The global foreign exchange market is the biggest market in the world. The 3.2 trillion USD daily turnover dwarfs the combined turnover of all the world's stock and bond markets.
There are many reasons for the popularity of foreign exchange trading, but among the most important are the leverage available, the high liquidity 24 hours a day and the very low dealing costs associated with trading.
Of course many commercial organisations participate purely due to the currency exposures created by their import and export activities, but the main part of the turnover is accounted for by financial institutions. Investing in foreign exchange remains predominantly the domain of the big professional players in the market - funds, banks and brokers. Nevertheless, any investor with the necessary knowledge of the market's functions can benefit from the advantages stated above.
In the following article, we would like to introduce you to some of the basic concepts of foreign exchange trading. If you would like any further information, we suggest that you sign up for a FREE Membership on this website, where you will be able to exchange views with other Forex traders and get answers to any questions you might have.
Margin Trading
Foreign exchange is normally traded on margin. A relatively small deposit can control much larger positions in the market. For trading the main currencies, Saxo Bank requires a 1% margin deposit. This means that in order to trade one million dollars, you need to place just USD 10,000 by way of security.
In other words, you will have obtained a gearing of up to 100 times. This means that a change of, say 2%, in the underlying value of your trade will result in a 200% profit or loss on your deposit. See below for specific examples. As you can see, this calls for a very disciplined approach to trading as both profit opportunities and potential risks are very large indeed. Please refer to our page Forex Rates & Conditions for current Spreads, Margins and Conditions.
Base Currency and Variable Currency
When you trade, you will always trade a combination of two currencies. For example, you will buy US dollars and sell euro. Or buy euro and sell Japanese yen, or any other combination of dozens of widely traded currencies. But there is always a long (bought) and a short (sold) side to a trade, which means that you are speculating on the prospect of one of the currencies strengthening in relation to the other.
The trade currency is normally, but not always, the currency with the highest value. When trading US dollars against Singapore dollars, the normal way to trade is buying or selling a fixed amount of US dollars, i.e. USD 1,000,000. When closing the position, the opposite trade is done, again USD 1,000,000. The profit or loss will be apparent in the change of the amount of SGD credited and debited for the two transactions. In other words, your profit or loss will be denominated in SGD, which is known as the price currency. As part of our service, Saxo Bank will automatically exchange your profits and losses into your base currency if you require this.
Dealing Spread, but No Commissions
When trading foreign exchange, you are quoted a dealing spread offering you a buying and a selling level for your trade. Once you accept the offered price and receive confirmation from our dealers, the trade is done. There is no need to call an exchange floor. There are no other time-consuming delays. This is possible due to live streaming prices, which are also a great advantage in times of fast-moving markets: You can see where the market is trading and you know whether your orders are filled or not.
The dealing spread is typically 3-5 points in normal market conditions. This means that you can sell US dollars against the euro at 1.7780 and buy at 1.7785. There are no further costs, commissions or exchange fees.
This ensures that you can get in and out of your trades at very low slippage and many traders are therefore active intra-day traders, given that a typical day in USDEUR presents price swings of 150-200 points.
Spot and forward trading
When you trade foreign exchange you are normally quoted a spot price. This means that if you take no further steps, your trade will be settled after two business days. This ensures that your trades are undertaken subject to supervision by regulatory authorities for your own protection and security. If you are a commercial customer, you may need to convert the currencies for international payments. If you are an investor, you will normally want to swap your trade forward to a later date. This can be undertaken on a daily basis or for a longer period at a time. Often investors will swap their trades forward anywhere from a week or two up to several months depending on the time frame of the investment.
Although a forward trade is for a future date, the position can be closed out at any time - the closing part of the position is then swapped forward to the same future value date.
Interest Rate Differentials
Different currencies pay different interest rates. This is one of the main driving forces behind foreign exchange trends. It is inherently attractive to be a buyer of a currency that pays a high interest rate while being short a currency that has a low interest rate.
