A

PROJECT REPORT

ON

THE STUDY

OF

FOREX MARKET AND RISK MANAGEMENT

(SUBMITTED IN PARTIAL FULFILLMENT FOR THE AWARD OF

MASTERS DEGREE IN BUSINESS ADMINISTRATION)

UNDER THE GUIDENCE OF: SUBMITTED BY:

MS. PUJA MANN SHIKHA SRIDHAR
H.O.D., M.B.A. Dept., MBA/04/54
Mr. SANDEEP JAGLAN
Lecturer, M.B.A Dept. 2004-2006

N.C.COLLEGE OF ENGINEERING, ISRANA

(KURUKSHETRA UNIVERSITY, KURUKSHETRA)

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 ACKNOWLEDGEMENT
Every person who touches heights, reaches that level with the grand support,
blessings of his /her loved ones, guides, teachers, elders.He cant deny the fact that
they are the people behind his success. I am very thankful to the people who provided
me their help and support.
I owe my special thanks to Ms. PUJA MANN (HOD, MBA Department) for
her grand support, guidance, and for being a helping hand in every possible
way in this project.
I am very thankful to Mr. SANDEEP JAGLAN (Lecturer, MBA
Department) for devoting his precious time and for leaving no stone unturned
for the completion of this project.

I would also like to extend my thanks to my supporting faculty of

N.C.C.E., ISRANA, KURUKSHETRA UNIVERSITY.
THANK YOU ALL!

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 EXECUTIVE SUMMARY
The project undertaken is based on the study of foreign exchange market and risk
management in general as well as in the forex market.

FOREIGN EXCHANGE MARKET: Foreign exchange market is a market where

foreign currencies are bought & sold.
Foreign exchange market is a system facilitating mechanism through which one
countrys currency can be exchanged for the currencies of another country.
The purpose of foreign exchange market is to permit transfers of purchasing power
denominated in one currency to another i.e. to trade one currency for another.
The project covers various trading areas of forex market such as, spot market, forward
market, derivatives, currency futures, currency swaps etc. It helps in understanding
various trend patterns and trend lines. What considerations are kept in mind while trading
in forex market and why one should enter such market is studied under this project.

Another part of this project covers Risk Management in general as well as in forex
market. Risk Management is the process of measuring, or assessing risk and then
developing strategies to manage the risk. In general, the strategies employed include
transferring the risk to another party, avoiding the risk, reducing the negative effect of the
risk, and accepting some or all of the consequences of a particular risk.
A person has to face risk whether hes in business or is entering the forex market.So, he
uses various strategies and methods to overcome that risk.

The data used in this project has been collected from websites based on related topics and
various books of forex market and risk management. The information displayed may be
limited,as each and every aspect related with the project that is provided by the avilable
sources might not be complete in all respects.

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 OBJECTIVES OF THE STUDY

To study Forex market & Risk management in general as well as in forex

market.
To have a knowledge of different types of forex markets and various
quotations in Forex markets.
To study risk in the Forex market as well as volatility in Forex market.
To have a knowledge of how people trade in forex market.
To study the factors that force different types of people in different markets.
To study various strategies of risk management.

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 HISTORY
Brief history of Forex trading
Initially, the value of goods was expressed in terms of other goods, i.e. an economy based
on barter between individual market participants. The obvious limitations of such a
system encouraged establishing more generally accepted means of exchange at a fairly
early stage in history, to set a common benchmark of value. In different economies,
everything from teeth to feathers to pretty stones has served this purpose, but soon
metals, in particular gold and silver, established themselves as an accepted means of
payment as well as a reliable storage of value.

Originally, coins were simply minted from the preferred metal, but in stable political
regimes the introduction of a paper form of governmental IOUs gained acceptance during
the Middle Ages. Such IOUs, often introduced more successfully through force than
persuasion were the basis of modern currencies.

Before the First World War, most central banks supported their currencies with
convertibility to gold. Although paper money could always be exchanged for gold, in
reality this did not occur often, fostering the sometimes disastrous notion that there was
not necessarily a need for full cover in the central reserves of the government.

At times, the ballooning supply of paper money without gold cover led to devastating
inflation and resulting political instability. To protect local national interests, foreign
exchange controls were increasingly introduced to prevent market forces from punishing
monetary irresponsibility.

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In the latter stages of the Second World War, the Bretton Woods agreement was reached
on the initiative of the USA in July 1944. The Bretton Woods Conference rejected John
Maynard Keynes suggestion for a new world reserve currency in favour of a system built
on the US dollar. Other international institutions such as the IMF, the World Bank and
GATT were created in the same period as the emerging victors of WW2 searched for a
way to avoid the destabilising monetary crises which led to the war. The Bretton Woods
agreement resulted in a system of fixed exchange rates that partly reinstated the gold
standard, fixing the US dollar at USD35/oz and fixing the other main currencies to the
dollar - and was intended to be permanent.

The Bretton Woods system came under increasing pressure as national economies moved
in different directions during the sixties. A number of realignments kept the system alive
for a long time, but eventually Bretton Woods collapsed in the early seventies following
president Nixon's suspension of the gold convertibility in August 1971. The dollar was no
longer suitable as the sole international currency at a time when it was under severe
pressure from increasing US budget and trade deficits.

The following decades have seen foreign exchange trading develop into the largest global
market by far. Restrictions on capital flows have been removed in most countries, leaving
the market forces free to adjust foreign exchange rates according to their perceived
values.

But the idea of fixed exchange rates has by no means died. The EEC introduced a new
system of fixed exchange rates in 1979, the European Monetary System. This attempt to
fix exchange rates met with near extinction in 1992-93, when pent-up economic pressures
forced devaluations of a number of weak European currencies. Nevertheless, the quest for
currency stability has continued in Europe with the renewed attempt to not only fix
currencies but actually replace many of them with the Euro back in 2001.

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This project is fairly advanced now and the final structure and fixed levels were decided
in May 1998. After this a dangerous three-year period loomed, where devaluation
candidates could be attacked nearly without risk until the final introduction of the Euro in
this Millennium.

The lack of sustainability in fixed foreign exchange rates gained new relevance with the
events in South East Asia in the latter part of 1997, where currency after currency was
devalued against the US dollar, leaving other fixed exchange rates, in particular in South
America, looking very vulnerable.

But while commercial companies have had to face a much more volatile currency
environment in recent years, investors and financial institutions have found a new
playground. The size of foreign exchange markets now dwarfs any other investment
market by a large factor. It is estimated that more than USD1, 200 billion is traded every
day, far more than the world's stock and bond markets combined.

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 INTRODUCTION TO TRADING FOREX

Foreign Exchange

This short introduction explains the basics of trading Forex online, a brief explanation of
the markets and the major benefits of trading Forex online. There are also two scenarios
describing the implications of trading in a bear as well as bull market to better acquaint
you with some of the risks and opportunities in the largest and most liquid market in the
world.

OVERVIEW

Foreign exchange , forex or just Forex are all terms used to describe the trading of the
world's many currencies. The forex market is the largest market in the world, with trades
amounting to more than $1.5 trillion every day. This is more than one hundred times the
daily trading on the NYSE (New York Stock Exchange) . Most forex trading is
speculative , with only a few percent of market activity representing governments' and
companies' fundamental currency conversion needs.

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Unlike trading on the stock market, the forex market is not carried out by a central
exchange, but on the interbank market , which is thought of as an OTC (over the
counter ) market. Trading takes place directly between the two counterparts necessary to
make a trade, whether over the telephone or on electronic networks all over the world.
The main centres for trading are Sydney, Tokyo, London, Frankfurt and New York. This
worldwide distribution of trading centres means that the forex market is a 24-hour
market.

TRADING FOREX
A currency trade is the simultaneous buying of one currency and selling of another one.
The currency combination used in the trade is called a cross (for example, the Euro/US
Dollar, or the GB Pound/Japanese Yen.). The most commonly traded currencies are the
so-called majors EURUSD, USDJPY, USDCHF and GBPUSD.

The most important forex market is the spot market as it has the largest volume. The
market is called the spot market because trades are settled immediately or on the spot.
In practice this means within two banking days.

FORWARD OUTRIGHTS
For forward outrights, settlement on the value date selected in the trade means that even
though the trade itself is carried out immediately, there is a small interest rate calculation
left. This is because if you trade e.g. NOKJPY, you get almost 7% (annual) interest in
Norway and close to 0% in Japan. So, if you borrow money in Japan, to finance the trade
as you must have one currency with which to buy or another, and place it in Norway you
have a positive interest rate differential.
This differential has to be calculated and added to your account. You can have both a
positive and a negative interest rate differential, so it may work for or against you when
you make a trade. The interest rate differential doesn't usually affect trade considerations
unless you plan on holding a position with a large differential for a long period of time.
The interest rate differential varies according to the cross you are trading.

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TRADING ON MARGIN

Trading on margin means that you can buy and sell assets that represent more value than
the capital in your account. Forex trading is usually done with relatively little margin
since currency exchange rate fluctuations tend to be less than one or two percent on any
given day. To take an example, a margin of 2.0% means you can trade up to $500,000
even though you only have $10,000 in your account. In terms of leverage this
corresponds to 50:1, because 50 times $10,000 is $500,000, or put another way, $10,000
is 2.0% of $500.000. Using this much leverage gives you the possibility to make profits
very quickly, but there is also a greater risk of incurring large losses and even being
completely wiped out.

Therefore, it is inadvisable to maximize your leveraging as the risks can be very high.

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 RESEARCH METHODOLOGY
To define the research methodology, one has to go step by step. Any research
methodology involves following steps:
I. PROBLEM RECOGNITION
II. SURVEY OF LITERATURE
III. HYPOTHESIS FORMULATION
IV. RESEARCH DESIGN
V. SAMPLE DESIGN
VI. DATA COLLECTION
VII. ANALYSIS AND INTERPRETATION.

RESEARCH PROBLEM: A problem properly defined is half solved.

It is very necessary for any research that research problem should be recognized.
It is critical to any research.
Once problem is identified, it is to be formulated properly.
Initially the plan is stated in a broad and general way and then it is properly
defined in specific terms.
Problem formulation means defining a problem precisely.
In this study our research problem is: THE STUDY OF FOREX MARKET AND
RISK MANAGEMENT.

LITERATURE SURVEY: To do any research, we have to review/study previous

literature. For this we studied Journals, Magazines & Books of FOREX & RISK
MANAGEMENT and also the search engine www.google.com. To get good results in
any research, it is very essential that this review of literature should be carefully done.
The review of literature survey for this project includes the following:

Elliot Wave This is considered by most experienced traders to be the purest

form of technical analysis, since Elliott Wave analysis measures investor
psychology. The Wave shows how the psychology of traders, en masse, moves

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 from pessimism to optimism on a stock. This shift occurs in a specific and
measurable. Detecting where a stock is in the pattern can help a trader estimate
the future movements of the market.
K.B. Advisory Ltd. This program offers you daily technical analysis and trading
recommendations that are based on sophisticated trading strategies developed by
Keith Black. It boasts a successful three-year track record.

TRL (Technical Research Limited) TRL is a Specialist Foreign Exchange

Forecasting Service that can help you with forecasting and trading analysis in the
global foreign exchange markets. Technical Research Limited is rated the No. 1
FX Advisory Service by customers in 39 different countries around the world.

PronetAnalytics - This program is very powerful, and offers real-time analysis for
market professionals who are looking for inexpensive real-time data and exchange
feeds with standard and simple graphical trading support.

IFR (International Financing Review) IFR Forex Watch has real-time technical
analysis of the FX spot and options markets. It connects you with analysts in
London, New York, Boston, San Francisco, Singapore and Sydney. IFR
specializes in sifting through the vast array of information that clutters up current
market participants, and boiling it down to its bare essentials.

GMR (Global Market Research) Global Market Research provides price

forecasting and performance-based Trade Strategies for the FX market. You can
check out their daily newsletter, their FX Technicals and intraday updates and
analysis through the Web. Or you can have them E-mailed to you.

CHQREK.com This is a resource created by a market professional that has been

trading and writing about markets for nearly 20 years. You can capitalize on of his
experience and his analysis, especially technical analysis, and get a real trader's
take on current market action.
4CASTWEB 4CAST sends out key market information and analysis to market

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 participants worldwide, including central banks. It also has an on-line service that
gives you fundamental, political, strategic and technical analysis 24 hours a day

ForexTRM ForexTRM is a forex charting service that pairs 18 world and

regional currencies and tracks them every day. This means ForexTRM lets you to
trade any one of the 18 currencies against any of the other 17. It uses trademarked
Sigma Bands and Hurst Cycle Analysis to correctly identify overbought/sold
FOREX markets, where trading risk is at its lowest point in time, and which
currency pairs are ready to trade.

HYPOTHESIS FORMULATION: Hypothesis is any assumption for the research

effectively & efficiently. The hypothesis of my research is that:

Forex market is very volatile in nature.

It is changing day by day showing a wide growth in economy.
Different factors like speculation, hedging forces different people to enter in
different market.
Risk is there in Forex market and various risk management strategies are there to
manage it.

RESEARCH DESIGN: Research design is a conceptual structure within which research

is conducted.
A Research design is the arrangement of conditions for collection and analysis of
data in a manner that aims to combine relevance to the research purpose with economy
in procedures.
Research design can be of various types.
- Descriptive.
- Exploratory.
- Experimental.
- Analytical.
Research Design of my study is EXPLORATORY & ANALYTICAL.

