutions and operates on several levels. Behind the scenes, banks turn to a smaller number of financial firms known as "dealers", who are involved in large quantities of foreign exchange trading. Most foreign exchange dealers are banks, so this behind-the-scenes market is sometimes called the "interbank market" (although a few insurance companies and other kinds of financial firms are involved). Trades between foreign exchange dealers can be very large, involving hundreds of millions of dollars. Because of the sovereignty issue when involving two currencies, Forex has little (if any) supervisory entity regulating its actions.

The foreign exchange market assists international trade and investments by enabling currency conversion. For example, it permits a business in the United States to import goods from European Union member states, especially Eurozone members, and pay Euros, even though its income is in United States dollars. It also supports direct speculation and evaluation relative to the value of currencies and the carry trade speculation, based on the differential interest rate between two currencies.^[2]

In a typical foreign exchange transaction, a party purchases some quantity of one currency by paying with some quantity of another currency.

The modern foreign exchange market began forming during the s. This followed three decades of government restrictions on foreign exchange transactions under the Bretton Woods system of monetary management, which set out the rules for commercial and financial relations among the world's major industrial states after World War II. Countries gradually switched to floating exchange rates from the previous exchange rate regime, which remained fixed per the Bretton Woods system.

The foreign exchange market is unique because of the following characteristics:

• its huge trading volume, representing the largest asset class in the world leading to high liquidity;
• its geographical dispersion;
• its continuous operation: 24 hours a day except for weekends, i.e., trading from UTC on Sunday (Sydney) until UTC Friday (New York);
• the variety of factors that affect exchange rates;
• the low margins of relative profit compared with other markets of fixed income; and
• the use of leverage to enhance profit and loss margins and with respect to account size.

As such, it has been referred to as the market closest to the ideal of perfect competition, notwithstanding currency intervention by central banks.

According to the Bank for International Settlements, the preliminary global results from the Triennial Central Bank Survey of Foreign Exchange and OTC Derivatives Markets Activity show that trading in foreign exchange markets averaged US$ trillion per day in April This is up from US$ trillion in April Measured by value, foreign exchange swaps were traded more than any other instrument in April , at US$ trillion per day, followed by spot trading at US$ trillion.^[3]

The $ trillion break-down is as follows:

History

Ancient

Currency trading and exchange first occurred in ancient times.^[4] Money-changers (people helping others to change money and also taking a commission or charging a fee) were living in the Holy Land in the times of the Talmudic writings (Biblical times). These people (sometimes called "kollybistẻs") used city stalls, and at feast times the Temple's Court of the Gentiles instead.^[5] Money-changers were also the silversmiths and/or goldsmiths^[6] of more recent ancient times.

During the 4th century AD, the Byzantine government kept a monopoly on the exchange of currency.^[7]

Papyri PCZ I (c/8 BC), shows the occurrences of exchange of coinage in Ancient Egypt.^[8]

Currency and exchange were important elements of trade in the ancient world, enabling people to buy and sell items like food, pottery, and raw materials.^[9] If a Greek coin held more gold than an Egyptian coin due to its size or content, then a merchant could barter fewer Greek gold coins for more Egyptian ones, or for more material goods. This is why, at some point in their history, most world currencies in circulation today had a value fixed to a specific quantity of a recognized standard like silver and gold.

Medieval and later

During the 15th century, the Medici family were required to open banks at foreign locations in order to exchange currencies to act on behalf of textile merchants.^[10][11] To facilitate trade, the bank created the nostro (from Italian, this translates to "ours") account book which contained two columned entries showing amounts of foreign and local currencies; information pertaining to the keeping of an account with a foreign bank.^{[12][13][14][15]} During the 17th (or 18th) century, Amsterdam maintained an active Forex market.^[16] In , foreign exchange took place between agents acting in the interests of the Kingdom of England and the County of Holland.^[17]

Early modern

Alex. Brown & Sons traded foreign currencies around and was a leading currency trader in the USA.^[18] In , J.M. do Espírito Santo de Silva (Banco Espírito Santo) applied for and was given permission to engage in a foreign exchange trading business.^[19][20]

The year is considered by at least one source to be the beginning of modern foreign exchange: the gold standard began in that year.^[21]

Prior to the First World War, there was a much more limited control of international trade. Motivated by the onset of war, countries abandoned the gold standard monetary system.^[22]

Modern to post-modern

From to , holdings of countries' foreign exchange increased at an annual rate of %, while holdings of gold increased at an annual rate of % between and ^[23]

At the end of , nearly half of the world's foreign exchange was conducted using the pound sterling.^[24] The number of foreign banks operating within the boundaries of London increased from 3 in , to 71 in In , there were just two London foreign exchange brokers.^[25] At the start of the 20th century, trades in currencies was most active in Paris, New York City and Berlin; Britain remained largely uninvolved until Between and , the number of foreign exchange brokers in London increased to 17; and in , there were 40 firms operating for the purposes of exchange.^[26]

