Forex Currencies: Conclusion
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  1. Forex Currencies: Introduction
  2. Forex Currencies: Trading Strategies
  3. Forex Currencies: Ways To Trade
  4. Forex Currencies: The Four Major Pairs
  5. Forex Currencies: The EUR/USD
  6. Forex Currencies: The USD/JPY
  7. Forex Currencies: The GBP/USD
  8. Forex Currencies: The USD/CHF
  9. Forex Currencies: Commodity Pairs (USD/CAD, USD/AUD, USD/NZD)
  10. Forex Currencies: Currency Cross Rates
  11. Forex Currencies: Emerging Market Currencies
  12. Forex Currencies: Conclusion

Forex Currencies: Conclusion

By Brian Perry

Conclusion

  • The currency markets are the largest and most actively traded financial markets in the world with daily trading volume of more than $3 trillion (Triennial Central Bank Survey 2007).
  • Each transaction in the currency market involves two different trades: the sale of one currency and the purchase of another.
  • As the world's reserve currency, the U.S. dollar is the most actively traded currency; pairs involving the dollar make up the majority of transactions.
  • Most currency trading strategies fall into two broad categories: hedging and speculating.
  • To avoid possible loss from fluctuating currencies, companies can hedge, or protect themselves, by trading currency pairs.
  • In arbitrage trades, an investor simultaneously buys and sells the same security (or currency) at slightly different prices, hoping to make a small risk-free profit.
  • Another popular category of currency trade is the carry trade, which involves selling the currency of a country with very low interest rates and investing the proceeds in the currency of a country with high interest rates.
  • There are several markets available to currency traders, including the forex market, derivatives markets and exchange-traded funds.
  • The majority of currency trading takes place in the forex spot market. In the forex spot market, large banks and other financial institutions trade currencies among themselves either for immediate delivery (spot market) or for settlement at a later date (forward market.)
  • Derivatives include futures, options and exotic, customizable derivative contracts. While the more exotic derivatives are generally designed for institutional investors, individual investors often use futures and options.
  • Individual investors can buy or sell the futures or the options to speculate on the direction of the currency pair.
  • ETFs have been popular vehicles for tracking stock or bond indexes for many years, but ETFs that track currency movements are relatively new. A currency ETF can be bought and sold just like any other stock.
  • Investors with no intention of directly trading foreign currencies, however, can benefit from a better understanding of the links between international currencies – because these currency movements can ultimately affect the value of other financial assets.
  • Four major currency pairs are the most popular: EUR/USD, the euro and the U.S. dollar; USD/JPY, the U.S. dollar and the Japanese yen; GBP/USD, the British pound sterling and the U.S. dollar; and USD/CHF, the U.S. dollar and the Swiss franc.
  • Because they are the two most popular currencies in the world, the euro and the U.S. dollar are the most actively traded currency pair.
  • Most foreign currencies trade against the U.S. dollar more often than in a pair with any other currency. For this reason, it is important for investors interested in the currency markets to have a firm grasp of the fundamentals of the United States economy and a solid understanding of the direction in which the U.S. dollar is going.
  • While the U.S. dollar is the currency of a single country, the euro is the single currency of 16 European countries within the European Union, collectively known as the "eurozone" or the European and Economic Monetary Union (EMU).
  • The primary factor that influences the direction of the euro/U.S. dollar pair is the relative strength of the two economies.
  • Because of Japan's large amount of trade with the United States, Asia, Europe, and other countries, multinational corporations have a regular need to convert local currency into yen and vice versa.
  • The Japanese central bank has been kept its interest rates very low to spur economic growth following a long period of economic decline. These low interest rates have made the Japanese yen extremely popular in the carry trade.
  • The U.S. dollar/Japanese yen pair features low bid-ask spreads and excellent liquidity. As such, it is an excellent starting place for newcomers to the currency market as well as a popular pair for more experienced traders.
  • Although the U.K. is a member of the European Union, the country remains outside the Eurozone (the European Monetary Union, or EMU) and maintains its own currency, the British pound sterling (known as the pound).