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DATA COLLECTION: The data is of two types: PRIMARY AND SECONDRY. Data
are the facts presented to the researcher from the study environment. The method of data
collection in my study is SECONDRY only. Because I have collected all the data from
books and from websites.

WHY TRADE FOREX

24 hour trading

One of the major advantages of trading forex is the opportunity to trade 24 hours
a day from Sunday evening (20:00 GMT) to Friday evening (22:00 GMT). This
gives you a unique opportunity to react instantly to breaking news that is affecting
the markets.

Superior liquidity

The forex market is so liquid that there are always buyers and sellers to trade
with. The liquidity of this market, especially that of the major currencies, helps
ensure price stability and low spreads . The liquidity comes mainly from large and
smaller banks that provide liquidity to investors, companies, institutions and other
currency market players.

No commissions

The fact that forex is often traded without commissions makes it very attractive as
an investment opportunity for investors who want to deal on a frequent basis.
Trading the majors is also cheaper than trading other cross because of the high
level of liquidity. For more information on the trading conditions at Saxo Bank,
go to the Account Summary on your Client Station and open the section entitled
"Trading Conditions" found in the top right-hand corner of the Account Summary.

.50:1 Leverage

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 With a minimum account of USD 10,000, for example, you can trade up to USD
500,000. The USD 10,000 is posted on margin as a guarantee for the future
performance of your position

.Profit potential in falling markets

Since the market is constantly moving, there are always trading opportunities,
whether a currency is strengthening or weakening in relation to another currency.
When you trade currencies, they literally work against each other. If the EURUSD
declines, for example, it is because the U.S. dollar gets stronger against the Euro
and vice versa. So, if you think the EURUSD will decline (that is, that the Euro
will weaken versus the dollar), you would sell EUR now and then later you buy
Euro back at a lower price and take your profits. The opposite trading scenario
would occur if the EURUSD appreciates .

TWO WAYS TO TRADE

There are two basic approaches to analyzing currency markets, fundamental analysis and
technical analysis. The fundamental analyst concentrates on the underlying causes of
price movements, while the technical analyst studies the price movements themselves.

TECHNICAL ANALYSIS

Technical analysis focuses on the study of price movements. Historical currency data is
used to forecast the direction of future prices. The premise of technical analysis is that all
current market information is already reflected in the price of that currency; therefore,
studying price action is all that is required to make informed trading decisions. The
primary tools of the technical analyst are charts. Charts are used to identify trends and
patterns in order to find profit opportunities. The most basic concept of technical analysis

15
is that markets have a tendency to trend. Being able to identify trends in their earliest
stage of development is the key to technical analysis.

FUNDAMENTAL ANALYSIS
Fundamental analysis focuses on the economic, social and political forces that drive
supply and demand. Fundamental analysts look at various macroeconomic indicators
such as economic growth rates, interest rates, inflation, and unemployment. However,
there is no single set of beliefs that guide fundamental analysis. There are several theories
as to how currencies should be valued.

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 PSYCHOLOGY OF TRADING

Four Principles for Becoming a Better Trader

(A). Trade with a DISCIPLINED Plan:

The problem with many traders is that they take shopping more seriously than trading.
The average shopper would not spend $400 without serious research and
examination of the product he is about to purchase, yet the average trader would
make a trade that could easily cost him $400 based on little more than a feeling or
hunch. Be sure that you have a plan in place BEFORE you start to trade. The plan
must include stop and limit levels for the trade, as your analysis should encompass
the expected downside as well as the expected upside.

(B). Cut your losses early and Let your Profits Run:

This simple concept is one of the most difficult to implement and is the cause of most
traders demise. Most traders violate their predetermined plan and take their profits before
reaching their profit target because they feel uncomfortable sitting on a profitable
position. These same people will easily sit on losing positions, allowing the market to
move against them for hundreds of points in hopes that the market will come back. In
addition, traders who have had their stops hit a few times only to see the market go back
in their favor once they are out, are quick to remove stops from their trading on the belief
that this will always be the case. Stops are there to be hit, and to stop you from losing
more then a predetermined amount!

The mistaken belief is that every trade should be profitable. If you can get 3 out of 6
trades to be profitable then you are doing well. How then do you make money with only

17
half of your trades being winners? You simply allow your profits on the winners to run
and make sure that your losses are minimal.

(C).Do not marry your trades:

The reason trading with a plan is the #1 tip is because most objective analysis is done
before the trade is executed. Once a trader is in a position he/she tends to analyze the
market differently in the hopes that the market will move in a favorable direction rather
than objectively looking at the changing factors that may have turned against your
original analysis. This is especially true of losses. Traders with a losing position tend to
marry their position, which causes them to disregard the fact that all signs point towards
continued losses.

Do not bet the farm:

Do not over trade. One of the most common mistakes that traders make is leveraging
their account too high by trading much larger sizes than their account should prudently
trade. Leverage is a double-edged sword. Just because one lot (100,000 units) of currency
only requires $1000 as a minimum margin deposit, it does not mean that a trader with
$5000 in his account should be able to trade 5 lots. One lot is $100,000 and should be
treated as a $100,000 investment and not the $1000 put up as margin. Most traders
analyze the charts correctly and place sensible trades, yet they tend to over leverage
themselves. As a consequence of this, they are often forced to exit a position at the
wrong time. A good rule of thumb is to trade with 1-10 leverage or never use more than
10% of your account at any given time. Trading currencies is not easy (if it was, everyone
would be a millionaire!).

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 FOREX TRADING EXAMPLES

Example 1
An investor has a margin deposit with Saxo Bank of USD100,000.

The investor expects the US dollar to rise against the Swiss franc and therefore decides to
buy USD2,000,000 - his maximum possible exposure.

The Saxo Bank dealer quotes him 1.5515-20. The investor buys USD at 1.5520.

Day 1: Buy USD2,000,000 vs CHF 1.5520 = Sell CHF3,104,000.

Four days later, the dollar has actually risen to CHF1.5745 and the investor decides to
take his profit.

Upon his request, the Saxo Bank dealer quotes him 1.5745-50. The investor sells at
1.5745.

Day 5: Sell USD2,000,000 vs CHF 1.5745 = Buy CHF3,149,000.

As the dollar side of the transaction involves a credit and a debit of USD2,000,000, the
investor's USD account will show no change. The CHF account will show a debit of
CHF3,104,000 and a credit of CHF3,149,000. Due to the simplicity of the example and
the short time horizon of the trade, we have disregarded the interest rate swap that would
marginally alter the profit calculation.

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This results in a profit of CHF45,000 = approx. USD28,600 = 28.6% profit on the deposit
of USD100,000.

Example 2:

The investor follows the cross rate between the Euro and the Japanese yen. He believes
that this market is headed for a fall. As he is less confident of this trade, he does not fully
use the leverage available on his deposit. He chooses to ask the dealer for a quote in
EUR1,000,000. This requires a margin of EUR1,000,000 x 5% = EUR50,000 = approx.
USD52,500 (EUR/USD1.05).

The dealer quotes 112.05-10. The investor sells EUR at 112.05.

Day 1: Sell EUR1,000,000 vs JPY 112.05 = Buy JPY112,050,000.

He protects his position with a stop-loss order to buy back the euro at 112.60. Two days
later, this stop is triggered as the euro strengthens short term in spite of the investor's
expectations.

Day 3: Buy EUR1,000,000 vs JPY 112.60 = Sell JPY112,600,000.

The EUR side involves a credit and a debit of EUR1,000,000. Therefore, the EUR
account shows no change. The JPY account is credited JPY112.05m and debited
JPY112.6m for a loss of JPY0.55m. Due to the simplicity of the example and the short
time horizon of the trade, we have disregarded the interest rate swap that would
marginally alter the loss calculation.

This results in a loss of JPY0.55m = approx.USD5,300 (USD/JPY 105) = 5.3% loss on

the original deposit of USD100,000.

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 Fundamentals Every Trader Should
Know

Currency prices reflect the balance of supply and demand for currencies. Two primary
factors affecting supply and demand are interest rates and the overall strength of the
economy. Economic indicators such as GDP, foreign investment and the trade balance
reflect the general health of an economy and are therefore responsible for the underlying
shifts in supply and demand for that currency. There is a tremendous amount of data
released at regular intervals, some of which is more important than others. Data related to
interest rates and international trade is looked at the closest.

(1).Interest Rates

If the market has uncertainty regarding interest rates, then any bit of news regarding
interest rates can directly affect the currency markets. Traditionally, if a country raises its
interest rates, the currency of that country will strengthen in relation to other countries as
investors shift assets to that country to gain a higher return. Hikes in interest rates,
however, are generally bad news for stock markets. Some investors will transfer money
out of a country's stock market when interest rates are hiked, causing the country's
currency to weaken. Which effect dominates can be tricky, but generally there is a
consensus beforehand as to what the interest rate move will do. Indicators that have the
biggest impact on interest rates are PPI, CPI, and GDP. Generally the timing of interest

21
rate moves are known in advance. They take place after regularly scheduled meetings by
the BOE, FED, ECB, BOJ, and other central banks.

(2).International Trade

The trade balance shows the net difference over a period of time between a nations
exports and imports. When a country imports more than it exports the trade balance will
show a deficit, which is generally considered unfavorable.

For example, if U.S dollars are sold for other domestic national currencies (to pay for
imports), the flow of dollars outside the country will depreciate the value of the currency.
Similarly if trade figures show an increase in exports, dollars will flow into the United
States and appreciate the value of the currency. From the standpoint of a national
economy, a deficit in and of itself is not necessarily a bad thing. However, if the deficit is
greater than market expectations then it will trigger a negative price movement.

CURRENCY PAIRS

In the Forex market, trading is always in currency pairs, such as EUR/USD or USD/JPY.

Trading
Forex Symbol Currency Pairs
Terminologies
EUR/USD Euro / U.S. Dollar Euro
GBP/USD British Pound / U.S. Dollar Cable or Sterling
USD/JPY U.S. Dollar / Japanese Yen Dollar Yen
USD/CHF U.S. Dollar / Swiss Franc Dollar Swiss
U.S. Dollar / Canadian
USD/CAD Dollar Canada
Dollar
Australian Dollar / U.S. Aussie Dollar or
AUD/USD
Dollar Aussie
EUR/GBP Euro / British Pound Euro Sterling
EUR/JPY Euro / Japanese Yen Euro Yen
EUR/CHF Euro / Swiss Franc Euro Swiss
British Pound / Japanese
GBP/JPY Sterling Yen
Yen

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The base currency-the first currency listed in the currency pair-is the basis for the buy or
the sell. As an example, the US Dollar is the base currency for USD/JPY (US
Dollar/Japanese Yen). The current bid/ask price for USD/JPY could be 107.20/107.23,
which means you could buy $1 US for 107.23 Japanese Yen, or sell $1 US for 107.20
Japanese Yen.

RISK MANAGEMENT
Generally, Risk Management is the process of measuring, or assessing risk and then
developing strategies to manage the risk. In general, the strategies employed include
transferring the risk to another party, avoiding the risk, reducing the negative effect of the
risk, and accepting some or all of the consequences of a particular risk. Traditional risk
management focuses on risks stemming from physical or legal causes (e.g. natural
disasters or fires, accidents, death, and lawsuits). Financial risk management, on the other
hand, focuses on risks that can be managed using traded financial instruments. Intangible
risk management focuses on the risks associated with human capital, such as knowledge
risk, relationship risk, and engagement-process risk. Regardless of the type of risk
management, all large corporations have risk management teams and small groups and
corporations practice informal, if not formal, risk management.

In ideal risk management, a prioritization process is followed whereby the risks with the
greatest loss and the greatest probability of occurring are handled first, and risks with
lower probability of occurrence and lower loss are handled later. In practice the process
can be very difficult, and balancing between risks with a high probability of occurrence
but lower loss vs. a risk with high loss but lower probability of occurrence can often be
mishandled.

Intangible risk management identifies a new type of risk - a risk that has a 100%
probability of occurring but is ignored by the organization due to a lack of identification

23
ability. For example, knowledge risk occurs when deficient knowledge is applied.
Relationship risk occurs when collaboration ineffectiveness occurs. Process-engagement
risk occurs when operational ineffectiveness occurs. These risks directly reduce the
productivity of knowledge workers, decrease cost effectiveness, profitability, service,
quality, reputation, brand value, and earnings quality.

Intangible risk management allows risk management to create immediate value from the
identification and reduction of risks that reduce productivity.

Risk management also faces a difficulty in allocating resources properly. This is the idea
of opportunity cost. Resources spent on risk management could be instead spent on more
profitable activities. Again, ideal risk management spends the least amount of resources
in the process while reducing the negative effects of risks as much as possible.