During the s, the Kleinwort family were known as the leaders of the foreign exchange market, while Japheth, Montagu & Co. and Seligman still warrant recognition as significant FX traders.^[27] The trade in London began to resemble its modern manifestation. By , Forex trade was integral to the financial functioning of the city. Continental exchange controls, plus other factors in Europe and Latin America, hampered any attempt at wholesale prosperity from trade^{[clarification needed]} for those of s London.^[28]

After World War II

In , the Bretton Woods Accord was signed, allowing currencies to fluctuate within a range of ±1% from the currency's par exchange rate.^[29] In Japan, the Foreign Exchange Bank Law was introduced in As a result, the Bank of Tokyo became a center of foreign exchange by September Between and , Japanese law was changed to allow foreign exchange dealings in many more Western currencies.^[30]

U.S. President, Richard Nixon is credited with ending the Bretton Woods Accord and fixed rates of exchange, eventually resulting in a free-floating currency system. After the Accord ended in ,^[31] the Smithsonian Agreement allowed rates to fluctuate by up to ±2%. In –62, the volume of foreign operations by the U.S. Federal Reserve was relatively low.^[32][33] Those involved in controlling exchange rates found the boundaries of the Agreement were not realistic and so ceased this^{[clarification needed]} in March , when sometime afterward^{[clarification needed]} none of the major currencies were maintained with a capacity for conversion to gold,^{[clarification needed]} organizations relied instead on reserves of currency.^[34][35] From to , the volume of trading in the market increased three-fold.^[36][37][38] At some time (according to Gandolfo during February–March ) some of the markets were "split", and a two-tier currency market^{[clarification needed]} was subsequently introduced, with dual currency rates. This was abolished in March ^[39][40][41]

Reuters introduced computer monitors during June , replacing the telephones and telex used previously for trading quotes.^[42]

Markets close

Due to the ultimate ineffectiveness of the Bretton Woods Accord and the European Joint Float, the forex markets were forced to close^{[clarification needed]} sometime during and March ^[43] The largest purchase of US dollars in the history of ^{[clarification needed]} was when the West German government achieved an almost 3 billion dollar acquisition (a figure is given as billion in total by The Statesman: Volume 18 ). This event indicated the impossibility of balancing of exchange rates by the measures of control used at the time, and the monetary system and the foreign exchange markets in West Germany and other countries within Europe closed for two weeks (during February and, or, March Giersch, Paqué, & Schmieding state closed after purchase of " million Dmarks" Brawley states " Exchange markets had to be closed. When they re-opened March 1 " that is a large purchase occurred after the close).^{[44][45][46][47]}

After

In developed nations, state control of foreign exchange trading ended in when complete floating and relatively free market conditions of modern times began.^[48] Other sources claim that the first time a currency pair was traded by U.S. retail customers was during , with additional currency pairs becoming available by the next year.^[49][50]

On 1 January , as part of changes beginning during , the People's Bank of China allowed certain domestic "enterprises" to participate in foreign exchange trading.^[51][52] Sometime during , the South Korean government ended Forex controls and allowed free trade to occur for the first time. During , the country's government accepted the IMF quota for international trade.^[53]

Intervention by European banks (especially the Bundesbank) influenced the Forex market on 27 February ^[54] The greatest proportion of all trades worldwide during were within the United Kingdom (slightly over one quarter). The United States had the second highest involvement in trading.^[55]

During , Iran changed international agreements with some countries from oil-barter to foreign exchange.^[56]

Market size and liquidity

The foreign exchange market is the most liquid financial market in the world. Traders include governments and central banks, commercial banks, other institutional investors and financial institutions, currency speculators, other commercial corporations, and individuals. According to the Triennial Central Bank Survey, coordinated by the Bank for International Settlements, average daily turnover was $ trillion in April (compared to $ trillion in ).^[3] Of this $ trillion, $ trillion was spot transactions and $ trillion was traded in outright forwards, swaps, and other derivatives.

Foreign exchange is traded in an over-the-counter market where brokers/dealers negotiate directly with one another, so there is no central exchange or clearing house. The biggest geographic trading center is the United Kingdom, primarily London. In April , trading in the United Kingdom accounted for % of the total, making it by far the most important center for foreign exchange trading in the world. Owing to London's dominance in the market, a particular currency's quoted price is usually the London market price. For instance, when the International Monetary Fund calculates the value of its special drawing rights every day, they use the London market prices at noon that day. Trading in the United States accounted for %, Singapore and Hong Kong account for % and %, respectively, and Japan accounted for %.^[3]

Turnover of exchange-traded foreign exchange futures and options was growing rapidly in , reaching $ billion in April (double the turnover recorded in April ).^[57] As of April , exchange-traded currency derivatives represent 2% of OTC foreign exchange turnover. Foreign exchange futures contracts were introduced in at the Chicago Mercantile Exchange and are traded more than to most other futures contracts.

Most developed countries permit the trading of derivative products (such as futures and options on futures) on their exchanges. All these developed countries already have fully convertible capital accounts. Some governments of emerging markets do not allow foreign exchange derivative products on their exchanges because they have capital controls. The use of derivatives is growing in many emerging economies.^[58] Countries such as South Korea, South Africa, and India have established currency futures exchanges, despite having some capital controls.

