The International Monetary Market (IMM)
November 7, 2010 by · Leave a Comment
The International Monetary Market (IMM) was introduced in December 1971 and formally implemented in May 1972, although its roots can be traced to the end of Bretton Woods through the 1971 Smithsonian Agreement and Nixon’s suspension of U.S. dollar’s convertibility to gold.
The IMM Exchange was formed as a separate division of the Chicago Mercantile Exchange, and as of 2009, was the second largest futures exchange in the world. The primary purpose of the IMM is to trade currency futures, a relatively new product previously studied by academics as a way to open a freely traded exchange market to facilitate trade among nations.
The first futures experimental contracts included trades against the U.S. dollar such as the British pound, Swiss franc, German deutschmark, Canadian dollar, Japanese yen and in September 1974, the French franc. This list would later expand to include the Australian dollar, the euro, emerging market currencies such as the Russian ruble, Brazilian real, Turkish lira, Hungarian forint, Polish zloty, Mexican peso and South African rand. In 1992, the German deutschmark/Japanese yen pair was introduced as the first futures cross rate currency. But these early successes didn’t come without a price. (Learn how to trade currencies, read Getting Started in Foreign Exchange Futures.)
The Drawbacks of Currency Futures
The challenging aspects were how to connect values of IMM foreign exchange contracts to the interbank market – the dominant means of currency trading in the 1970s - and how to allow the IMM to be the free-floating exchange envisioned by academics. Clearing member firms were incorporated to act as arbitrageurs between banks and the IMM to facilitate orderly markets between bid and ask spreads. The Continental Bank of Chicago was later hired as a delivery agent for contracts. These successes bred an unforeseen level of competition for new futures products.
The Chicago Board Options Exchange competed and received the right to trade U.S. 30-year bond futures while the IMM secured the right to trade eurodollar contracts, a 90 day interest rate contract settled in cash rather than physical delivery. Eurodollars came to be known as the “eurocurrency market,” which is used mainly by the Organization for Petroleum Exporting Countries (OPEC), which always required payment for oil in U.S. dollars. This cash settlement aspect would later pave the way for index futures such as world stock market indexes and the IMM Index. Cash settlement would also allow the IMM to later become known as a “cash market” because of its trade in short-term, interest rate sensitive instruments.
A System for Transactions
With new competition, a transaction system was desperately needed. The CME and Reuters Holdings created the Post Market Trade (PMT) to allow a global electronic automated transaction system to act as a single clearing entity and link the world’s financial centers like Tokyo and London. Today, PMT is known as Globex, which facilitates not only clearing but electronic trading for traders around the world. In 1975, U.S. T-bills were born and began trading on the IMM in January 1976. T-bill futures began trading in April 1986 with approval from the Commodities Futures Trading Commission.
The Rise of the Forex Market
The real success would come in the mid 1980s when options began trading on currency futures. By 2003, foreign exchange trading had hit a notional value of $347.5 billion. (Be aware of forex risks, check out Foreign-Exchange Risk.)
The 1990s were a period of explosive growth for the IMM due to three world events:
- Basel I in July 1988
The 12 nation European Central Bank governors agreed to standardize guidelines for banks. Bank capital had to be equal to 4% of assets. (For background reading, see Does The Basel Accord Strengthen Banks?) - 1992 Single European Act
This not only allowed capital to flow freely throughout national borders but also allowed all banks to incorporate in any EU nation. - Basel II
This is geared to control risk by preventing losses, the realization of which is still a work in progress. (To learn more, read Basel II Accord To Guard Against Financial Shocks.)
A bank’s role is to channel funds from depositors to borrowers. With these news acts, depositors could be governments, governmental agencies and multinational corporations. The role for banks in this new international arena exploded in order to meet the demands of financing capital requirements, new loan structures and new interest rate structures such as overnight lending rates; increasingly, IMM was used for all finance needs.
Plus, a whole host of new trading instruments was introduced such as money market swaps to lock in or reduce borrowing costs, and swaps for arbitrage against futures or hedge risk. Currency swaps would not be introduced until the the 2000s. (Find out how tools magnify your gains and losses, read Forex Leverage: A Double-Edged Sword.)
Financial Crises and Liquidity
In financial crisis situations, central bankers must provide liquidity to stabilize markets because risk may trade at premiums to a bank’s target rates, called money rates, that central bankers can’t control. Central bankers then provide liquidity to banks that trade and control rates. These are called repo rates, and they are traded through the IMM. Repo markets allow participants to undertake rapid refinancing in the interbank market independent of credit limits to stabilize the system. A borrower pledges securitized assets such as stocks in exchange for cash to allow its operations to continue.
Asian Money Markets and the IMM
Asian money markets linked up with the IMM because Asian governments, banks and businesses needed to facilitate business and trade in a faster way rather than borrowing U.S. dollar deposits from European banks. Asian banks, like European banks, were saddled with dollar-denominated deposits because all trades were dollar-denominated as a result of the U.S. dollar’s dominance. So, extra trades were needed to facilitate trade in other currencies, particularly euros. Asia and the E.U. would go on to share not only an explosion of trade but also two of the most widely traded world currencies on the IMM. For this reason, the Japanese yen is quoted in U.S. dollars, while eurodollar futures are quoted based on the IMM Index, a function of the three-month LIBOR.