The Forex Market is the largest and most liquid financial market in the world. Since
macroeconomic forces are one of the main drivers of the value of currencies in the global
economy, currencies tend to have the most identifiable trend patterns. Therefore, the
Forex market is a very attractive market for active traders, and presumably where they
should be the most successful. However, success has been limited mainly for the
following reasons:
Many traders come with false expectations of the profit potential, and lack the discipline
required for trading. Short term trading is not an amateur's game and is not the way most
people will achieve quick riches. Simply because Forex trading may seem exotic or less
familiar then traditional markets (i.e. equities, futures, etc.), it does not mean that the
rules of finance and simple logic are suspended. One cannot hope to make extraordinary
gains without taking extraordinary risks, and that means suffering inconsistent trading
performance that often leads to large losses. Trading currencies is not easy, and many
traders with years of experience still incur periodic losses. One must realize that trading
takes time to master and there are absolutely no short cuts to this process.

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The most enticing aspect of trading Forex is the high degree of leverage used. Leverage
seems very attractive to those who are expecting to turn small amounts of money into
large amounts in a short period of time.

However, leverage is a double-edged sword. Just because one lot ($10,000) of currency
only requires $100 as a minimum margin deposit, it does not mean that a trader with
$1,000 in his account should be easily able to trade 10 lots. One lot is $10,000 and should
be treated as a $100,000 investment and not the $1000 put up as margin. Most traders
analyze the charts correctly and place sensible trades, yet they tend to over leverage
themselves (get in with a position that is too big for their portfolio), and as a
consequence, often end up forced to exit a position at the wrong time.

For example, if your account value is $10,000 and you place a trade for 1 lot, you are in
effect, leveraging yourself 10 to 1, which is a very significant level of leverage. Most
professional money managers will leverage no more then 3 or 4 times. Trading in small
increments with protective stops on your positions will allow one the opportunity to be
successful in Forex trading.

UTILIZING STOP LOSS ORDER

A stop-loss is an order linked to a specific position for the purpose of closing that position
and preventing the position from accruing additional losses. A stop-loss order placed on a
Buy (or Long) position is a stop-loss order to Sell and close that position. A stop-loss
order placed on a Sell (or Short) position is a stop-loss order to Buy and close that
position. A stop-loss order remains in effect until the position is liquidated or the client
cancels the stop-loss order. As an example, if an investor is Long (Buy) USD at 120.27,
they might wish to put in a stop-loss order to Sell at 119.49, which would limit the loss
on the position to the difference between the two rates (120.27-119.49) should the dollar
depreciate below 119.49. A stop-loss would not be executed and the position would

25
remain open until the market trades at the stop-loss level. Stop-loss orders are an essential
tool for controlling your risk in currency trading.

RISK WARNING
Trading foreign currencies is a challenging and potentially profitable opportunity for
educated and experienced investors. However, before deciding to participate in the Forex
market, you should carefully consider your investment objectives, level of experience and
risk appetite. Most importantly, do not invest money you cannot afford to lose.
There is considerable exposure to risk in any foreign exchange transaction. Any
transaction involving currencies involves risks including, but not limited to, the potential
for changing political and/or economic conditions that may substantially affect the price
or liquidity of a currency. Moreover, the leveraged nature of FX trading means that any
market movement will have an effect on your deposited funds proportionally equal to the
leverage factor. This may work against you as well as for you. The possibility exists that
you could sustain a total loss of initial margin funds and be required to deposit additional
funds to maintain your position. If you fail to meet any margin call within the time
prescribed, your position will be liquidated and you will be responsible for any resulting
losses. Investors may lower their exposure to risk by employing risk-reducing strategies
such as 'stop-loss' or 'limit' orders.
There are also risks associated with utilizing an internet-based deal execution software
application including, but not limited, to the failure of hardware and software and
communications difficulties.

26
OBJECTIVES OF RISK MANAGEMENT
Mere survival;
Peace of mind;
Lower risk management costs and thus higher profits;
Fairly stable earnings;
Little or no interruption of operations;
Continued growth;
Satisfaction of the firms sense of social responsibility desire for a good image;
Satisfaction of externally imposed obligations.

STEPS IN THE RISK MANAGEMENT

PROCESS
The core of the process is a series of five steps:

Establish the context

Identify risks
Analyse risks
Evaluate risks
Treat risks

In parallel with the core process, communication & consultation is required to ensure
adequate information is provided and conclusions are disseminated. Monitoring and
review is an intrinsic part of the process required to ensure that the process is executed in
a timely fashion and the identification, analysis, evaluation and treatment are kept up to
date.

1. Establish the context

27
Establishing the context includes planning the remainder of the process and mapping out
the scope of the exercise, the identity and objectives of stakeholders, the basis upon
which risks will be evaluated and defining a framework for the process, and agenda for
identification and analysis.

2.Identification
After establishing the context, the next step in the process of managing risk is to identify
potential risks. Risks are about events that, when triggered, will cause problems. Hence,
risk identification can start with the source of problems, or with the problem itself.

Source analysis Risk sources may be internal or external to the system that is the
target of risk management. Examples of risk sources are: stakeholders of a
project, employees of a company or the weather over an airport.
Problem analysis Risks are related to identified threats. For example: the threat
of losing money, the threat of abuse of privacy information or the threat of
accidents and casualties. The threats may exist with various entities, most
important with shareholder, customers and legislative bodies such as the
government.

When either source or problem is known, the events that a source may trigger or the
events that can lead to a problem can be investigated. For example: stakeholders
withdrawing during a project may endanger funding of the project; privacy information
may be stolen by employees even within a closed network; lightning striking a Boeing
747 during takeoff may make all people onboard immediate casualties.

The chosen method of identifying risks may depend on culture, industry practice and
compliance. The identification methods are formed by templates or the development of
templates for identifying source, problem or event. Common risk identification methods
are:

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 Objectives-based Risk Identification Organizations and project teams have
objectives. Any event that may endanger achieving an objective partly or
completely is identified as risk.
Objective-based risk identification is at the basis of COSO's Enterprise Risk
Management - Integrated Framework
Scenario-based Risk Identification In scenario analysis different scenarios are
created. The scenarios may be the alternative ways to achieve an objective, or an
analysis of the interaction of forces in, for example, a market or battle. Any event
that triggers an undesired scenario alternative is identified as risk.
Taxonomy-based Risk Identification The taxonomy in taxonomy-based risk
identification is a breakdown of possible risk sources. Based on the taxonomy and
knowledge of best practices, a questionnaire is compiled. The answers to the
questions reveal risks.
Common-risk Checking In several industries lists with known risks are
available. Each risk in the list can be checked for application to a particular
situation.

3.Assessment
Once risks have been identified, they must then be assessed as to their potential severity
of loss and to the probability of occurrence. These quantities can be either simple to
measure, in the case of the value of a lost building, or impossible to know for sure in the
case of the probability of an unlikely event occurring. Therefore, in the assessment
process it is critical to make the best educated guesses possible in order to properly
prioritize the implementation of the risk management plan.

The fundamental difficulty in risk assessment is determining the rate of occurrence since
statistical information is not available on all kinds of past incidents. Furthermore,
evaluating the severity of the consequences (impact) is often quite difficult for immaterial
assets. Asset valuation is another question that needs to be addressed. Thus, best educated
opinions and available statistics are the primary sources of information.

29
Nevertheless, risk assessment should produce such information for the management of
the organisation that the primary risks are easy to understand and that the risk
management decisions may be prioritized. Thus, there have been several theories and
attempts to quantify risks. Numerous different risk formulae exist, but perhaps the most
widely accepted formula for risk quantification is:

Rate of occurrence multiplied by the impact of the event equals risk

Later research has shown that the financial benefits of risk management are not so much
dependent on the formulae used. The most significant factor in risk management seems to
be that

1.) risk assessment is performed frequently and

2.) it is done using as simple methods as possible.

In business it is imperative to be able to present the findings of risk assessments in

financial terms. Robert Courtney Jr. (IBM, 1970) proposed a formulae for presenting
risks in financial terms. The Courtney formulae was accepted as the official risk analysis
method for the US governmental agencies. The formulae proposes calculation of ALE
(Annualised Loss Expectancy) and compares the expected loss value to the security
control implementation costs (cost-benefit analysis).

Potential Risk Treatments

Once risks have been identified and assessed, all techniques to manage the risk fall into
one or more of these four major categories:

Transfer
Avoidance
Reduction (aka Mitigation)
Acceptance (aka Retention)

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Ideal use of these strategies may not be possible. Some of them may involve trade offs
that are not acceptable to the organization or person making the risk management
decisions.

Risk avoidance
Includes not performing an activity that could carry risk. An example would be not
buying a property or business in order to not take on the liability that comes with it.
Another would be not flying in order to not take the risk that the airplane were to be
hijacked. Avoidance may seem the answer to all risks, but avoiding risks also means
losing out on the potential gain that accepting (retaining) the risk may have allowed. Not
entering a business to avoid the risk of loss also avoids the possibility of earning the
profits.

Risk reduction

Involves methods that reduce the severity of the loss. Examples include sprinklers
designed to put out a fire to reduce the risk of loss by fire. This method may cause a
greater loss by water damage and therefore may not be suitable. Halon fire suppression
systems may mitigate that risk, but the cost may be prohibitive as a strategy.

Modern software development methodologies reduce risk by developing and delivering

software incrementally. Early methodologies suffered from the fact that they only
delivered software in the final phase of development; any problems encountered in earlier
phases meant costly rework and often jeopardized the whole project. By developing in
increments, software projects can limit effort wasted to a single increment. A current
trend in software development, spearheaded by the Extreme Programming community, is
to reduce the size of increments to the smallest size possible, sometimes as little as one
week is allocated to an increment.

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Risk retention

Involves accepting the loss when it occurs. True self insurance falls in this category. Risk
retention is a viable strategy for small risks where the cost of insuring against the risk
would be greater over time than the total losses sustained. All risks that are not avoided or
transferred are retained by default. This includes risks that are so large or catastrophic
that they either cannot be insured against or the premiums would be infeasible. War is an
example since most property and risks are not insured against war, so the loss attributed
by war is retained by the insured. Also any amounts of potential loss (risk) over the
amount insured is retained risk. This may also be acceptable if the chance of a very large
loss is small or if the cost to insure for greater coverage amounts is so great it would
hinder the goals of the organization too much.

Risk transfer

Means causing another party to accept the risk, typically by contract or by hedging.
Insurance is one type of risk transfer that uses contracts. Other times it may involve
contract language that transfers a risk to another party without the payment of an
insurance premium. Liability among construction or other contractors is very often
transferred this way. On the other hand, taking offsetting positions in derivatives is
typically how firms use hedging to financially manage risk.

Some ways of managing risk fall into multiple categories. Risk retention pools are
technically retaining the risk for the group, but spreading it over the whole group
involves transfer among individual members of the group. This is different from
traditional insurance, in that no premium is exchanged between members of the group up
front, but instead losses are assessed to all members of the group.

Create the plan

Decide on the combination of methods to be used for each risk. Each risk management
decision should be recorded and approved by the appropriate level of management. For

32
example, a risk concerning the image of the organization should have top management
decision behind it whereas IT management would have the authority to decide on
computer virus risks.

The risk management plan should propose applicable and effective security controls for
managing the risks. For example, an observed high risk of computer viruses could be
mitigated by acquiring and implementing anti virus software. A good risk management
plan should contain a schedule for control implementation and responsibile persons for
those actions. The risk management concept is old but is still not very effectively
measured

4.Implementation
Follow all of the planned methods for mitigating the effect of the risks. Purchase
insurance policies for the risks that have been decided to be transferred to an insurer,
avoid all risks that can be avoided without sacrificing the entity's goals, reduce others,
and retain the rest.

5.Review and evaluation of the plan

Initial risk management plans will never be perfect. Practice, experience, and actual loss
results, will necessitate changes in the plan and contribute information to allow possible
different decisions to be made in dealing with the risks being faced.

Risk analysis results and management plans should be updated periodically. There are
two primary reasons for this:

1. to evaluate whether the previously selected security controls are still applicable
and effective, and
2. to evaluate the possible risk level changes in the business environment. For
example, information risks are a good example of rapidly changing business
environment.

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 Foreign Exchange Risk Management
Guidelines
Your business is open to risks from movements in competitors' prices, raw material
prices, competitors' cost of capital, foreign exchange rates and interest rates, all of which
need to be (ideally) managed.

This section addresses the task of managing exposure to Foreign Exchange movements.

These Risk Management Guidelines are primarily an enunciation of some good and
prudent practices in exposure management. They have to be understood, and slowly
internalized and customized so that they yield positive benefits to the company over time.

It is imperative and advisable for the Apex Management to both be aware of these
practices and approve them as a policy. Once that is done, it becomes easier for the
Exposure Managers to get along efficiently with their task.

(1).Exposure Analysis

An Exposure can be defined as a Contracted, Projected or Contingent Cash Flow whose

magnitude is not certain at the moment. The magnitude depends on the value of variables
such as Foreign Exchange rates and Interest rates.

The company will determine and analyze its Foreign Exchange exposures.

Determination:
The following cash flows/ transactions will be considered for the purpose of exposure
management.

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Variable / Cash Flows Transaction Type
Both Capital and Revenue in
Contracted Foreign Currency Cash Flows nature
Foreign Interest Rates, whether Floating or All Interest Payments/
Fixed Receipts
Cash Flows from Hedge Transactions All Open hedge transactions

Projected/ Contingent Cash Flows Both Capital and Revenue in

nature
Cash Flows above $100,000/- in value will be brought to the notice of the
Exposure Manager, as soon as they are projected.
It is the responsibility of the Exposure Manager to ensure that he receives the
requisite information on exposures from various sections of the company in time.