Foreign exchange trading increased by 20% between April and April and has more than doubled since ^[59] The increase in turnover is due to a number of factors: the growing importance of foreign exchange as an asset class, the increased trading activity of high-frequency traders, and the emergence of retail investors as an important market segment. The growth of electronic execution and the diverse selection of execution venues has lowered transaction costs, increased market liquidity, and attracted greater participation from many customer types. In particular, electronic trading via online portals has made it easier for retail traders to trade in the foreign exchange market. By , retail trading was estimated to account for up to 10% of spot turnover, or $ billion per day (see below: Retail foreign exchange traders).

Market participants

See also: Forex scandal

Unlike a stock market, the foreign exchange market is divided into levels of access. At the top is the interbank foreign exchange market, which is made up of the largest commercial banks and securities dealers. Within the interbank market, spreads, which are the difference between the bid and ask prices, are razor sharp and not known to players outside the inner circle.^{[citation needed]}

The difference between the bid and ask prices widens (for example from 0 to 1 pip to 1–2 pips for currencies such as the EUR) as you go down the levels of access. This is due to volume. If a trader can guarantee large numbers of transactions for large amounts, they can demand a smaller difference between the bid and ask price, which is referred to as a better spread. The levels of access that make up the foreign exchange market are determined by the size of the "line" (the amount of money with which they are trading). The top-tier interbank market accounts for 51% of all transactions.^[61] From there,^{[clarification needed]} smaller banks, followed by large multi-national corporations (which need to hedge risk and pay employees in different countries), large hedge funds, and even some of the retail market makers. According to Galati and Melvin, “Pension funds, insurance companies, mutual funds, and other institutional investors have played an increasingly important role in financial markets in general, and in FX markets in particular, since the early s.” () In addition, he notes, “Hedge funds have grown markedly over the – period in terms of both number and overall size”.^[62] Central banks also participate in the foreign exchange market to align currencies to their economic needs.

Commercial companies

An important part of the foreign exchange market comes from the financial activities of companies seeking foreign exchange to pay for goods or services. Commercial companies often trade fairly small amounts compared to those of banks or speculators, and their trades often have a little short-term impact on market rates. Nevertheless, trade flows are an important factor in the long-term direction of a currency's exchange rate. Some multinational corporations (MNCs) can have an unpredictable impact when very large positions are covered due to exposures that are not widely known by other market participants.

Central banks

National central banks play an important role in the foreign exchange markets. They try to control the money supply, inflation, and/or interest rates and often have official or unofficial target rates for their currencies. They can use their often substantial foreign exchange reserves to stabilize the market. Nevertheless, the effectiveness of central bank "stabilizing speculation" is doubtful because central banks do not go bankrupt if they make large losses as other traders would. There is also no convincing evidence that they actually make a profit from trading.

Foreign exchange fixing

Foreign exchange fixing is the daily monetary exchange rate fixed by the national bank of each country. The idea is that central banks use the fixing time and exchange rate to evaluate the behavior of their currency. Fixing exchange rates reflect the real value of equilibrium in the market. Banks, dealers, and traders use fixing rates as a market trend indicator.

The mere expectation or rumor of a central bank foreign exchange intervention might be enough to stabilize the currency. However, aggressive intervention might be used several times each year in countries with a dirty float currency regime. Central banks do not always achieve their objectives. The combined resources of the market can easily overwhelm any central bank.^[63] Several scenarios of this nature were seen in the –93 European Exchange Rate Mechanism collapse, and in more recent times in Asia.

Investment management firms

Investment management firms (who typically manage large accounts on behalf of customers such as pension funds and endowments) use the foreign exchange market to facilitate transactions in foreign securities. For example, an investment manager bearing an international equity portfolio needs to purchase and sell several pairs of foreign currencies to pay for foreign securities purchases.

Some investment management firms also have more speculative specialist currency overlay operations, which manage clients' currency exposures with the aim of generating profits as well as limiting risk. While the number of this type of specialist firms is quite small, many have a large value of assets under management and can, therefore, generate large trades.

Retail foreign exchange traders

Main article: Retail foreign exchange trading

Individual retail speculative traders constitute a growing segment of this market. Currently, they participate indirectly through brokers or banks. Retail brokers, while largely controlled and regulated in the US by the Commodity Futures Trading Commission and National Futures Association, have previously been subjected to periodic foreign exchange fraud.^[64][65] To deal with the issue, in the NFA required its members that deal in the Forex markets to register as such (i.e., Forex CTA instead of a CTA). Those NFA members that would traditionally be subject to minimum net capital requirements, FCMs and IBs, are subject to greater minimum net capital requirements if they deal in Forex. A number of the foreign exchange brokers operate from the UK under Financial Services Authority regulations where foreign exchange trading using margin is part of the wider over-the-counter derivatives trading industry that includes contracts for difference and financial spread betting.