  • The British pound/U.S. dollar pair is one of the most liquid in the currency market.
  • As with the euro/U.S. dollar, the most important factor in determining the relationship between the U.S. dollar and the British pound is the relative strength of the countries' respective economies.
  • One unique aspect of trading the British pound is that there is often conjecture that the U.K. may choose to join the eurozone (or European Monetary Union, known as the EMU). If this were to happen, the U.K. would have to give up the pound and use only the euro.
  • Although the country remains outside the European Union to maintain its neutrality, Switzerland does enjoy extensive trade with its European neighbors, the United States and other countries around the world.
  • Because of Switzerland's historic political neutrality and reputation for stable and discreet banking, the Swiss franc is commonly viewed as a safe haven in international capital markets.
  • Although it is somewhat less liquid than the euro and the pound, the Swiss franc is still an easy currency to trade.
  • The factor most likely to cause large movements in the value of the Swiss franc is international political and economic instability.
  • The commodity currencies are currencies from countries that possess large quantities of commodities or other natural resources.
  • Commodity currency trading typically focuses on three countries that are rich in natural resources and also have liquid, freely floating currencies: Canada, Australia and New Zealand.
  • The Canadian economy is also closely linked to the state of the U.S. economy, because weaker growth in the U.S. can result in decreased exports for Canada.
  • Australia finds it necessary to import large quantities of goods not produced domestically. These imports can result in large trade deficits that pressure the Australian dollar.
  • New Zealand is a small island nation blessed with many natural resources and a large agricultural sector. These resources result in the New Zealand economy's heavy exposure to international commodity prices.
  • The primary determinant of the movement of the commodity currencies is the price of commodities.
  • The currencies of Canada, Australia, and New Zealand are all actively traded but are less liquid than those of the United Kingdom, Japan or the eurozone.
  • A currency trading pair that does not involve the U.S. dollar is known as a currency cross rate.
  • Because currency cross rates, by definition, do not include the U.S. dollar, the most heavily traded cross pairs do involve the second most commonly used currency, the euro.
  • An investor interested in cross rates does not need to be as concerned with the fundamentals of the U.S. economy as an investor trading more traditional pairs.
  • A second unique characteristic of cross rates is that they are usually somewhat less liquid (and less actively traded) than traditional pairs, bringing both benefits and drawbacks for investors.
  • Perhaps the most important factor in cross-rate movements is not what affects them, but what does not. Cross rates are not directly influenced by the direction of the U.S. dollar.
  • The opportunity to generate above-average returns by studying and researching cross currency pairs makes this corner of the currency market a potentially attractive one for investors.
  • In emerging market countries, the financial and banking systems are usually still forming (compared to those in more developed economies), and the middle-class population may be small or even nonexistent. These characteristics result in greater financial volatility and larger swings between economic prosperity and economic decline.
  • Emerging markets often have political systems that are less stable than those of developed nations, resulting in a greater possibility of governmental actions that adversely affect investors.
  • Many emerging market countries do not allow their currencies to float freely.
  • Emerging markets often suffer from illiquidity and large bid-ask spreads – conditions that are exacerbated during times of market volatility.
  • Individual investors who are unable or unwilling to trade emerging market currencies directly can still be exposed to the risk.
  • International investors with no intention of directly trading foreign currencies should understand the influence currency movements can have on foreign stock and bond holdings.

  1. Forex Currencies: Introduction
  2. Forex Currencies: Trading Strategies
  3. Forex Currencies: Ways To Trade
  4. Forex Currencies: The Four Major Pairs
  5. Forex Currencies: The EUR/USD
  6. Forex Currencies: The USD/JPY
  7. Forex Currencies: The GBP/USD
  8. Forex Currencies: The USD/CHF
  9. Forex Currencies: Commodity Pairs (USD/CAD, USD/AUD, USD/NZD)
  10. Forex Currencies: Currency Cross Rates
  11. Forex Currencies: Emerging Market Currencies
  12. Forex Currencies: Conclusion
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