Analysis
These exposures will be analyzed and the following aspects will be studied:

Foreign Currency Cash Flows/ Schedules

Variability of Cash flows - how certain are the amounts and/ or value dates?
Inflow-Outflow Mismatches / Gaps
Time Mismatches / Gaps
Currency Portfolio Mix
Floating / Fixed Interest Rate ratio

(2). MARKET FORECASTS

After determining its Exposures, the company has to form an idea of where the market is
headed. The company will focus on forecasts for the next 6 months, as forecasts for
periods beyond 6 months can be unreliable.

35
The focus of the Apex Management is to be aware of :

the Direction or the Big Trend in rates.

the underlying assumptions behind the forecasts
the Probability that can be assigned to the forecast coming true
the possible extent of the move

The Risk Appraisal exercise and Benchmarking decisions will be based on such
forecasts.

(3).RISK APPRAISAL
This exercise is aimed at determining where the company's exposures stand vis--vis
market forecasts.
The following Risks will be considered.
1.Risk to the Exposure or Value at Risk (VAR)
Given a particular view or forecast, VAR tries to determine by how much the companys
underlying cash flows are affected.

2. Forecast Risk
What is the likelihood of the rate actually moving to xx.xxxx and what is the likelihood
of a forecast going wrong. It is imperative to know this before deciding on a Benchmark
and devising a hedging strategy.

3. Market and Transaction Risk

This will take into consideration the risks attached with each particular market and the
likelihood of a transaction not going through smoothly. For instance,

The Rupee is given to sudden swings in sentiment, whereas the Deutschemark is

generally more predictable.
The monetary and time costs of hedging with a nationalized bank are generally
higher than with a private/ foreign bank.

36
 4. Systems Risk
The risks that arise through gaps or weaknesses in the Exposure Management system.
For example:

Reporting Gap where there are delays/ errors in reporting exposures to the
Exposure Management cell
Implementation Gap where there is a gap between the decision to hedge and the
implementation of such hedge decision.

(4). BENCHMARKING
This exercise aims to state where the company would like its exposures to reach.

1. The company will set a Benchmark for its Exposure Management practices.
2. The Benchmarks will be set for 6 months periods.
3. The Benchmark will reflect and incorporate the following:

i. The Objective of Exposure Management, or in other words, "Should Exposure

Management be conducted on a Profit Centre or Cost Centre basis?"
ii. The Forecasts discussed and agreed upon earlier. Mathematically, the Benchmark
should be the Probabilistic Expectation of the rate in question.
iii. The Forecast risk, Market and Transaction risk, and Systems risk as determined
earlier.
iv. Room for error in keeping with the Stop Loss Policy to be decided

4. The Benchmark will be realistic and achievable.

Suggestions:
Companies whose exposures are of long-term Capital nature can look to manage them on
a Profit Centre basis, since the exposures are not open to day-to-day business risks.
Companies whose exposures are of short-term Revenue nature should manage them on a
Cost Centre basis, since the exposures impact the P&L Account directly.

A small note on the Profit/ Cost centre concept:

37
Profit Centre under this concept, the Exposure Manager is required to generate a NET
profit on the exposure over time. This is an aggressive stance implying a
high degree of risk appetite on the part of Apex Management. A company
with a strong position in its daily bread and butter business can afford to
take some financial risks and can opt for this concept.

The Benchmarks under a Profit-Centre concept would take the form of The
total cost of a foreign currency loan should be reduced by at least 25 bp over
a one year period, from the forecasted rate of ex. % p.a..
Cost Centre under this concept, the Exposure Manager would be required to ensure that
the cashflows of the company are not adversely affected beyond a certain
point. This is a defensive strategy, implying a lower risk appetite. A
company whose cash-flows are volatile, or whose underlying business is not
on a very sound footing would be advised to adopt this concept.

The Benchmarks under a Cost-Centre concept would take the form of

Foreign Exchange fluctuations should add no more than x% to the cost of
Imported Raw Material over and above the budgeted cost.

(5). HEDGING

This is the most visible and glamorized part of the Exposure Management function.
However, the Trader is like the Driver in a car rally, who needs to follow the general
directions of the Navigator.

1. Hedging strategies will be designed to meet the Exposure Management objectives, as

represented by the Benchmarks
2. The Exposure Management Cell will be accorded full operational freedom to carry out
the hedging function on a day to day basis
3. Hedges will be undertaken only after appropriate Stop-Loss and Take-Profit levels
have been predetermined
4. The company will use all hedging techniques available to it, as per need and

38
requirement. In this regard, it will pass a Board Resolution authorizing the use of the
following:

Rupee-Foreign Currency Forward Contracts

Cross Currency Forward Contracts
Forward-to-Forward Contracts
FRAs
Currency Swaps
Interest Rate Swaps
Currency Options
Interest Rate Options
Others, as may be required.

Suggestion:
Indian companies with sizeable US Dollar denominated exposures are extremely
vulnerable to sudden drastic moves in the USD-INR rate. They can, to an extent, insulate
themselves from such shocks by undertaking hedges in currencies other than Rupee-
Dollar.

For instance, a Dollar payable can be hedged by selling a currency (say Sterling Pound) in
order to buy Dollars, instead of selling the Rupee. The choice of currency would, of
course, depend on the trend and forecast for the currency(s) at that point of time.

It is easier and safer to generate profits from a Cross-Currency Forward Contract and a Rs
1 Lac profit thereon is equivalent to saving a 10 paisa depreciation in the Rupee (on USD
1 million)

(6). STOPLOSS

39
Exposure Management should not be undertaken without having a Stop-Loss policy in
place. A Stop-Loss policy is based on the following two fundamental principles:
1. To err is human
2. A stitch in time saves nine

It is appropriate to recount here some words from a speech Dr Alan Greenspan, Chairman
of the US Federal Reserve, delivered in December 1997, on the Asian financial crisis. He
says,

There is a significant bias in political systems of all varieties to substitute hope (read,
wishful thinking) for possibly difficult pre-emptive policy moves. There is often denial
and delay in instituting proper adjustments Reality eventually replaces hope and the cost
of the delay is a more abrupt and disruptive adjustment than would have been required if
action had been more preemptive.

Whether an Exposure is hedged or not, it is assumed that the decision to hedge/ not to
hedge is backed by a View or Forecast, whether implicit or explicit. As such, Stop Loss is
nothing but a commitment to reverse a decision when the view is proven to be wrong.

Suggestions:
Stop Losses should be activated when
Critical levels in the rate being monitored are reached, which clearly tell that the
view held has been proven wrong.
The factors/ assumptions behind a view either change or are proven wrong.
The Exposure Manager should be accorded flexibility to set appropriate Stop-
Losses for each trade.

The Exposure Manager should, however, make sure he has set a stop-loss for
positions he enters into, on an a priori basis.

While Benchmarks will be based upon the Big Trend and will incorporate a certain
amount of room for error, the Exposure Manager should be careful to not violate the
Benchmark on the wrong side.

40
 (7). REPORTING AND REVIEW

There needs to be continuous monitoring whether the Exposures are headed where they
are intended to reach. As such, the Exposure Management activities need to be reported
and reviewed.

Reporting
The Exposure Manager will prepare the following Reports on a regular basis:

Report Name What it shows Periodicity

MTM Report The Mark-to-Market Profit/ Loss status on Open Forward
Daily, closing
Contracts
Exposure NAV The All-in-all exchange/ interest rate achieved on each
Fortnightly
Report Exposure, and profitability vis--vis the Benchmark
VAR Report Expected changes in overall Exposure due to forecasted
Monthly
exchange/ interest rate movements

Review
A monthly Review meeting will consider the following:

Issue On the basis of Points to be reviewed

Exposure Exposure NAV Report Is the Benchmark being met/
Performance bettered?
What are the chances of the
Benchmark being violated on the
wrong side?
Reasons for the Benchmark
being violated on the wrong side
Market Reviews of market developments Is the Big Trend still in place? Or
Forecasts of market movements
Situation has it changed?
Does the Benchmark need to be
Benchmarking The above two
changed?
Hedging MTM and Exposure NAV Reports Is the strategy working well? Or

41
 does it need to be fine-tuned/
Strategy
overhauled?
Operational Operational problems to be solved
Exposure Manager's experiences
issues

(8). CONCLUSION

Exposure Management is an essential part of business and should be viewed with

Objectivity. It is neither a license to print money nor is it a cause for getting trapped in a
Fear Psychosis, and should be viewed with the same clarity of vision as, say, Production
or Marketing is viewed.

Having said that, it should be remembered that

All that has been stated above cannot start happening straightaway
Installing Hedging, Reporting and Review systems that work takes time and effort
There will be a Learning Curve to be overcome when setting Benchmarks
There will be initial losses, which should be viewed as what they are - initial
losses.

There has to be a long-term commitment to Exposure Management, because it is today an

activity, which no company can afford to ignore.

WHY HEDGE FOREIGN CURRENCY

RISK
International commerce has rapidly increased as the internet has provided a new and
more transparent marketplace for individuals and entities alike to conduct international
business and trading activities. Significant changes in the international economic and
political landscape have led to uncertainty regarding the direction of foreign exchange
rates. This uncertainty leads to volatility and the need for an effective vehicle to hedge

42
foreign exchange rate risk and/or interest rate changes while, at the same time, effectively
ensuring a future financial position.

Each entity and/or individual that has exposure to foreign exchange rate risk will have
specific foreign exchange hedging needs and this website can not possibly cover every
existing foreign exchange hedging situation. Therefore, we will cover the more common
reasons that a foreign exchange hedge is placed and show you how to properly hedge
foreign exchange rate risk.

Foreign Exchange Rate Risk Exposure - Foreign exchange rate risk exposure is
common to virtually all who conduct international business and/or trading. Buying and/or
selling of goods or services denominated in foreign currencies can immediately expose
you to foreign exchange rate risk. If a firm price is quoted ahead of time for a contract
using a foreign exchange rate that is deemed appropriate at the time the quote is given,
the foreign exchange rate quote may not necessarily be appropriate at the time of the
actual agreement or performance of the contract. Placing a foreign exchange hedge can
help to manage this foreign exchange rate risk.

Interest Rate Risk Exposure - Interest rate exposure refers to the interest rate
differential between the two countries' currencies in a foreign exchange contract. The
interest rate differential is also roughly equal to the "carry" cost paid to hedge a forward
or futures contract. As a side note, arbitragers are investors that take advantage when
interest rate differentials between the foreign exchange spot rate and either the forward or
futures contract are either to high or too low. In simplest terms, an arbitrager may sell
when the carry cost he or she can collect is at a premium to the actual carry cost of the
contract sold. Conversely, an arbitrager may buy when the carry cost he or she may pay is
less than the actual carry cost of the contract bought. Either way, the arbitrager is looking
to profit from a small price discrepancy due to interest rate differentials.

Foreign Investment / Stock Exposure - Foreign investing is considered by many

investors as a way to either diversify an investment portfolio or seek a larger return on
investment(s) in an economy believed to be growing at a faster pace than investment(s) in

43
the respective domestic economy. Investing in foreign stocks automatically exposes the
investor to foreign exchange rate risk and speculative risk. For example, an investor buys
a particular amount of foreign currency (in exchange for domestic currency) in order to
purchase shares of a foreign stock. The investor is now automatically exposed to two
separate risks. First, the stock price may go either up or down and the investor is exposed
to the speculative stock price risk. Second, the investor is exposed to foreign exchange
rate risk because the foreign exchange rate may either appreciate or depreciate from the
time the investor first purchased the foreign stock and the time the investor decides to
exit the position and repatriates the currency (exchanges the foreign currency back to
domestic currency). Therefore, even if a speculative profit is achieved because the
foreign stock price rose, the investor could actually net lose money if devaluation of the
foreign currency occurred while the investor was holding the foreign stock (and the
devaluation amount was greater than the speculative profit). Placing a foreign exchange
hedge can help to manage this foreign exchange rate risk.

Hedging Speculative Positions - Foreign currency traders utilize foreign exchange

hedging to protect open positions against adverse moves in foreign exchange rates, and
placing a foreign exchange hedge can help to manage foreign exchange rate risk.
Speculative positions can be hedged via a number of foreign exchange hedging vehicles
that can be used either alone or in combination to create entirely new foreign exchange
hedging strategies.

How To Trade Forex Successfully: Forex

Trading Risk Management

Trading the Markets

44
Trading the markets for speculation purposes is a challenging task that numerous
amounts of people have embarked on. Do you know anyone who successfully makes
money trading? The answer is most likely no. If you do I recommend you become as
friendly as possible with the person and learn everything you can from him, unless he is
charging for his services. That usually means he is not a successful trader.

With the type of leverage that is offered in the futures, options and forex markets, I
personally find it hard to believe that anyone who has a successful system that is right for
them will be too eager to teach it. Why should they teach if they can be trading the
daylights out of it and be making millions with the 400:1 leverage that some forex
platforms offer.

On the other hand numerous people have made millions trading. Look at the list of CTAs
on IASG.com, look at John W. Henry, Max Ansbacher, Warren Buffet, Peter Lynch and
all the Market Wizards. I recommend reading the market wizards book for some
inspiration.