There are two main types of retail FX brokers offering the opportunity for speculative currency trading: brokers and dealers or market makers. Brokers serve as an agent of the customer in the broader FX market, by seeking the best price in the market for a retail order and dealing on behalf of the retail customer. They charge a commission or "mark-up" in addition to the price obtained in the market. Dealers or market makers, by contrast, typically act as principals in the transaction versus the retail customer, and quote a price they are willing to deal at.

Non-bank foreign exchange companies

Non-bank foreign exchange companies offer currency exchange and international payments to private individuals and companies. These are also known as "foreign exchange brokers" but are distinct in that they do not offer speculative trading but rather currency exchange with payments (i.e., there is usually a physical delivery of currency to a bank account).

It is estimated that in the UK, 14% of currency transfers/payments are made via Foreign Exchange Companies.^[66] These companies' selling point is usually that they will offer better exchange rates or cheaper payments than the customer's bank.^[67] These companies differ from Money Transfer/Remittance Companies in that they generally offer higher-value services. The volume of transactions done through Foreign Exchange Companies in India amounts to about US$2 billion^[68] per day This does not compete favorably with any well developed foreign exchange market of international repute, but with the entry of online Foreign Exchange Companies the market is steadily growing. Around 25% of currency transfers/payments in India are made via non-bank Foreign Exchange Companies.^[69] Most of these companies use the USP of better exchange rates than the banks. They are regulated by FEDAI and any transaction in foreign Exchange is governed by the Foreign Exchange Management Act, (FEMA).

Money transfer/remittance companies and bureaux de change

Main articles: Payment system and Bureaux de change

Money transfer companies/remittance companies perform high-volume low-value transfers generally by economic migrants back to their home country. In , the Aite Group estimated that there were $ billion of remittances (an increase of 8% on the previous year). The four largest foreign markets (India, China, Mexico, and the Philippines) receive $95 billion. The largest and best-known provider is Western Union with , agents globally, followed by UAE Exchange.^{[citation needed]}

Bureaux de change or currency transfer companies provide low-value foreign exchange services for travelers. These are typically located at airports and stations or at tourist locations and allow physical notes to be exchanged from one currency to another. They access foreign exchange markets via banks or non-bank foreign exchange companies.

Most traded currencies by value

There is no unified or centrally cleared market for the majority of trades, and there is very little cross-border regulation. Due to the over-the-counter (OTC) nature of currency markets, there are rather a number of interconnected marketplaces, where different currencies instruments are traded. This implies that there is not a single exchange rate but rather a number of different rates (prices), depending on what bank or market maker is trading, and where it is. In practice, the rates are quite close due to arbitrage. Due to London's dominance in the market, a particular currency's quoted price is usually the London market price. Major trading exchanges include Electronic Broking Services (EBS) and Thomson Reuters Dealing, while major banks also offer trading systems. A joint venture of the Chicago Mercantile Exchange and Reuters, called Fxmarketspace opened in and aspired but failed to the role of a central market clearing mechanism.^{[citation needed]}

The main trading centers are London and New York City, though Tokyo, Hong Kong, and Singapore are all important centers as well. Banks throughout the world participate. Currency trading happens continuously throughout the day; as the Asian trading session ends, the European session begins, followed by the North American session and then back to the Asian session.

Fluctuations in exchange rates are usually caused by actual monetary flows as well as by expectations of changes in monetary flows. These are caused by changes in gross domestic product (GDP) growth, inflation (purchasing power parity theory), interest rates (interest rate parity, Domestic Fisher effect, International Fisher effect), budget and trade deficits or surpluses, large cross-border M&A deals and other macroeconomic conditions. Major news is released publicly, often on scheduled dates, so many people have access to the same news at the same time. However, large banks have an important advantage; they can see their customers' order flow.

Currencies are traded against one another in pairs. Each currency pair thus constitutes an individual trading product and is traditionally noted XXXYYY or XXX/YYY, where XXX and YYY are the ISO international three-letter code of the currencies involved. The first currency (XXX) is the base currency that is quoted relative to the second currency (YYY), called the counter currency (or quote currency). For instance, the quotation EURUSD (EUR/USD) is the price of the Euro expressed in US dollars, meaning 1 euro = dollars. The market convention is to quote most exchange rates against the USD with the US dollar as the base currency (e.g. USDJPY, USDCAD, USDCHF). The exceptions are the British pound (GBP), Australian dollar (AUD), the New Zealand dollar (NZD) and the euro (EUR) where the USD is the counter currency (e.g. GBPUSD, AUDUSD, NZDUSD, EURUSD).

The factors affecting XXX will affect both XXXYYY and XXXZZZ. This causes a positive currency correlation between XXXYYY and XXXZZZ.

On the spot market, according to the Triennial Survey, the most heavily traded bilateral currency pairs were:

• EURUSD: %
• USDJPY: %
• GBPUSD (also called cable): %

The U.S. currency was involved in % of transactions, followed by the euro (%), the yen (%), and sterling (%) (see table). Volume percentages for all individual currencies should add up to %, as each transaction involves two currencies.

Trading in the euro has grown considerably since the currency's creation in January , and how long the foreign exchange market will remain dollar-centered is open to debate. Until recently, trading the euro versus a non-European currency ZZZ would have usually involved two trades: EURUSD and USDZZZ. The exception to this is EURJPY, which is an established traded currency pair in the interbank spot market.