Although such interest rate differentials may not appear very large, they are of great significance in a highly leveraged position. For example, the interest rate differential between the US dollar and the Japanese yen has been approximately 5% for several years. In a position that can be supported by a 5% margin deposit, this results in a 100% profit on capital per annum when you buy the US dollar. Of course, an even more important factor normally is the relative value of the currencies, which changed 15% from low to high during 2005 – disregarding the interest rate differential. From a pure interest rate differential viewpoint, you have an advantage of 100% per annum in your favour by being long US dollar and an initial disadvantage of the same size by being short.
Please refer to our page Forex Rates & Conditions for current Spreads, Margins and Conditions!
Such a situation clearly benefits the high interest rate currency and as result, the US dollar was in a strong bull market all through 2005. But it is by no means a certainty that the currency with the higher interest rate will be strongest. If the reason for the high interest rate is runaway inflation, this may undermine confidence in the currency even more than the benefits perceived from the high interest rate.
Stop-loss discipline
As you can see from the description above, there are significant opportunities and risks in foreign exchange markets. Aggressive traders might experience profit/loss swings of 20-30% daily. This calls for strict stop-loss policies in positions that are moving against you.
Fortunately, there are no daily limits on foreign exchange trading and no restrictions on trading hours other than the weekend. This means that there will nearly always be an opportunity to react to moves in the main currency markets and a low risk of getting caught without the opportunity of getting out. Of course, the market can move very fast and a stop-loss order is by no means a guarantee of getting out at the desired level.
But the main risk is really an event over the weekend, where all markets are closed. This happens from time to time as many important political events, such as G7 meetings, are normally scheduled for weekends.
For speculative trading, we always recommend the placement of protective stop-lossorders. With Saxo Bank Internet Trading you can easily place and change such orders while watching market development graphically on your computer screen.
13 mar 2010
12 mar 2010
PPI - Producer Price Index
Importance (A-F): This release merits a B-.
Source: Bureau of Labor statistics, U.S. Department of Labor.
Release Time: Around the 11th of each month at 8:30 ET for the prior month.
Raw Data Available At: www.bls.gov
The Producer Price Index measures prices of goods at the wholesale level. There are three broad subcategories within PPI: crude, intermediate, and finished. The market tracks the finished goods index most closely, as it represents prices for goods that are ready for sale to the end user. Goods prices at the crude and intermediate stages of production often provide an indication of coming (dis)inflationary pressures, but the closer you get to crude goods, the more that these prices track commodity prices which are already available in traded indices such as the CRB (Commodity Research Bureau).
At all stages of production, the market places more emphasis on the index excluding food and energy, referred to as the core rate. Food and energy prices tend to be quite volatile and obscure trends in the underlying inflation rate. Though the market reaction is determined by the month/month changes, year/year changes are also noted by analysts. The index is not revised on a monthly basis, but annual revisions to seasonal adjustment factors can produce small adjustments to past releases.
Source: Bureau of Labor statistics, U.S. Department of Labor.
Release Time: Around the 11th of each month at 8:30 ET for the prior month.
Raw Data Available At: www.bls.gov
The Producer Price Index measures prices of goods at the wholesale level. There are three broad subcategories within PPI: crude, intermediate, and finished. The market tracks the finished goods index most closely, as it represents prices for goods that are ready for sale to the end user. Goods prices at the crude and intermediate stages of production often provide an indication of coming (dis)inflationary pressures, but the closer you get to crude goods, the more that these prices track commodity prices which are already available in traded indices such as the CRB (Commodity Research Bureau).
At all stages of production, the market places more emphasis on the index excluding food and energy, referred to as the core rate. Food and energy prices tend to be quite volatile and obscure trends in the underlying inflation rate. Though the market reaction is determined by the month/month changes, year/year changes are also noted by analysts. The index is not revised on a monthly basis, but annual revisions to seasonal adjustment factors can produce small adjustments to past releases.