The problem is that most traders go into trading with the wrong attitude. Have you ever
heard this phrase I am tired of working I need to trade to get rich. It takes 7 years to
complete medical school and there is no green arrow red arrow system for performing
heart surgery.

Trading will pay you much more than doctors make so you should expect to have to do
more work than doctors do for a longer period of time to get wealthy and become a
market wizard. While you start and practice it is imperative that you do so at a low cost,
meaning you dont blow out your account on bad trades due to poor risk management.

It has been hypothesized that, with proper risk management, a simple system like flipping
a coin to buy or sell could be successful. However having the slightest edge should
enhance the traders chances a great deal. By edge, I mean something that will make the
trader make more money than he looses. An edge can be discretional or algorithmic as
long as the trader makes money in the long run.

45
A perfect example of this is the game of blackjack. The house has a very slight edge less
than not more than 2%. But by repetitive play they consistently end up profitable. This is
because they have a set approach, and edge, and they dont get emotional when a player
goes on a winning streak. Good traders put themselves in the position of a casino.

Traders can make money discretionally by following support and resistance levels,
watching the volume, size and market action. Or, traders can create a trading system by
back-testing a certain edge. Calculate the systems expectancy, develop trading and risk
management rules, and follow those rules religiously to generate profits. Numerous
people will try to sell systems.

It is very important that with any system traders create a reevaluation point. By
reevaluation point I mean a point where the trader starts to question the systems
effectiveness and begins to look for other systems that he expects to fair profitable over
time. The reevaluation point should be decided upon before trading begins. It should be
based on the back tested data, and you must take into account concepts that we will
discuss such as a drawdown, consecutive loosing sessions, reward risk ratio.

TOOLS FOR MANAGING RISK IN

FOREX MARKET

THE SPOT MARKET

46
 1. Introduction

The spot market accounts for nearly a third of global foreign exchange turnover. It can be
broadly divided into two tiers:

The interbank market where currency is bought and sold for delivery and settlement
within two days, with the banks acting as wholesalers or market makers.

The retail market made up of private traders, who deal over the telephone or the internet
through intermediaries (brokers).

The forex market has no centralized exchanges. All trades are over-the-counter deals,
agreed and settled by individual counterparties known to one another. The forex market is
truly global and operates 24 hours a day, Monday to Friday. Daily trading commences in
Wellington, New Zealand and follows the sun to (inter alia) Sydney, Tokyo, Hong Kong,
Singapore, Bahrain, Frankfurt, Geneva, Zurich, Paris, London, New York, Chicago and
Los Angeles before starting again.

2. Currency pairs and the rate of exchange

Every foreign exchange transaction is an exchange between a pair of currencies. Each

currency is denoted by a unique three-character International Standardization
Organization (ISO) code (e.g. GBP represents sterling and USD the US dollar). Currency
pairings are expressed as two ISO codes separated by a division symbol (e.g. GBP/USD),
the first representing the base currency and the other the secondary currency.

The rate of exchange is simply the price of one currency in terms of another. For example
GBP/USD = 1.5545 denotes that one unit of sterling (the base currency) can be
exchanged for 1.5545 US dollars (the secondary currency). The base currency is the one
that you are buying or selling. This elementary point is often lost on beginners.

Exchange rates are usually written to four decimal places, with the exception of Japanese
yen which is written to two decimal places. The rate to two (out of four) decimal places is

47
known as the big figure while the third and fourth decimal places together measure the
points or pips. For instance, in GBP/USD = 1.5545 the big figure is 1.55 while the
45 (i.e. the third and fourth decimal places) represents the points.

2.1. Bid offer spread

As with other financial commodities, there is a buying price (offer or ask price) and a
selling price (bid price). The difference is known as the bid-offer spread or the
spread.

The spread is written in a particular format, best demonstrated by way of an example.

GBP/USD = 1.5545/50 means that the bid price of GBP is 1.5545 USD and the offer
price is 1.5550 USD. The spread in this case is 5 points.

2.2.The major pairings

All pairings with the US dollar are known as the majors. The big four majors are: -
EUR/USD denoting euro/USdollar
GBP/USD denoting sterling/US dollar (known as cable)
USD/JPY denoting US dollar /Japanese yen
USD/CHF denoting US dollar/Swiss franc.

2.3.Crossrates

Pairings of non-US dollar currencies are known as crosses. We can derive cross
exchange rates for GPB, EUR, JPY and CHF from the aforementioned major pairs.
Exchange rates must be consistent across all currencies, or else it will be possible to
roundtripand make riskless profits.
The following major exchange rates (red) imply the cross rates (blue). An illustration
of how cross rates are computed is given in Appendix A.

3. Buying equals selling

48
Every purchase of the base currency implies a reciprocal sale of the secondary currency.
Likewise, sale of the base currency implies the simultaneous purchase of the secondary
currency.
For example, when I sell 1 GBP, I am simultaneously buying 1.5545 USD. Likewise,
when I buy 1 GBP, I am simultaneously selling 1.5550 USD.
We can express this equivalence by inverting the GBP/USD exchange rate and rotating
the bid and offer reciprocals, to derive the USD/GBP rate i.e.
USD/GBP = (1/1.5550) bid; (1/1.5545) offer = 0.6431/33
This means that the bid price of one USD is 0.6431 GBP (or 64.31p) and the offer price
of one USD is 0.6433 GBP (or 64.33p). Note that USD has now become the base
currency and that the spread is 2 points.

4. Practical spot trading

4.1 Units of trading lots

As we have already seen, every forex transaction is an exchange of one currency for
another. The basic unit of trading for private investors is known as a lot which consists
of 100,000 units of the base currency (although some brokers may arrange trading in
mini-lots).
Using the data in Table A, the purchase of a single lot of GBP/USD will involve the
purchase of 100,000 GBP at a price of 1.5852 USD = 158,520 USD.
Similarly, the sale of a single lot of GBP/USD entails the sale of 100,000 GBP at 1.5847
USD = 158,470 USD.

4.2 Margin

A private investor who purchases a GBP/USD lot does not have to put down the full
value of the trade (158,520 USD). Instead, the buyer is required to put down a deposit
known as margin which enables the investor to gear up the trade size to institutional
level.

49
Since the sale of one currency involves the simultaneous purchase of another, the seller of
a GBP/USD lot will have bought a volume of USD, and will also have to put down
margin for the value of the deal (158,470 USD).
The normal margin requirement is between 1% and 5% of the underlying value of the
trade.

The currency denomination depends on the brokerage through which you execute your
trade. If you are dealing through an American broker (say online), then it is likely that
you will have to deposit margin in USD even if you are resident in the UK.

With 5,000 USD in your margin account and with margin requirement of 2.5%, you can
open positions worth 200,000 USD. Your positions will be valued continuously. If the
funds in your margin account drop below the minimum required to support your open
positions, then you may be asked to provide additional funds. This is known as a margin
call.
If your trade is denominated in a currency other than that accepted by the
broker, you will have to convert your gains and losses back into an acceptable currency.
For example, if you trade a USD/JPY pair, then your gains and losses will be
denominated in JPY. If your brokers home currency is USD, then your profits and losses
will be converted back to USD at the relevant USD/JPY offer rate.

4.3 Closing out

An open position is one that is live and ongoing. As long as the position is open, its value
will fluctuate in accordance with the exchange rate in the market. Any profits and losses
will exist on paper only and will be reflected in your margin account.

To close out your position, you conduct an equal and opposite trade in the same currency
pair. For example, if you have gone long in one lot of GBP/USD (at the prevailing offer
price) you can close out that position by subsequently going short in one GBP/USD lot
(at the prevailing bid price).
Your opening and closing trades must the conducted through the same intermediary. You
cannot open a GBP/USD position with Broker A and close it out through Broker B.

50
5. Worked example

5.1 Betting on a rise

Assume that you start with a clean slate and that the current GPB/USD rate is 1.5847/52.
You expect the pound to appreciate against the US dollar, so you buy a single lot of
100,000 GBP at the offer price of 1.5852 USD.
The value of the contract is 100,000 X $1.5852 = $158, 520.

The broker wants margin of 2.5% in USD, so you must ensure that you deposit at least
2.5% of 158,520 USD = 3,963 USD in your margin account
GBP/USD duly appreciates to 1.6000/05 and you decide to close out your position by
selling your sterling for US dollars at the bid rate. Your gain is:
100,000 X (1.6000 1.5852) USD = 1,480 USD, the equivalent of 10 USD per point
Your rate of return is 1,480/3,963 = 37.35%, on an exchange rate movement of less than
1%. This illustrates the positive effect of buying on margin.
Had GBP/USD fallen to 1.5700/75, your loss would have been:
100,000 X (1.5852 1.5700) USD = 1,520 USD, a return of 38.35%
The lesson is that margin trading magnifies your rate of profit or loss.

6. Screen-based spot trading

The technology for trading forex has evolved from the telephone and telex (not forgetting
voice dealing) through to the modern Electronic Broking System (EBS) that enables
straight through processing (STP) with integrated quotation, transactional and
administrative functionality.
EBS-type technology is now available to individual, private investors who can receive
live, streaming data from and transact directly through their chosen brokers. The private
dealer, however, does not deal on the highly competitive inter-bank market with its tight
spreads. In practice, brokers add points to the price spread in lieu of dealing commission.

A private trader requires:

51
 A margin account broker with internet access and a fast connection
A computer terminal capable of running several programmes simultaneously
Proprietary software to open and manage positions and to display technical analysis
tools.
Sufficient monitors to handle market data, submit dealing instructions, display technical
analysis; and for keeping tabs on open positions, managing orders (e.g. stop loss, TPO,
limit etc.) and viewing the state of the margin account. For demonstrations of the kind of
proprietary software available, visit Pronet Analytics (www.pronetanalytics.com) and
Nostradamus (www.nostradamus.co.uk)

Pronet Analytics provides the only chart-based software package approved by

Association of Cambistes Internationale, the governing body of professional forex
trading.

From early 2003, a new spot trading software package from US provider Gain Capital
will be available through the UK online margin broker Easy2Trade
(www.easy2trade.com), better known for its futures online global trading platform. We
will build our required margin into the bid-offer spread, says Easy2Trade chief executive
David Wenman. It will be free to use after that.
Before you splash out on the full kit, why not does a test drive by renting a dealing desk
at an organization like TraderHouse (www.traderhouse.net).

7. Fundamental and technical analysis

Without the apparatus for making sense of the currency market, any trade represents a
pure gamble. There are two broad schools of analysis, which are not mutually exclusive.

7.1Fundamentalanalysis
Fundamental analysis is the application of micro and macroeconomic theory to markets,
with the aim of predicting future trends. So what fundamental forces drive currency
markets?

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(a). The balance of trade: Currencies that are associated with long term trade
surpluses will tend to strengthen against those associated with persistent deficits - simply
because there is net buying of surplus currencies corresponding to the excess of exports
over imports.
Trends are important too. An improving balance of trade should cause the relevant
currency to appreciate relative to those associated with a deteriorating or stable balance
of trade.
(b). Relative inflation rates: If country A is suffering a higher rate of price inflation
than country B, then As currency ought to weaken relative to Bs in order to restore
purchasing power parity.

(c). Interest rates: International capital flows seek the highest inflation-adjusted
returns, creating additional demand for high real interest-rate currencies and pushing up
their rates of exchange.

(d). Expectations and speculation: Markets anticipate events. Speculation on, say,
the future rate of inflation may be enough to move the exchange rate - long before the
actual trend becomes apparent.

It should be understood that these economic forces act in concert. It is a supremely

difficult task, however, to establish where the sum of interacting economic forces will
take the market. The solution, some argue, lies in technical analysis.

7.2Technical analysis

Technical analysis is concerned with predicting future price trends from historical price
and volume data. The underlying axiom of technical analysis is that all fundamentals
(including expectations) are factored into the market and are reflected in exchange rates.
The tools of technical analysis are now freely available to private investors in support of
their trading decisions. It cannot be stressed too heavily, however, that such tools are only
estimators and are not infallible.
The following is the briefest of introductions to the technical analytical tools used to

53
identify trends and recurring patterns in a volatile marketplace. Aspiring forex dealers are
advised to undergo proper training in technical analysis, although true proficiency comes
with practice, endurance and experience.

TREND CLASSIFICATIONS

DRAWING TRENDLINES
The basic trendline is one of the simplest technical tools employed by the trader, and is
also one of the most valuable in any type of technical trading.
For an up trendline to be drawn, there must be at least two low points in the graph where
the 2nd low point is higher than the first.
A price low is the lowest price reached during a counter trend move.

BULLISH TREND LINES

54
TREND, ANALYSIS AND TIMING

55
Markets don't move straight up and down. The direction of any market at any time is
either Bullish (Up), Bearish (Down), or Neutral (Sideways). Within those trends, markets
have countertrend (backing & filling) movements. In a general sense "Markets move in
waves", and in order to make money a trader must catch the wave at the right time.

DRAWING VARIOUS TRENDLINES

DRAWING TRENDLINES

56
 TRENDLINES
Drawing Trendlines will help to determine when a trend is changing.

TREND

The direction of trend is absolutely essential to trading and analyzing the market.

57
In the Foreign Exchange (FX) Market it is possible to profit from UP and Down
movements, because of the buying of one currency and selling against the other currency
e.g. Buy US Dollar Sell German Mark. ex. Up Trend chart.