Determinants of exchange rates

Main article: Exchange rate

In a fixed exchange rate regime, exchange rates are decided by the government, while a number of theories have been proposed to explain (and predict) the fluctuations in exchange rates in a floating exchange rate regime, including:

• International parity conditions: Relative purchasing power parity, interest rate parity, Domestic Fisher effect, International Fisher effect. To some extent the above theories provide logical explanation for the fluctuations in exchange rates, yet these theories falter as they are based on challengeable assumptions (e.g., free flow of goods, services, and capital) which seldom hold true in the real world.
• Balance of payments model: This model, however, focuses largely on tradable goods and services, ignoring the increasing role of global capital flows. It failed to provide any explanation for the continuous appreciation of the US dollar during the s and most of the s, despite the soaring US current account deficit.
• Asset market model: views currencies as an important asset class for constructing investment portfolios. Asset prices are influenced mostly by people's willingness to hold the existing quantities of assets, which in turn depends on their expectations on the future worth of these assets. The asset market model of exchange rate determination states that “the exchange rate between two currencies represents the price that just balances the relative supplies of, and demand for, assets denominated in those currencies.”

None of the models developed so far succeed to explain exchange rates and volatility in the longer time frames. For shorter time frames (less than a few days), algorithms can be devised to predict prices. It is understood from the above models that many macroeconomic factors affect the exchange rates and in the end currency prices are a result of dual forces of supply and demand. The world's currency markets can be viewed as a huge melting pot: in a large and ever-changing mix of current events, supply and demand factors are constantly shifting, and the price of one currency in relation to another shifts accordingly. No other market encompasses (and distills) as much of what is going on in the world at any given time as foreign exchange.^[71]

Supply and demand for any given currency, and thus its value, are not influenced by any single element, but rather by several. These elements generally fall into three categories: economic factors, political conditions, and market psychology.

Economic factors

Economic factors include: (a) economic policy, disseminated by government agencies and central banks, (b) economic conditions, generally revealed through economic reports, and other economic indicators.

• Economic policy comprises government fiscal policy (budget/spending practices) and monetary policy (the means by which a government's central bank influences the supply and "cost" of money, which is reflected by the level of interest rates).
• Government budget deficits or surpluses: The market usually reacts negatively to widening government budget deficits, and positively to narrowing budget deficits. The impact is reflected in the value of a country's currency.
• Balance of trade levels and trends: The trade flow between countries illustrates the demand for goods and services, which in turn indicates demand for a country's currency to conduct trade. Surpluses and deficits in trade of goods and services reflect the competitiveness of a nation's economy. For example, trade deficits may have a negative impact on a nation's currency.
• Inflation levels and trends: Typically a currency will lose value if there is a high level of inflation in the country or if inflation levels are perceived to be rising. This is because inflation erodes purchasing power, thus demand, for that particular currency. However, a currency may sometimes strengthen when inflation rises because of expectations that the central bank will raise short-term interest rates to combat rising inflation.
• Economic growth and health: Reports such as GDP, employment levels, retail sales, capacity utilization and others, detail the levels of a country's economic growth and health. Generally, the more healthy and robust a country's economy, the better its currency will perform, and the more demand for it there will be.
• Productivity of an economy: Increasing productivity in an economy should positively influence the value of its currency. Its effects are more prominent if the increase is in the traded sector.^[72]

Political conditions

Internal, regional, and international political conditions and events can have a profound effect on currency markets.

All exchange rates are susceptible to political instability and anticipations about the new ruling party. Political upheaval and instability can have a negative impact on a nation's economy. For example, destabilization of coalition governments in Pakistan and Thailand can negatively affect the value of their currencies. Similarly, in a country experiencing financial difficulties, the rise of a political faction that is perceived to be fiscally responsible can have the opposite effect. Also, events in one country in a region may spur positive/negative interest in a neighboring country and, in the process, affect its currency.

Market psychology

Market psychology and trader perceptions influence the foreign exchange market in a variety of ways:

• Flights to quality: Unsettling international events can lead to a "flight-to-quality", a type of capital flight whereby investors move their assets to a perceived "safe haven". There will be a greater demand, thus a higher price, for currencies perceived as stronger over their relatively weaker counterparts. The US dollar, Swiss franc and gold have been traditional safe havens during times of political or economic uncertainty.^[73]
• Long-term trends: Currency markets often move in visible long-term trends. Although currencies do not have an annual growing season like physical commodities, business cycles do make themselves felt. Cycle analysis looks at longer-term price trends that may rise from economic or political trends.^[74]
• "Buy the rumor, sell the fact": This market truism can apply to many currency situations. It is the tendency for the price of a currency to reflect the impact of a particular action before it occurs and, when the anticipated event comes to pass, react in exactly the opposite direction. This may also be referred to as a market being "oversold" or "overbought". To buy the rumor or sell the fact can also be an example of the cognitive bias known as Anchoring, when investors focus too much on the relevance of outside events to currency prices.
• Economic numbers: While economic numbers can certainly reflect economic policy, some reports and numbers take on a talisman-like effect: the number itself becomes important to market psychology and may have an immediate impact on short-term market moves. "What to watch" can change over time. In recent years, for example, money supply, employment, trade balance figures and inflation numbers have all taken turns in the spotlight.
• Technical trading considerations: As in other markets, the accumulated price movements in a currency pair such as EUR/USD can form apparent patterns that traders may attempt to use. Many traders study price charts in order to identify such patterns.^[75]