Philadelphia Fed Index
Importance (A-F): The Philadelphia Fed Index merits a B.
Source: The Philadelphia Federal Reserve bank.
Release Time: Third Thursday of the month at 10 ET for the current month.
In Brief
There are many regional manufacturing surveys, and they tend to be ranked in order of timeliness and the importance of the region. The Philadelphia Fed's survey is first each month, actually coming out during the third week of the month for which it is reporting. Several smaller surveys are then released before the Chicago purchasing managers' report on the last day of each month. A few, such as the Atlanta and Richmond Fed surveys, are released after the NAPM and are of little value. The purchasing managers' reports are measured like the national NAPM - 50% marks the breakeven line between an expanding and contracting manufacturing sector. For the Philadelphia and Atlanta Fed indices, 0 is the breakeven mark.
These surveys can be of some help in forecasting the national NAPM - particularly the Philadelphia and Chicago surveys which are more closely watched due to their timeliness and the fact that these regions represent a reasonable cross section of national manufacturing activities.
In Depth
The market has been bombarded with a bevy of surveys purporting to measure manufacturing activity in every nook and cranny of the country. First it was Philadelphia, then Chicago, and Detroit, Milwaukee, New York, Cincinnati, Richmond, Atlanta, Boston, and there might as well have been a Nome survey. This hodge-podge of releases is begging for someone - namely us - to come along and cut this group down to a more manageable size, say....two. And the winners are...
Nuts and Bolts
Not so fast. We need a build-up before we cut to the proverbial chase. Let's start with the issue of what these manufacturing surveys are trying to measure and how they go about doing it. The leader of this pack of regional surveys is the NAPM - National Association of Purchasing Managers - index. It has been around since 1931 (1948 on an uninterrupted basis), it is national, and it is one of the most timely measures of manufacturing activity available. In other words, it sets the standards by which its progeny are measured.
The NAPM index is actually a composite of five sub-indices - new orders, production, supplier deliveries, inventories, and employment. In surveying over 300 companies each month, the NAPM asks for positive, negative, or unchanged readings on each of these indicators. The positive responses are added to one half of the unchanged responses to produce the diffusion index. For example, if 50% of respondents reported stronger orders, 40% reported weaker, and 10% unchanged, the diffusion index for orders would be 55%, the 50% positive plus half of the 10% unchanged. To calculate the total index, the NAPM uses weights for the five indicators, which are as follows: 30% new orders, 25% production, 20% employment, 15% supplier deliveries, and 10% inventories.
The Selection Criteria
Since this methodology has made the NAPM index one of the better leading indicators of economic activity over the years, we will measure the usefulness of the regional indices based on their ability to help in forecasting the national index. In our effort to arrive at the two most important regional index, these criteria make eliminating most of the candidates easy for one simple reason - they are released after the national index. While regional economic developments are of interest to those who live in the region, they are not particularly important to the Treasury market. If a region cannot help in forecasting national trends, then its data are not particularly useful. So say adios to Atlanta, Richmond, Kansas City, and who knows how many others which have cropped up in recent years.
And the Winners Are...
Let's focus on the regional surveys which precede the release of the national index on the first business day of each month (with data for the prior month). The contestants are Philadelphia, Chicago, Milwaukee, Detroit, New York, and the most recent addition to the bunch - the APICS survey. We looked at the correlation of all of these indices to the national NAPM and found substantial differences in their forecasting ability. The winners are...drum roll please...Chicago and Philadelphia, in that order.
The Chicago NAPM index, which is released on the last business day of the month (with data for the same month), has an impressive 91% correlation with the national NAPM. The Philadelphia Fed index, which is released on the third Thursday of the month (with data for the same month), was a distant second at 76%. Philly Fed's performance improved slightly to 78% when Briefing measured its results using the NAPM methodology. The Philly index as released is not a composite of its subindices, as the NAPM is. Instead, the Philly Fed survey asks many questions, but the total index is based on the general question "are business conditions better or worse than last month." It is often the case that a weighted measure of the individual questions on specifics such as new orders and production moves in a different direction than the index based on the general question.