8. Tips for aspiring spot traders

Andy Shearman, a director of forex day-trading service Trader House Network (UK) has
Seven Pillars of Wisdom for aspiring forex traders: -

58
(1) Dont be under-capitalized or you will lose trading opportunities.
(2) Dont suspend your daily (successful) economic activity while you are learning to
trade currencies.
(3) Get an education. Make time to practice and to check markets every day.
(4) Decide what your monetary goals are and devise a trading plan to realize them.
Remember that you have overheads and that risk is involved. Your target remuneration
must not only be realistic but must include a risk premium.
(5) Choose a good broker preferably one that feeds live, streaming prices to your
screen.
(6) Be decisive. Over-caution will cost you money. You cant make any profits if you
dont trade. Dont agonize too long over a deal and trust your instincts.

(7) Watch your back. Never leave your trading screen even momentarily without putting
stop losses in place. A pee is a long time in the forex market.
Trading forex is a bit like life in a combat zone, says Shearman. There are bouts of
frenetic, exhilarating and even panic-stricken activity interspersed with periods of
uneventful ness. No one can physically trade 24 hours a day. You need your rest and
recreation.
Trader House has come up with a novel solution. It has set up a tutorial centre (with a
night school for those with a day job) and a dealing room at the Cottesmore Country Club
in West Sussex. You can play hard in the forex markets and chill out later in the bar, the
gym, the pool or on the golf course - all for the rental of a dealing desk. Who needs the
Lottery!

CURRENCY FORWARD

59
A forward contract that locks-in the price an entity can buy or sell currency on a future
date.

In currency forward contracts, the contract holders are obligated to buy or sell the
currency at a specified price, at a specified quantity, and on a specified future date. These
contracts cannot be transferred.
Also known as "outright forward currency transaction."

CURRENCY FUTURES
A transferable futures contract that specifies the price at which a specified currency can
be bought or sold at a future date. Currency future contracts allow investors to hedge
against foreign exchange risk. Since these contracts are marked-to-market daily, investors
can--by closing out their position--exit from their obligation to buy or sell the currency
prior to the contract's delivery date.

A currency future, also FX future or foreign exchange future, is a futures contract to

exchange one currency for another at a specified date in the future at a price (exchange
rate) that is fixed on the last trading date. Typically, one of the currencies is the US dollar.
The price of a future is then in terms of US dollars per unit of other currency. This can be
different from the standard way of quoting in the spot foreign exchange markets.

The trade unit of each contract is then a certain amount of other currency, for instance
EUR 125,000. Most contracts have physical delivery, so for those held at the end of the
last trading day, actual payments are made in each currency. However, most contracts are
closed out before that.

Example
Peter buys 10 September CME
Euro FX Futures, at 1.2713
USD/EUR. At the end of the day,
the futures close at 1.2784

60
 USD/EUR. The change in price is
0.0071 USD/EUR. As each
contract is over EUR 125,000, and
he has 10 contracts, his profit is
USD 8,875. As with any future,
this is paid to him immediately.
More generally, each change of
0.0001 USD/EUR (the minimum
tick size), is a profit or loss of
USD 12.5 per contract.

Investors use these futures contracts to hedge against foreign exchange risk. They can
also be used to speculate and, by incurring a risk, attempt to profit from rising or falling
exchange rates. Investors can close out the contract at any time prior to the contract's
delivery date.

Currency futures were first created at the Chicago Mercantile Exchange (CME) in 1972,
less than one year after the system of fixed exchange rates was abandoned along with the
gold standard. Some commodity traders at the CME did not have access to the inter-bank
exchange markets in the early seventies, when they believed that significant changes
were about to take place in the currency market. They established the International
Monetary Market (IMM) and launched trading in seven currency futures on May 16,
1972. Today, the IMM is a division of CME. In the second quarter of 2005, an average of
332,000 contracts with a notional value of USD 43 billion were traded every day. Most of
these are traded electronically nowadays [1].

The Advantages of Trading Currency Futures

Currency futures trade nearly 24 hours. Traders looking to profit from market
movements can act any time of the day or night during the trading week to take
advantage of changing market conditions. CME currency futures trade virtually
24 hours per day during the trading week, and XPRESSTRADE gives you the
ability to trade in the open-outcry pits or on the Globex electronic platform, day
or night.
FX markets are deep and liquid. Traders can enter the market and exit positions
efficiently. Since their inception, CME currency futures have produced an active

61
 trading environment through which customers collectively place trades worth up
to $32.1 billion (CME single-day notional volume record, December 9, 2002).
The success of FX futures has created a robust trading environment.

Currency futures offer diversification. In today's equity market environment,

diversification is a critical factor in individual portfolio management. Because exchange
rates march to their own beat, currency futures can offer valuable diversification for an
investment portfolio that has equity market risk. On a historical basis, changes in
exchange rates have had very low correlations with price movements in stock market
values and interest rates. This lack of any systematic relationship can lower portfolio risk
and generate positive returns when other markets are in a depressed state.

OPTIONS ON FUTURE CONTRACTS

INTRODUCTION

Options on futures contracts have added a new dimension to futures trading. Like futures,
options provide price protection against adverse price moves. Present-day options trading
on the floor of an exchange began in April 1973 when the Chicago Board of Trade
created the Chicago Board Options Exchange (CBOE) for the sole purpose of trading
options on a limited number of New York Stock Exchange-listed equities. Options on

62
futures contracts were introduced at the CBOT in October 1982 when the exchange began
trading Options on U.S. Treasury Bond futures.

What Are Options?

There are two basic types of options on futures contracts: "calls" and "puts." A call
option on futures contracts conveys the right (but not the obligation) to the buyer to
purchase a specific futures contract (for example, a corn contract for a December 1997
delivery month) at a particular price during a specified period of time. A put option
conveys the right (but not the obligation) to the buyer to sell a specific futures contract at
a given price during a specified period of time. The price for which the futures contract
can be brought (in the case of a call option) or sold (in the case of a put option) under the
terms of the option contract is referred to as the option's strike price or exercise price.
The date on which an option expires--the date after which it can no longer be exercised--
is the option's expiration date. The price of a specific option, that is, the amount of money
paid by the buyer of an option and received by the seller of any option, is the option
premium.

Where Are Options Traded?

Options are traded on the same exchanges as those of the underlying futures contracts.
There are 11 different commodity exchanges in the U.S. as well as abroad. The major
domestic agricultural crops are traded on the Chicago Board of Trade, the Kansas City
Board of Trade, the Minneapolis Grain Exchange, the New York Cotton Exchange, and
the Coffee, Sugar and Cocoa Exchange.

How Are Options Traded?

Options contracts are traded in much the same manner as their underlying futures
contracts. There are several important factors to remember when trading options. The
most important one is that trading a call option is completely separate and distinct from
trading a put option. If producers buy or sell a call option, it does not in any way involve

63
a put option. Trading a put does not involve a call option. Calls and puts are separate
contracts, not opposite sides of the same transaction.

At any given time, there is simultaneous trading in a number of different call and put
options--different in terms of delivery months and strike prices. Option delivery months
are typically the same as those of the underlying futures contract.

Strike prices are listed in predetermined multiples for each commodity. The listed strike
prices will include an at- or near-the-money option, at least five strikes below, and at least
nine strikes above the at-the-money option.

At-the-money is defined as an option whose strike price is equal--or approximately

equal--to the current market price of the underlying futures contract. The five lower
strikes would follow normal intervals. The nine higher strikes would include five normal
intervals above the at-the-money option(s), plus an additional four strikes listed in even
strikes that are double the normal interval.

As prices increase or decrease, additional strike prices are listed as needed so that there
are always five strike prices listed in normal intervals and four strike prices in double
intervals above the current futures price, and at lease five strike prices below the current
futures prices.

An important difference between futures and options is that trading in futures contracts is
based on prices, while trading in options is based on premiums. The premium depends on
market conditions such as volatility, time until expiration, and other economic variables
affecting the value of the underlying futures contract. How various factors influence
premiums and how and to what extent market price declines are offset by option profits
are among the topics to discuss in detail with a broker.

The premium is the only part of the option contract negotiated in the trading pit; all other
contract terms are predetermined. For an option buyer, the premium represents the
maximum amount that he or she can lose, since the buyer is limited only to his initial
investment. For an option seller, however, the premium represents the maximum amount

64
he or she can gain, since the option seller faces the possibility of the option being
exercised against him or her. When an option is exercised, the futures position assigned to
an option seller will almost always be a losing one, since only an in-the-money option
will normally be exercised by the option buyer.

Reasons for using Options

Options differ considerably from futures. When used prudently, options can be of
immense importance, especially in attempting to preserve the value of an existing fixed-
income portfolio.
To many in the financial markets, options are considered "insurance" against adverse
price movements while offering the flexibility to benefit from possible favorable price
movement.
The reasons for using options on futures are reflected in the structure of an option
contract.
First, an option, when purchased, gives the buyer the right, but not the obligation, to buy
or sell a specific amount of a specific commodity at a specific price within a specific
period of time. By comparison, a futures contract requires a buyer or seller to perform
under the terms of the contract if an open position is not offset before expiration.

Second, the decision to exercise the option is entirely that of the buyer.
Third, the purchaser of the option can lose no more than the initial amount of money
invested (premium). That is not the case, however, for the buyer of a futures contract.

Finally, an option buyer is never subject to margin calls. This enables the purchaser to
maintain a market position, despite any adverse moves without putting up additional
funds.

Options Terminology

65
There are several important terms the would-be user of options on futures should
understand. They include:

call option:
Gives the buyer the right, but not the obligation, to buy a specific futures contract
at a predetermined price within a limited period of time.
put option:
Gives the buyer the right, but not the obligation, to sell a specific futures contract
at a predetermined price within a limited period of time.
holder:
The buyer of the option.
premium:
The dollar amount paid by the buyer of the option to the seller.
writer:
The option seller.
strike price:
The predetermined price at which a given futures contract can be bought or sold.
Also called the exercise price, these levels are set at regular intervals.

For example, if Treasury bond futures were at 79-00, T-bond option strike prices
would be at 74, 76, 78, 80, 82, and 84.
at-the-money:
An option is at-the-money when the underlying futures price equals, or nearly
equals, the strike price. For example, a T-bond put or call option is at-the-money
if the option strike price is 78 and the price of the Treasury bond futures contract
is at, or near, 78-00.

in-the-money:
A call option is in-the-money when the underlying futures price is greater than the
strike price. For example, if Treasury bond futures are at 80-00 and the T-bond

66
 call option strike price is 78, the call is in-the-money. The put option is in-the-
money when the strike price of the option is greater then the price of the
underlying futures contract. For example, if the strike price of the put option is 80
and T-bond futures are trading at 77-00, the put option is in-the-money.
out-of-the-money:
A call option is out-of-the-money if the strike price is greater than the underlying
futures price. For example, if T-bond futures are at 80-00 and the T-bond call
option has an 82 strike price, the option is out-of-the-money. The put option is
out-of-the-money if the underlying futures price is greater then the strike price.
For example, if T-bond futures are at 77-00, and the T-bond put option strike price
is 76, the put option is out-of-the-money.

Call option Put option

In-the-money Futures > Strike Futures < Strike

At-the money Futures = Strike Futures = Strike
Out-of-the-money Futures < Strike Futures > Strike

Options are considered "wasting assets." In other words, they have a limited life because
each expires on a certain day, although it may be weeks, months, or years away. The
expiration date is the last day the option can be exercised, otherwise it expires worthless.

For every option buyer there is an option seller. In other words, for every call buyer there
is a call seller; for every put buyer, a put seller. The buyer of the option, unlike the buyer
of a futures contract, need not worry about margin calls. However, the seller of the option
is generally required to post margin.

If an option position is covered, the seller holds an offsetting position in the underlying
commodity itself or a futures contract. For example, the seller of a Treasury bond call
option would be covered if he actually owned cash market U.S. Treasury bonds or was
long the Treasury bond futures contract.
If the writer did not hold either, he would have an uncovered or "naked" position. In such

67
instances, margin would be required because the seller would be obligated to fulfill terms
of the option contract in the event the contract is exercised by the buyer. It is imperative,
therefore, that the seller demonstrate the ability to meet any potential contractual
obligations beforehand. In addition, the seller of uncovered options on interest rate
futures assumes the potential for significant losses.

Motives for Buying and Selling Options

One may be a buyer or seller of call or put options for a variety of reasons.
A call option buyer, for example, is bullish. That is, he or she believes the price of the
underlying futures contract will rise. If prices do rise, the call option buyer has three
courses of action available.
The first is to exercise the option and acquire the underlying futures contract at the strike
price. The second is to offset the long call position with a sale and realize a profit. The
third, and least acceptable, is to let the option expire worthless and forfeit the unrealized
profit.

The seller of the call option expects futures prices to remain relatively stable or to decline
modestly. If prices remain stable, the receipt of the option premium enhances the rate of
return on a covered position.

If prices decline, selling the call against a long futures position enables the writer to use
the premium as a cushion to provide downside protection to the extent of the premium
received.