Financial instruments

Spot

Main article: Foreign exchange spot

A spot transaction is a two-day delivery transaction (except in the case of trades between the US dollar, Canadian dollar, Turkish lira, euro and Russian ruble, which settle the next business day), as opposed to the futures contracts, which are usually three months. This trade represents a “direct exchange” between two currencies, has the shortest time frame, involves cash rather than a contract, and interest is not included in the agreed-upon transaction. Spot trading is one of the most common types of forex trading. Often, a forex broker will charge a small fee to the client to roll-over the expiring transaction into a new identical transaction for a continuation of the trade. This roll-over fee is known as the "swap" fee.

Forward

See also: Forward contract

One way to deal with the foreign exchange risk is to engage in a forward transaction. In this transaction, money does not actually change hands until some agreed upon future date. A buyer and seller agree on an exchange rate for any date in the future, and the transaction occurs on that date, regardless of what the market rates are then. The duration of the trade can be one day, a few days, months or years. Usually the date is decided by both parties. Then the forward contract is negotiated and agreed upon by both parties.

Non-deliverable forward (NDF)

See also: Non-deliverable forward

Forex banks, ECNs, and prime brokers offer NDF contracts, which are derivatives that have no real deliver-ability. NDFs are popular for currencies with restrictions such as the Argentinian peso. In fact, a forex hedger can only hedge such risks with NDFs, as currencies such as the Argentinian peso cannot be traded on open markets like major currencies.^[76]

Swap

Main article: Foreign exchange swap

The most common type of forward transaction is the foreign exchange swap. In a swap, two parties exchange currencies for a certain length of time and agree to reverse the transaction at a later date. These are not standardized contracts and are not traded through an exchange. A deposit is often required in order to hold the position open until the transaction is completed.

Futures

Main article: Currency future

Futures are standardized forward contracts and are usually traded on an exchange created for this purpose. The average contract length is roughly 3 months. Futures contracts are usually inclusive of any interest amounts.

Currency futures contracts are contracts specifying a standard volume of a particular currency to be exchanged on a specific settlement date. Thus the currency futures contracts are similar to forward contracts in terms of their obligation, but differ from forward contracts in the way they are traded. In addition, Futures are daily settled removing credit risk that exist in Forwards.^[77] They are commonly used by MNCs to hedge their currency positions. In addition they are traded by speculators who hope to capitalize on their expectations of exchange rate movements.

Option

Main article: Foreign exchange option

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

Speculation

Controversy about currency speculators and their effect on currency devaluations and national economies recurs regularly. Economists, such as Milton Friedman, have argued that speculators ultimately are a stabilizing influence on the market, and that stabilizing speculation performs the important function of providing a market for hedgers and transferring risk from those people who don't wish to bear it, to those who do.^[78] Other economists, such as Joseph Stiglitz, consider this argument to be based more on politics and a free market philosophy than on economics.^[79]

Large hedge funds and other well capitalized "position traders" are the main professional speculators. According to some economists, individual traders could act as "noise traders" and have a more destabilizing role than larger and better informed actors.^[80]

Currency speculation is considered a highly suspect activity in many countries.^[where?] While investment in traditional financial instruments like bonds or stocks often is considered to contribute positively to economic growth by providing capital, currency speculation does not; according to this view, it is simply gambling that often interferes with economic policy. For example, in , currency speculation forced Sweden's central bank, the Riksbank, to raise interest rates for a few days to % per annum, and later to devalue the krona.^[81]Mahathir Mohamad, one of the former Prime Ministers of Malaysia, is one well-known proponent of this view. He blamed the devaluation of the Malaysian ringgit in on George Soros and other speculators.

Gregory Millman reports on an opposing view, comparing speculators to "vigilantes" who simply help "enforce" international agreements and anticipate the effects of basic economic "laws" in order to profit.^[82] In this view, countries may develop unsustainable economic bubbles or otherwise mishandle their national economies, and foreign exchange speculators made the inevitable collapse happen sooner. A relatively quick collapse might even be preferable to continued economic mishandling, followed by an eventual, larger, collapse. Mahathir Mohamad and other critics of speculation are viewed as trying to deflect the blame from themselves for having caused the unsustainable economic conditions.

Risk aversion

See also: Safe-haven currency

Risk aversion is a kind of trading behavior exhibited by the foreign exchange market when a potentially adverse event happens that may affect market conditions. This behavior is caused when risk averse traders liquidate their positions in risky assets and shift the funds to less risky assets due to uncertainty.