The IMM Index base of 100 is subtracted from the three-month LIBOR to ensure that bid prices are below the ask price. These are normal procedures used in other widely traded instruments on the IMM to insure market stabilization.
The Fundamentals Of Forex Fundamentals
November 7, 2010 by · Leave a Comment
Since fundamental analysis is about looking at the intrinsic value of an investment, its application in forex entails looking at the economic conditions that affect the valuation of a nation’s currency. Here we look at some of the major fundamental factors that play a role in the movement of a currency.
Economic Indicators
Economic indicators are reports released by the government or a private organization that detail a country’s economic performance. Economic reports are the means by which a country’s economic health is directly measured, but do remember that a great deal of factors and policies will affect a nation’s economic performance.
These reports are released at scheduled times, providing the market with an indication of whether a nation’s economy has improved or declined. The effects of these reports are comparable to how earnings reports, SEC filings and other releases may affect securities. In forex, as in the stock market, any deviation from the norm can cause large price and volume movements.
You may recognize some of these economic reports, such as the unemployment numbers, which are well publicized. Others, like housing stats, receive little coverage. However, each indicator serves a particular purpose, and can be useful. Here we outline four major reports, some of which are comparable to particular fundamental indicators used by equity investors:
The Gross Domestic Product (GDP)
The GDP is considered the broadest measure of a country’s economy, and it represents the total market value of all goods and services produced in a country during a given year. Since the GDP figure itself is often considered a lagging indicator, most traders focus on the two reports that are issued in the months before the final GDP figures: the advance report and the preliminary report. Significant revisions between these reports can cause considerable volatility. The GDP is somewhat analogous to the gross profit margin of a publicly traded company in that they are both measures of internal growth. (Learn more about this important number in High GDP Means Economic Prosperity, Or Does It?)
Retail Sales
The retail-sales report measures the total receipts of all retail stores in a given country. This measurement is derived from a diverse sample of retail stores throughout a nation. The report is particularly useful because it is a timely indicator of broad consumer spending patterns that is adjusted for seasonal variables. It can be used to predict the performance of more important lagging indicators, and to assess the immediate direction of an economy. Revisions to advanced reports of retail sales can cause significant volatility. The retail sales report can be compared to the sales activity of a publicly traded company. (Read more in Using Consumer Spending As A Market Indicator.)Industrial Production
This report shows the change in the production of factories, mines and utilities within a nation. It also reports their ‘capacity utilizations‘, the degree to which the capacity of each of these factories is being used. It is ideal for a nation to see an increase of production while being at its maximum or near maximum capacity utilization.Traders using this indicator are usually concerned with utility production, which can be extremely volatile since the utilities industry, and in turn the trading of and demand for energy, is heavily affected by changes in weather. Significant revisions between reports can be caused by weather changes, which in turn, can cause volatility in the nation’s currency.
Consumer Price Index (CPI)
The CPI is a measure of the change in the prices of consumer goods across over 200 different categories. This report, when compared to a nation’s exports, can be used to see if a country is making or losing money on its products and services. Be careful, however, to monitor the exports – it is a focus that is popular with many traders because the prices of exports often change relative to a currency’s strength or weakness. (For further reading, check out The Consumer Price Index: A Friend To Investors.)
Some of the other major indicators include the purchasing managers index (PMI), producer price index (PPI), durable goods report, employment cost index (ECI), and housing starts. And don’t forget the many privately issued reports, the most famous of which is the Michigan Consumer Confidence Survey. All of these provide a valuable resource to traders, if used properly.
So, How Are These Used?
Since economic indicators gauge a country’s economic state, changes in the conditions reported will therefore directly affect the price and volume of a country’s currency. It is important to keep in mind, however, that the indicators discussed above are not the only things that affect a currency’s price. There are third-party reports, technical factors, and many other things that also can drastically affect a currency’s valuation. Here are a few useful tips that may help you when conducting fundamental analysis in the foreign exchange market:
- Keep an economic calendar on hand that lists the indicators and when they are due to be released. Also, keep an eye on the future; often markets will move in anticipation of a certain indicator or report due to be released at a later time. (You’ll find more information in Trading On News Releases.)
- Be informed about the economic indicators that are capturing most of the market’s attention at any given time. Such indicators are catalysts for the largest price and volume movements. For example, when the U.S. dollar is weak, inflation is often one of the most watched indicators.
- Know the market expectations for the data, and then pay attention to whether or not the expectations are met. That is far more important than the data itself. Occasionally, there is a drastic difference between the expectations and actual results and, if there is, be aware of the possible justifications for this difference.
- Don’t react too quickly to the news. Oftentimes, numbers are released and then revised, and things can change quickly. Pay attention to these revisions, as they may be a useful tool for seeing the trends and reacting more accurately to future reports.