For instance, if T-bond futures were purchased at 80-00 and a call option with an 80
strike price was sold for 2-00, T-bond futures could decline to the 78-00 level before there
would be a net loss in the position (excluding, of course, margin and commission
requirements).
However, should T-bond futures rise to 82-00, the call option seller forfeits the
opportunity for profit because the buyer would likely exercise the call against him and
acquire a futures position at 80-00 (the strike price).

68
The perspectives of the put buyer and put seller are completely different. The buyer of the
put option believes prices for the underlying futures contract will decline. For example, if
a T-bond put option with a strike price of 82 is purchased for 2-00, while T-bond futures
also are at 82-00, the put option will be profitable for the purchaser to exercise if T-bond
futures decline below 80-00.

In many instances, puts will be purchased in conjunction with a long cash or long T-bond
futures position for "insurance" purposes. For instance, if an institution is long T-bond
futures at 82-00 and a T-bond put option with an 82 strike is purchased for 2-00, the
futures contract could, theoretically, fall to zero and the put option holder could exercise
the option for the 82 strike price, assuming the option had not yet expired.

The seller of put options on fixed-income securities believes interest rates will stay at
present levels or decline. In selling the put option, the writer, of course, receives income.
However, if interest rates rise, the buyer of the put option can require the writer to take
delivery of the underlying instrument at a price greater than that in the new market
environment.
Since an option is a wasting asset, an open position must be closed or exercised,
otherwise the option expires worthless. The chart below illustrates what happens to the
buyer and the seller after an option is exercised.

Futures Positions After Option Exercise

Call option Put option

Buyer assumes Long T-bond/note Short T-bond/note

futures position futures position
Seller assumes Short T-bond/note Long T-bond/note
futures position futures position

69
 Option Premium Valuation

The price (value) of an option premium is determined competitively by open outcry

auction on the trading floor of the CBOT. The premium is affected by the influx of buy
and sell orders reaching the exchange floor. An option buyer pays the premium in cash to
the option seller. This cash payment is credited to the seller's account.

Prices for T-bond and T-note futures contracts are quoted differently from the options
premiums on these futures. Options on these contracts are quoted in 64th of a point.
Therefore, a quote of -01 in options means 1/64, in futures, 1/32.

The option premium has two components: "intrinsic value" and "time value." The
intrinsic value is the gross profit that would be realized upon immediate exercise of the
option. In other words, intrinsic value is the amount by which the portion is in-the-
money. (An option that is out-of-the- money or at-the-money has no intrinsic value.)

For example, in December, a June Treasury bond futures contract is priced at 82-00,
while the June 80 call is priced at 3 10/64. The intrinsic value of the option is 2-00:

Bond futures 82-00

Option strike price 80-00

Intrinsic value 2-00

Time value reflects the probability the option will gain in intrinsic value or become
profitable to exercise before it expires.

Time value is determined by subtracting intrinsic value from the option premium:

Time value = Option premium - Intrinsic value

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 = 3 10/64 - 2-00
= 1 10/64

Several other factors also have an impact on the premium. One is the relationship
between the underlying futures price and strike price. The more an option is in-the-
money, the more it is worth.

A second factor is volatility. Volatile prices of the underlying commodity can stimulate
option demand, enhancing the premium. The greater the volatility, the greater the chance
the option premium will increase in value and the option will be exercised; thus, buyers
pay more while writers demand higher premiums.

A third factor affecting the premium is time until expiration. Since the underlying value
of the futures contract changes more within a longer time period, option premiums are
subject to greater fluctuation.

Some parallels can be drawn between the time value component of an option premium
and the premium charged for an automobile insurance policy. The longer the term of the
policy, the greater the probability a claim will be made by the policyholder. This, of
course, presents a greater risk to the insurance company. To compensate for this increased
risk, the insurer charges a greater premium.

CURRENCY SWAPS
Currency Swaps are derivative products that help manage exchange rate and interest rate
exposure on long-term liabilities. A Currency Swap involves exchange of interest
payments denominated in two different currencies for a specified term, along with
exchange of principals. The rate of interest in each leg could either be a fixed rate, or a
floating rate indexed to some reference rate, like the LIBOR.

Consider a corporate who has a USD loan with interest rate at a spread over 6-month
LIBOR. The corporate faces the following risks:

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 Currency risk: If the rupee depreciates against USD, it will be more expensive for
the corporate to service its loan
Interest rate risk: An upward movement in LIBOR would increase the cost of
servicing the loan

In order to hedge its risks the corporate can enter into a currency swap where it moves
from USD floating rate loan to a INR fixed rate loan. The currency swap could be
represented as follows:

Currency Swaps therefore enable a swap into both, a different currency and a different
interest rate basis. Some of the advantages of currency swaps are:

Enables moving a liability from one currency into another

Can be customized
Can be reversed at any time (at a cost or benefit)
Off Balance Sheet, and does not change the terms of the existing liability.

Currency swaps can be structured to synthetically move liabilities in one currency to

another depending on which risks and what costs are acceptable. The interest rates on
either of the legs can be floating or fixed.

It is also possible to move rupee liabilities into foreign currencies through currency
swaps. Corporates wishing to match currency of loan repayments with currency of
receivables (for example, exporters having a long tenor Rupee liabilities) could enter into
such swaps. Corporates could also undertake such swaps if they wish to take advantage
of lower interest rates in return for exchange rate risk.

Consider a corporate that has an INR 25 Crores loan at 9% fixed rate, repayable bullet at
the end of two years. If this corporate wishes to swap its liability into a USD loan, the
structure of the loan would be as follows:

The cash flows in this swap would be as follows:

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.At inception

None. The loan is notionally converted from INR into USD at current USDINR spot rate.
These will then be the principal amounts on which the interest will be computed.

.Every 6 months

Company pays to the bank 6 month USD LIBOR plus a spread on the notional USD
principal

Company receives from the bank Rupee interest @ 9% on the notional INR principal

.At maturity

Company receives INR principal from IDBI Bank.

Pays USD principal to the IDBI Bank.

The company therefore gains from a lower interest rate loan, for which it bears the cost of
INR depreciation against USD during the tenor of the swap.

Currency swaps can be used to move from any currency to any other desired currency
and interest rate.

For example, a corporate could swap its INR liability into JPY to benefit from the low
JPY interest rates. The risk of adverse JPY/USD exchange rate movement can be limited
to desired levels at a price. Such products can be customized to suit specific corporate
interest.

It is also possible to structure swaps to hedge specific risks. For example, there could be
swap such that only the principal amount of a foreign currency loan is protected at
current exchange rates (Principal Only Swap). Coupon swaps swaps involving only
interest payments and no principal amounts is another such variant.

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THE EXCHANGE OF PRINCIPAL AT INCEPTION AND AT
MATURITY

In an interest rate swap, we were concerned exclusively with the exchange of cash flows
relating to the interest payments on the designated notional amount. However, there was
no exchange of notional at the inception of the contract. The notional amount was the
same for both sides of the currency and it was delineated in the same currency. Principal
exchange is redundant.

However, in the case of a currency swap, principal exchange is not redundant. The
exchange of principal on the notional amounts is done at market rates, often using the
same rate for the transfer at inception as is employed at maturity.

For example, consider the US-based company ("Acme Tool & Die") that has raised
money by issuing a Swiss Franc-denominated Eurobond with fixed semi-annual coupon
payments of 6% on 100 million Swiss Francs. Upfront, the company receives 100 million
Swiss Francs from the proceeds of the Eurobond issue (ignoring any transaction fees,
etc.). They are using the Swiss Francs to fund their US operations.

ADVANTAGES OF USING CURRENCY SWAP

.FLEXIBILITY

Currency swaps give companies extra flexibility to exploit their comparative advantage
in their respective borrowing markets.

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Interest rate swaps allow companies to focus on their comparative advantage in
borrowing in a single currency in the short end of the maturity spectrum vs. the long-end
of the maturity spectrum.

Currency swaps allow companies to exploit advantages across a matrix of currencies and
maturities.

The success of the currency swap market and the success of the Eurobond market are
explicitly linked.

.EXPOSURE

Because of the exchange and re-exchange of notional principal amounts, the currency
swap generates a larger credit exposure than the interest rate swap.

Companies have to come up with the funds to deliver the notional at the end of the
contract. They are obliged to exchange one currency's notional against the other
currency's notional at a fixed rate. The more actual market rates have deviated from this
contracted rate, the greater the potential loss or gain.

This potential exposure is magnified with time. Volatility increases with time.
The longer the contract, the more room for the currency to move to one side
or other of the agreed upon contracted rate of principal exchange.

This explains why currency swaps tie up greater credit lines than regular interest rate
swaps.

PRICING

We price or value currency swaps in the same way that we learned how to price interest
rate swaps, using a discounted cash flow analysis having obtained the zero coupon
version of the swap curves.

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Generally, currency swaps transact at inception with a net present value of zero. Over the
life of the instrument, the currency swap can go in-the-money, out-of-the-money or it can
stay at-the-money.

CONCLUSION

Currency swaps allow companies to exploit the global capital markets more efficiently.
They are an integral arbitrage link between the interest rates of different developed
countries.

The future of banking lies in the securitization and diversification of loan portfolios. The
global currency swap market will play an integral role in this transformation. Banks will
come to resemble credit funds more than anything else, holding diversified portfolios of
global credit and global credit equivalents with derivative overlays used to manage the
variety of currency and interest rate risk.

Derivatives

Commodities whose value is derived from the price of some underlying asset like
securities, commodities, bullion, currency, interest level, stock market index or anything

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else are known as Derivatives.

In more simpler form, derivatives are financial security such as an option or future whose
value is derived in part from the value and characteristics of another security, the
underlying asset.

It is a generic term for a variety of financial instruments. Essentially, this means you buy
a promise to convey ownership of the asset, rather than the asset itself. The legal terms of
a contract are much more varied and flexible than the terms of property ownership. In
fact, its this flexibility that appeals to investors.

When a person invests in derivative, the underlying asset is usually a commodity, bond,
stock, or currency. He bet that the value derived from the underlying asset will increase
or decrease by a certain amount within a certain fixed period of time.

Futures and options are two commodity traded types of derivatives. An options
contract gives the owner the right to buy or sell an asset at a set price on or before a given
date. On the other hand, the owner of a futures contract is obligated to buy or sell the
asset.

The other examples of derivatives are warrants and convertible bonds (similar to shares
in that they are assets). But derivatives are usually contracts. Beyond this, the derivatives
range is only limited by the imagination of investment banks. It is likely that any person
who has funds invested, an insurance policy or a pension fund, that they are investing in,
and exposed to, derivatives wittingly or unwittingly.

Shares or bonds are financial assets where one can claim on another person or
corporation; they will be usually be fairly standardized and governed by the property of
securities laws in an appropriate country.

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On the other hand, a contract is merely an agreement between two parties, where the
contract details may not be standardised.

Derivatives securities or derivatives products are in real terms contracts rather than solid
as it fairly sounds.

SIGNIFICANCE OF THE STUDY

Forex market is changing day by day showing a wide growth in the economy.
Forex market is more volatile in nature.

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 There are different factors like speculation, hedging which force different people to
enter in different markets.
There is risk in Foreign market and various Risk management strategies are there to
manage it.
Risk management is done in order to minimize the adverse effects of potential losses
at the least possible cost.
How a person manages risk in foreign market, it depends upon his needs and
perception.
How a person trades in foreign market.

Due to all these factors, one can interpret that foreign market plays a significant role in
economy of any country and risk is managed by different strategies in foreign market to
maximize profit in the long run and that give a boost to the economy.

ANALYSIS AND INTERPRETATIONS

Understanding Strategy and Analysis

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All successful traders have a carefully thought out system that they follow to make
profitable trades. This system is generally based on a strategy that allows them to find
good trades. And the strategy is based on some form of market analysis. Successful
traders need some way to interpret and even predict some of the movements of the
market.

There are two basic approaches to analysing market movements, in both equity markets
and the FOREX market. These are technical analysis and fundamental analysis. However,
technical analysis is much more likely to be used by traders. Still, its good to have an
understanding of both types of analysis, so that you can decide which type would work
best for your system.

Fundamental Analysis
In fundamental analysis, you are basically valuing either a business, for equity markets,
or a country, for FOREX. If you think it's hard enough to value one company, you should
try valuing a whole country. It can be quite difficult to do, but there are indicators that can
be studied to give insight into how the country works. A few indicators you might want to
study are: Non-farm payrolls, Purchasing Managers Index (PMI), Consumer Price Index
(CPI), Retail Sales, and Durable Goods.

Most traders in the FOREX market only use fundamental analysis to predict long-term
trends. However, some traders do trade short-term based on the reactions to different
news releases. There are also quite a variety of meetings where you can get quotes and
commentary that can affect markets just as much as any news release or indicator report.
These meetings are often discuss interest rates, inflation, and other issues that have the
ability to affect currency values.

Even changes in how things are worded in statements addressing these types of issues,
such as the Federal Reserve chairman's comments on interest rates, can cause volatility in

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the market. Two important meetings that you should watch for are the Federal Open
Market Committee and the Humphrey Hawkins Hearings.

Just by reading the reports and examining the commentary, a FOREX fundamental
analyst can get a better understanding of most long-term market trends. Keeping up on
these developments will also allow short-term traders to profit from extraordinary
happenings. If you do decide to follow a fundamental strategy, you will want to keep an
economic calendar handy at all times so you know when these reports are released. Your
broker may also be able to provide you with real-time access to this kind of information.