In the context of the foreign exchange market, traders liquidate their positions in various currencies to take up positions in safe-haven currencies, such as the US dollar.^[83] Sometimes, the choice of a safe haven currency is more of a choice based on prevailing sentiments rather than one of economic statistics. An example would be the financial crisis of The value of equities across the world fell while the US dollar strengthened (see Fig.1). This happened despite the strong focus of the crisis in the US.^[84]

Carry trade

Main article: Carry trade

Currency carry trade refers to the act of borrowing one currency that has a low interest rate in order to purchase another with a higher interest rate. A large difference in rates can be highly profitable for the trader, especially if high leverage is used. However, with all levered investments this is a double edged sword, and large exchange rate price fluctuations can suddenly swing trades into huge losses.

See also

Notes

References

Nowadays, popular trading platforms offer in excess of indicators. You could say you are almost spoilt for choice. The mammoth selection, however, tends to be detrimental, often leaving traders overwhelmed, particularly those in the earlier junctures of their journey.

Fortunately, a handful of indicators have stood the test of time.

Including, but certainly not limited to, the Slow Stochastic, The Moving Average Convergence & Divergence (MACD), Moving Averages and the Relative Strength Index (RSI) are well known among the technical community.

For the purpose of this piece, though, focus is drawn towards the RSI.

Getting to know the RSI indicator

Developed by J. Welles Wilder, and presented in his book New Concepts in Technical Trading Systems (), the RSI remains a prominent momentum oscillator – momentum is the rate of the rise or fall in price.

The RSI calculates momentum as a ratio of higher price closes over lower closes. For example, markets experiencing more upside momentum naturally have a higher RSI reading.

As is evident from the image below, the indicator is basic in form, oscillating between In addition to this, an exponential moving average (EMA) is applied to its canvas, along with high and low levels marked at 70 and

RSI settings

The RSI indicator’s default calculation is 14 periods, the suggested value by Wilder in his book. This means the indicator examines the closing price of 14 candles to create a reading on the timeframe being analysed.

Although 14 is the default, a number of settings are available which typically depends on the trading strategy employed:

• Short-term intraday traders (day trading) may favour lower settings using periods of
• Medium-term swing traders tend to adopt the default setting of
• Longer-term position traders normally prefer a higher period, ranging from

In terms of the indicator’s calculation, today’s trading platforms are capable of performing the RSI calculation automatically, leaving traders free to focus on what’s important. For those who wish to understand the numbers behind the RSI, nevertheless, here’s a brief look at its calculation:

RSI = average gain in the period / loss in the period.

RSI = – ( / [1 + RS]).

Average gain is calculated as (previous average gain * (period – 1) + current gain) / period except for the first day which is just an SMA. The average loss is similarly calculated using losses.

The many uses of the RSI indicator

Overbought and Oversold:

Traditionally, an RSI value beyond 70 indicates overbought conditions, whereas an RSI value below 30 suggests oversold conditions.

These two terms are relatively self-explanatory. An overbought level describes consistent upward moves over a period of time and can alert traders to a potentially waning market, or weakening trend. The term oversold, nonetheless, defines consistent downward moves visible over a period of time, and thus reflects a possible trend reversal to the upside is in the offing.

In addition to the above, traders also need to take into account the RSI can remain overbought or oversold for extended periods in trending environments. This is important to recognize as it can lead to numerous false signals. To help tackle this, some traders elect to use more extreme values in the range of as an alternative to the traditional

Divergence:

Divergence occurs when underlying price movement (the candlesticks) prints a fresh high/low that is not confirmed by the RSI. To the side are two examples of divergences seen regularly in the market (blue signifies price action and red represents RSI movement).

To help solidify the image, here is an example of regular bearish divergence on a trading chart – the opposite of this is simply a mirror version offering regular bullish divergence:

Divergence signals can offer an effective edge on the price chart, enabling traders to spot a potentially weakening/strengthening market.

Divergences are visible across all timeframes. For the best results, however, divergence observed on higher timeframes tends to suggest higher-probability signals.

RSI centre line:

The centre line of most oscillators is often overlooked. Found in the middle of the range at 50, this barrier is in place to discern early shifts in the underlying price trend. A push above 50 portends a strong immediate trend, whereas a move below 50 indicates an immediate bearish trend.

RSI patterns:

The RSI EMA has the ability to formulate patterns that precede price action. Trend lines, support and resistance, double bottoms and tops are just some of the technical formations to keep a watchful eye on.

By way of an example, the EUR/AUD M30 chart shown below was, at the time, compressed within a mild ascending channel pattern, with traders likely expecting its borders to hold.

The large bearish candle (point 1) shows strength to the downside, though price had yet to penetrate the channel support. Yet, on the RSI the indicator pierced beneath trend line support (point 2), providing an early signal price action may continue to press lower and eventually break the price chart’s channel support, which it did. In addition, there was also an opportunity to enter short at point 3 at the retest of the recently broken channel support (now acting resistance), given the RSI was also chalking up a similar retest play around the underside of its trend line support-turned resistance at point 4.

The chart, although reasonably simple, demonstrates the effectiveness of combining a price action pattern with the tools offered through the RSI indicator.