Combined Forces Power Forex Snap Strategy
November 7, 2010 by · Leave a Comment
Astute technical traders and chartists have heard of both the stochastic and moving average convergence divergence (MACD) indicators helping to isolate ranging opportunities in currency pairs in the foreign exchange market. Although both are easy and simple to use, their technical influence tends to wane a bit as the price action turns into a trending environment. However, by combining the power of both oscillators, traders can isolate profitable setups in the market that are of higher probability than when these indicators are used individually. In this article, we’ll show you how to apply this concept to your personal trading strategy.
Stochastic and MACD
Before diving into the intricacies of the combined strategy, let’s first briefly review how to interpret both the stochastic and MACD oscillators.
Stochastic Oscillator
The stochastic oscillator was developed in the 1950s and is used to show the positioning of the current close relative to the high/low range of the currency over a period of time. The indicator shows buying or selling pressure in the market. Consistently higher levels reflect buying support in the market, while comparatively lower levels indicate of selling pressure. As a result, the oscillator uncovers extreme readings in price levels, showing overextended momentum through barriers set at 20 and 80. Readings below the 20 reference mark indicate that the market has been oversold; readings rising above 80 represent overbought conditions.
The stochastic oscillator is able to isolate tops and bottoms in the market that correspond with support and resistance in range-bound channel environments. Because of this, the stochastic oscillator is great for short-term trading. (To learn more, read Exploring Oscillators And Indicators: Stochastics Oscillator.)
MACD Oscillator
Used in range-bound markets, the MACD oscillator is based on moving averages (a 26-day and 12-day exponential moving average (EMA) with a trigger moving average established by a nine-day exponential moving average).
Notably, instead of showing overbought or oversold conditions, MACD shows the relationship between prices. As a result, and similar to simple moving average crossovers, bullish and bearish sentiment will be triggered on a move higher or lower in the indicator’s moving averages. For example, a bullish signal is produced when the MACD (difference between the 12- and 26-day moving averages) rises above the trigger line (nine-day EMA). This oscillator is great for longer-term trends. (For more insight, check out Exploring The Exponentially Weighted Moving Average.)
Trading on the “Snap”
If we take both tools into consideration, the underlying theme with trading a “snap” setup relies on the strengths of both indicators. Establishing the longer term trend in the MACD, the trader is able to create entry opportunities in the foreign exchange market using the stochastic as a reference. However, in this case, most traders will choose to adjust the parameters of the indicator so that the number of periods corresponds to the longer-term trend. Ultimately, a longer, smoother stochastic D% line is the best way to confirm the directional bias with the MACD line as in Figure 1.
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| Source: FX Trek Intellicharts |
| Figure 1: Stochastic and MACD show the directional bias in the market. |
In Figure 1, both the MACD and Stochastic D% line move in tandem over the span of 24 hours in the euro/Japanese yen currency pair. Although the MACD does lag behind the stochastic visual, it virtually confirms the longer term upside bias in the currency pair. Now, with the longer term bias established, the trader or currency speculator will begin entering when the shorter K% stochastic line “snaps” back upward or rejoins the overall upward trend. Our first example is shown at Point A.
With the currency pair declining over the last 24 hours, the momentum seemed to be turning as price begins to consolidate. The notion is confirmed by what seems to be a turn in the stochastic, later confirmed by the turn in MACD. As a result, after seeing the confirming uptick in the longer term MACD trend, the trader sees the opportunity as the K% line turns up and rejoins the longer term upward direction of the market. Ultimately, with a corresponding stop placed at the previous session low, the trader is able to capture the short-term burst that occurs in the price action.
Putting It All Together
Now let’s take an easy, step-by-step approach to applying the “snap” setup in the New Zealand dollar/Japanese yen currency cross (Figure 2). After declining over the last 24 hours, the market looks to take the pair higher, as both the stochastic and MACD oscillators have turned upward. Notably, it is good to remember at this point that the stochastic oscillator has been revamped to reflect settings of 7, 3 and 20, rather than remaining at the standard settings. (For more insight, read Make The Currency Cross Your Boss.)
- Establish the trend. With stochastic D% line turning upward first, the trader looks for a confirming rise/crossover in the MACD, establishing the longer term trend.
- Take positions in the direction of the trend. In the trade example presented in Figure 2, the speculator would be looking to take a long position as both stochastic and MACD have turned higher. As a result, our first trade will be at Point B.
- Assess the position. With the trade setup in place, a long position is taken at the “snap”, placing the entry at the close of the hourly session, 94.29. Subsequently, the stop would be placed at the session low of 94.01, keeping in time with disciplined risk management. As the trade unfolds, a trailing stop is applied to the position in order to further gains and minimize substantial moves against the outstanding buy. As a result, the full length of the move to 95.88 gives the trader ample reward – 159 pips overall – before any initial take-back is seen.
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| Source: FX Trek Intellicharts |
| Figure 2: A perfect “snap” setup in the NZD/JPY currency pair |