Technical Analysis
Just like their counterparts in the equity markets, technical analysts in the FOREX market
analyze price trends. The only real difference between technical analysis in FOREX and
technical analysis in equities is the time frame. FOREX markets are open 24 hours a day.

Because of this, some forms of technical analysis that factor in time have to be modified
so that they can work in the 24-hour FOREX market. Some of the most common forms of
technical analysis used in FOREX are: Elliott Waves, Fibonacci studies, Parabolic SAR,
and Pivot points.

A lot of technical analysts combine technical indicators to make more accurate

predictions. (The most common tendency is to combine Fibonacci studies with Elliott
Waves.) Others prefer to create entire trading systems in an effort to repeatedly locate
similar buying and selling condition.

FINDINGS

Trading by Numbers Eighteen Tips

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You can never have too many tips or tricks up your sleeve when you are trading. Most of
the tips Im including here are received wisdom, trading truisms that you should
remember. They apply to all markets, but are particularly useful in a volatile and
technical market like the FOREX

1. Pay attention to the market. Exit and enter trades based on market information.
Dont wait for a price you think the currency should hit when the market has
changed direction on you.

2. There are times when, due to a lack of liquidity or excessive volatility, you should
not trade at all. On a similar note, never trade when you are sick. You cant count
on yourself to be alert to the shifts of the markets, and make good decisions.
3. Trading systems that work in an up market may not work in a down market, and a
system that works for trending markets, or for range bound markets may not work
in other markets. Have a system for each type of market.
4. Up market and down market patterns are ALWAYS there, but you have to look for
the dominant trends. Always select trades that move with the trends
5. During the blowout stage of the market, either up or down, the risk managers are
usually issuing margin call position liquidation orders. They don't generally check
the screen to see whats overbought or oversold; they just keep issuing liquidation
orders. Make sure you stay out of their way.
6. Trust your instincts. If something feels wrong about a trade, dont make it. Its
better to be superstitious than to loose money.
7. Rumour is king. Buy when you hear the rumour, sell when you hear the news.
8. The first and last ticks are always the most expensive. Get in the market late, and
out early. And never trade in the direction of a gap, either opening or closing.
9. When everyone else is in, it's time for you to get out. If a stock or currency is
overbought, its time to exit your position.
10. Dont worry about missing out on an opportunity to trade. There will always be
another good one just around the corner. If the trade you are considering doesnt
meet all your entry signals but it seems to good to pass up, remember, youre
never going to run out of trades you can make.

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11. Dont get too confident. No one can predict the market with 100% accuracy. You
need to always expect the unexpected. If you become uneasy, or the market
becomes choppy, exit your trades.
12. Don't turn three losing trades in a row into six. When youre off, turn off the
screen, do something else. Often the best way to break a streak of consecutive
loses is to not trade for a day.
13. But, don't stop trading when youre on a winning streak.
14. Measure your success by the profit made in a day, not on a trade. Its even better
to measure it over two or three days. A successful traders goal is to make money,
not to win on every trade.
15. Scalpers reduce the number of variables affecting market risk by being in a
position only for a few seconds. Day traders reduce market risk by being in trades
for minutes. If you convert a scalp or day trade into a position trade, you
probably didnt analyze the risks of the trade properly.
16. There is no secret to understanding the market. You can spend much of your
valuable time and money looking for these kinds of secrets. Its better to take the
time to create a solid trading system, and realize that the secret to success is hard
work.
17. Never ask for someone else's opinion, they probably didnt do as much homework
as you did anyways.
18. When the market is going up, say it out loud. When the market is going down, say
that out loud too. Youll be amazed at how hard it is to say what is going on right
in front of you when you want it the market to be doing something else.

HOW TO AVOID TYPICAL PITFALLS AND START

MAKING MORE MONEY IN YOUR FOREX TRADING

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1. Trade pairs, not currencies - Like any relationship, you have to know both
sides. Success or failure in forex trading depends upon being right about both
currencies and how they impact one another, not just one.
2. Knowledge is Power - When starting out trading forex online, it is essential that
you understand the basics of this market if you want to make the most of your
investments.
3. Unambitious trading - Many new traders will place very tight orders in order to
take very small profits. This is not a sustainable approach because although you
may be profitable in the short run (if you are lucky), you risk losing in the longer
term as you have to recover the difference between the bid and the ask price
before you can make any profit and this is much more difficult when you make
small trades than when you make larger ones.
4. Over-cautious trading - Like the trader who tries to take small incremental
profits all the time, the trader who places tight stop losses with a retail forex
broker is doomed. As we stated above, you have to give your position a fair
chance to demonstrate its ability to produce. If you don't place reasonable stop
losses that allow your trade to do so, you will always end up undercutting yourself
and losing a small piece of your deposit with every trade.
5. Independence - If you are new to forex, you will either decide to trade your own
money or to have a broker trade it for you. So far, so good. But your risk of losing
increases exponentially if you either of these two things:

Interfere with what your broker is doing on your behalf (as his strategy might
require a long gestation period);

Seek advice from too many sources - multiple input will only result in multiple
losses. Take a position, ride with it and then analyse the outcome - by yourself, for
yourself.

6. Tiny margins - Margin trading is one of the biggest advantages in trading forex
as it allows you to trade amounts far larger than the total of your deposits.
However, it can also be dangerous to novice traders as it can appeal to the greed

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 factor that destroys many forex traders. The best guideline is to increase your
leverage in line with your experience and success.
7. No strategy - The aim of making money is not a trading strategy. A strategy is
your map for how you plan to make money. Your strategy details the approach
you are going to take, which currencies you are going to trade and how you will
manage your risk. Without a strategy, you may become one of the 90% of new
traders that lose their money.
8. Trading Off-Peak Hours - Professional FX traders, option traders, and hedge
funds posses a huge advantage over small retail traders during off-peak hours
(between 2200 CET and 1000 CET) as they can hedge their positions and move
them around when there is far small trade volume is going through (meaning their
risk is smaller). The best advice for trading during off peak hours is simple - don't.
9. The only way is up/down - When the market is on its way up, the market is on its
way up. When the market is going down, the market is going down. That's it.
There are many systems which analyse past trends, but none that can accurately
predict the future. But if you acknowledge to yourself that all that is happening at
any time is that the market is simply moving, you'll be amazed at how hard it is to
blame anyone else.
10. Trade on the news - Most of the really big market moves occur around news
time. Trading volume is high and the moves are significant; this means there is no
better time to trade than when news is released. This is when the big players
adjust their positions and prices change resulting in a serious currency flow.
11. Exiting Trades - If you place a trade and it's not working out for you, get out.
Don't compound your mistake by staying in and hoping for a reversal. If you're in
a winning trade, don't talk yourself out of the position because you're bored or
want to relieve stress; stress is a natural part of trading; get used to it.
12. Don't trade too short-term - If you are aiming to make less than 20 points profit,
don't undertake the trade. The spread you are trading on will make the odds
against you far too high.

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13. Don't be smart - The most successful traders I know keep their trading simple.
They don't analyse all day or research historical trends and track web logs and
their results are excellent.
14. Tops and Bottoms - There are no real "bargains" in trading foreign exchange.
Trade in the direction the price is going in and you're results will be almost
guaranteed to improve.
15. Ignoring the technicals- Understanding whether the market is over-extended
long or short is a key indicator of price action. Spikes occur in the market when it
is moving all one way.
16. Emotional Trading - Without that all-important strategy, you're trades essentially
are thoughts only and thoughts are emotions and a very poor foundation for
trading. When most of us are upset and emotional, we don't tend to make the
wisest decisions. Don't let your emotions sway you.
17. Confidence - Confidence comes from successful trading. If you lose money early
in your trading career it's very difficult to regain it; the trick is not to go off half-
cocked; learn the business before you trade. Remember, knowledge is power.

SUGGESTIONS
1. Take it like a man - If you decide to ride a loss, you are simply displaying
stupidity and cowardice. It takes guts to accept your loss and wait for tomorrow to
try again. Sticking to a bad position ruins lots of traders - permanently. Try to
remember that the market often behaves illogically, so don't get commit to any
one trade; it's just a trade. One good trade will not make you a trading success; it's
ongoing regular performance over months and years that makes a good trader.
2. Focus - Fantasizing about possible profits and then "spending" them before you
have realized them is no good. Focus on your current position(s) and place

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 reasonable stop losses at the time you do the trade. Then sit back and enjoy the
ride - you have no real control from now on, the market will do what it wants to
do.
3. Don't trust demos - Demo trading often causes new traders to learn bad habits.
These bad habits, which can be very dangerous in the long run, come about
because you are playing with virtual money. Once you know how your broker's
system works, start trading small amounts and only take the risk you can afford to
win or lose.
4. Stick to the strategy - When you make money on a well thought-out strategic
trade, don't go and lose half of it next time on a fancy; stick to your strategy and
invest profits on the next trade that matches your long-term goals.
5. Trade today - Most successful day traders are highly focused on what's
happening in the short-term, not what may happen over the next month? If you're
trading with 40 to 60-point stops focus on what's happening today as the market
will probably move too quickly to consider the long-term future. However, the
long-term trends are not unimportant; they will not always help you though if
you're trading intraday.
6. The clues are in the details - The bottom line on your account balance doesn't
tell the whole story. Consider individual trade details; analyse your losses and the
telling losing streaks.
7. Generally, traders that make money without suffering significant daily losses have
the best chance of sustaining positive performance in the long term.
8. Simulated Results - Be very careful and wary about infamous "black box"
systems. These so-called trading signal systems do not often explain exactly how
the trade signals they generate are produced. Typically, these systems only show
their track record of extraordinary results - historical results. Successfully
predicting future trade scenarios is altogether more complex. The high-speed
algorithmic capabilities of these systems provide significant retrospective trading
systems, not ones which will help you trade effectively in the future.
9. Get to know one cross at a time - Each currency pair is unique, and has a unique
way of moving in the marketplace. The forces which cause the pair to move up

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 and down are individual to each cross, so study them and learn from your
experience and apply your learning to one cross at a time.
10. Risk Reward - If you put a 20 point stop and a 50 point profit your chances of
winning are probably about 1-3 against you. In fact, given the spread you're
trading on, it's more likely to be 1-4. Play the odds the market gives you.
11. Trading for Wrong Reasons - Don't trade if you are bored, unsure or reacting on
a whim. The reason that you are bored in the first place is probably because there
is no trade to make in the first place. If you are unsure, it's probably because you
can't see the trade to make, so don't make one.
12. Zen Trading- Even when you have taken a position in the markets, you should
try and think as you would if you hadn't taken one. This level of detachment is
essential if you want to retain your clarity of mind and avoid succumbing to
emotional impulses and therefore increasing the likelihood of incurring losses. To
achieve this, you need to cultivate a calm and relaxed outlook. Trade in brief
periods of no more than a few hours at a time and accept that once the trade has
been made, it's out of your hands.
13. Determination - Once you have decided to place a trade, stick to it and let it run
its course. This means that if your stop loss is close to being triggered, let it
trigger. If you move your stop midway through a trade's life, you are more than
likely to suffer worse moves against you. Your determination must be show itself
when you acknowledge that you got it wrong, so get out.
14. Short-term Moving Average Crossovers - This is one of the most dangerous
trade scenarios for non professional traders. When the short-term moving average
crosses the longer-term moving average it only means that the average price in the
short run is equal to the average price in the longer run. This is neither a bullish
nor bearish indication, so don't fall into the trap of believing it is one.
15. Stochastic - Another dangerous scenario. When it first signals an exhausted
condition that's when the big spike in the "exhausted" currency cross tends to
occur. My advice is to buy on the first sign of an overbought cross and then sell
on the first sign of an oversold one. This approach means that you'll be with the
trend and have successfully identified a positive move that still has some way to

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 go. So if percentage K and percentage D are both crossing 80, then buy! (This is
the same on sell side, where you sell at 20).
16. One cross is all that counts - EURUSD seems to be trading higher, so you buy
GBPUSD because it appears not to have moved yet. This is dangerous. Focus on
one cross at a time - if EURUSD looks good to you, then just buy EURUSD.
17. Wrong Broker - A lot of FOREX brokers are in business only to make money
from yours. Read forums, blogs and chats around the net to get an unbiased
opinion before you choose your broker.
18. Too bullish - Trading statistics show that 90% of most traders will fail at some
point. Being too bullish about your trading aptitude can be fatal to your long-term
success. You can always learn more about trading the markets, even if you are
currently successful in your trades. Stay modest, and keep your eyes open for new
ideas and bad habits you might be falling in to.
19. Interpret forex news yourself - Learn to read the source documents of forex
news and events - don't rely on the interpretations of news media or others.

BIBLIOGRAPHY

o www.google.com GOOGLE SEARCH ENGINE

o Dr. G. KOTRESHWAR, RISK MANAGEMENT, HIMALAYA
PUBLISHING HOUSE, MUMBAI.
o A.K.SETH, INTERNATIONAL FINANCIAL MANAGEMENT.
o LEVY, INTERNATIONAL FINANCIAL MANAGEMENT.
o V.K.BHALLA, INTERNATIONAL FINANCIAL MANAGEMENT.
o SHAPIRO, INTERNATIONAL FINANCIAL MANAGEMENT.

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