A final point to consider here is there is absolutely no need for the RSI pattern and chart pattern to emulate each other: In other words, the RSI pattern could form a trend line support, while price action trades from a demand zone.

Does the RSI show strength?

It shows a mathematical calculation of strength.

Although the RSI certainly has its place in a technician’s toolbox, trading it in isolation is challenging. If trading could be boiled down to following an indicator’s movement, there’d be a lot more traders that are successful.

Combining the power of the RSI along with additional technical tools such as supply and demand, support and resistance, trend lines or moving averages is certainly a viable option. There are a number of technical indicators that complement RSI movement.

As an example, check out the NZD/USD M30 price chart depicted below. Two resistance levels stand out: and (red/green arrows). Both are of equal weighting as far as resistance levels go, though the upper barrier boasted additional confluence by way of an RSI bearish (regular) divergence signal within overbought territory. What’s more, the RSI engulfed a demand area (point 1) prior to forming the divergence signal. As a result of this, not only did we have a solid resistance level in play on the candles, the RSI exhibited a clear indication this market was likely weakening.

Final thoughts

The best form of technical analysis will always be what suits YOUR trading style and personality.

The RSI momentum indicator, as demonstrated in this article, has a multitude of uses which could benefit your trading.

As humans we love to overcomplicate things!

While an elaborate trading strategy may impress your family and friends, it is unnecessary to succeed.

For those that have been involved in the markets for a while will know that keeping things simple is a MUST in trading. And that&#;s why the trend line remains a favourite among the technical community.

By definition, trend lines are linear and are constructed by linking two or more price points that extends into the future to be used as support or resistance. We will not go into too much detail here regarding form since we already covered that here: How to Identify Trendlines. Our objective in this piece is to demonstrate the many uses the trend line possesses.

What happens when your trusted trend line fails?

As with all technical methods, nothing is guaranteed to work % of the time. Trend lines WILL fail from time to time, and when they do this tends to give way to a retest play.

As you can see on the M30 GBP/AUD chart depicted below, the trend line support recently experienced a somewhat aggressive breach to the downside. In one fell swoop the barrier was wiped out. While a loss may have been incurred, trading the underside of this level as (in this case) resistance is now a plausible option.

What causes a response on the retest of a broken trend line?

Well, from an order-flow perspective one could put it down to supply and demand.

One way of potentially looking at order flow here is through the eyes of pro money (generally thought to be institutional traders with particularly deep pockets):

• Those that entered into a long position off of the trend line support pictured above likely had stop-loss orders sited pips beneath the barrier.
• Given the recent move lower, stop-loss orders have, therefore, been filled and thus become sell orders.
• Using these sell orders pro money buys into this liquidity, lifting price action higher. They do this in order to reach the unfilled sell orders left at the break of the trend line. As the initial break was strong, it&#;s unlikely that pro money were able to fill all of their sell orders. Remember, we are not talking 10 lots here!
• So, in order to fill these unfilled sell orders, price is bid higher and as soon as the sell orders have been triggered, pro money liquidates its initial buy orders, thus letting price push its way south.

The RSI indicator also loves a trend line!

An often overlooked, yet highly effective, method of using the RSI indicator is combining trend lines. The RSI indicator typically finds its use when the oscillator reads an overbought or oversold signal. It is also great at finding divergences. However, drawing trend lines directly over the oscillator itself is also highly effective. Connecting rising swing lows in an uptrend or lower swing highs in a downtrend, traders are able to find excellent trading opportunities.

There are two solid examples of potential short trades posted on the AUD/JPY H1 chart above. Note how the break of the two ascending trend lines indicated a downside move was likely in the making, before the candles actually set off lower.

As we highlighted above, though, nothing is guaranteed in trading. As you can see, there was a false signal to the upside marked with a green circle. This is why we believe one should never trade any technical tool in isolation. Combining RSI trend lines with candlestick structure is recommended.

Not only does the RSI indicator work well with trend lines on any timeframe, it might be worth noting that it is also particularly fond of support and resistance levels as well!

Additional points to consider

• Trend lines can be great tools for trade management, potentially leading to huge gains if handled correctly. For example, imagine you&#;re long the EUR/USD and price has moved nicely away from the entry point and printed a higher low. At this point, you could extend a trend line using the initial reaction and newly-formed higher low as a basis for a trend line to manage the trade. A close beneath the trend line would be considered a signal to exit the position.
• Trend lines are also exceptionally good at confirming areas of interest. By way of illustration, let&#;s assume you have spotted a nice-looking resistance level on the H1 timeframe. You&#;ve noted that it has good history, but lacks technical confluence. Do you just ignore the level or trade in hope? Well, trading in hope is not how professionals approach this business! An alternative, therefore, is to wait for additional confirmation, rather than passing on what could be a profitable resistance. A trend line support break/retest play is something traders could look for. Generally, though, you&#;ll have to drill down to the lower timeframes in order to catch this.

As a reminder, broken trend lines are BEST traded in combination with additional technical tools. The more reasons there are to trade an area, the more likely it&#;ll hold.