The rest of the regional indices fared poorly, ranging from correlations as poor as 55% (APICS) to 73% (Milwaukee). Chicago was the clear winner, but the Philly Fed index definitely deserves recognition, particularly since it is released so much earlier than the rest. In the future, then, we would recommend setting aside most of the regional manufacturing surveys and focussing on just Philly and Chicago, which offer the best hope of predicting the national index. And when you look at the Philly index, improve your chances by looking at the Philly numbers calculated on an NAPM basis, which Briefing will be happy to provide.
Source: The Philadelphia Federal Reserve bank.
Release Time: Third Thursday of the month at 10 ET for the current month.
In Brief
There are many regional manufacturing surveys, and they tend to be ranked in order of timeliness and the importance of the region. The Philadelphia Fed's survey is first each month, actually coming out during the third week of the month for which it is reporting. Several smaller surveys are then released before the Chicago purchasing managers' report on the last day of each month. A few, such as the Atlanta and Richmond Fed surveys, are released after the NAPM and are of little value. The purchasing managers' reports are measured like the national NAPM - 50% marks the breakeven line between an expanding and contracting manufacturing sector. For the Philadelphia and Atlanta Fed indices, 0 is the breakeven mark.
These surveys can be of some help in forecasting the national NAPM - particularly the Philadelphia and Chicago surveys which are more closely watched due to their timeliness and the fact that these regions represent a reasonable cross section of national manufacturing activities.
In Depth
The market has been bombarded with a bevy of surveys purporting to measure manufacturing activity in every nook and cranny of the country. First it was Philadelphia, then Chicago, and Detroit, Milwaukee, New York, Cincinnati, Richmond, Atlanta, Boston, and there might as well have been a Nome survey. This hodge-podge of releases is begging for someone - namely us - to come along and cut this group down to a more manageable size, say....two. And the winners are...
Nuts and Bolts
Not so fast. We need a build-up before we cut to the proverbial chase. Let's start with the issue of what these manufacturing surveys are trying to measure and how they go about doing it. The leader of this pack of regional surveys is the NAPM - National Association of Purchasing Managers - index. It has been around since 1931 (1948 on an uninterrupted basis), it is national, and it is one of the most timely measures of manufacturing activity available. In other words, it sets the standards by which its progeny are measured.
The NAPM index is actually a composite of five sub-indices - new orders, production, supplier deliveries, inventories, and employment. In surveying over 300 companies each month, the NAPM asks for positive, negative, or unchanged readings on each of these indicators. The positive responses are added to one half of the unchanged responses to produce the diffusion index. For example, if 50% of respondents reported stronger orders, 40% reported weaker, and 10% unchanged, the diffusion index for orders would be 55%, the 50% positive plus half of the 10% unchanged. To calculate the total index, the NAPM uses weights for the five indicators, which are as follows: 30% new orders, 25% production, 20% employment, 15% supplier deliveries, and 10% inventories.
The Selection Criteria
Since this methodology has made the NAPM index one of the better leading indicators of economic activity over the years, we will measure the usefulness of the regional indices based on their ability to help in forecasting the national index. In our effort to arrive at the two most important regional index, these criteria make eliminating most of the candidates easy for one simple reason - they are released after the national index. While regional economic developments are of interest to those who live in the region, they are not particularly important to the Treasury market. If a region cannot help in forecasting national trends, then its data are not particularly useful. So say adios to Atlanta, Richmond, Kansas City, and who knows how many others which have cropped up in recent years.
And the Winners Are...
Let's focus on the regional surveys which precede the release of the national index on the first business day of each month (with data for the prior month). The contestants are Philadelphia, Chicago, Milwaukee, Detroit, New York, and the most recent addition to the bunch - the APICS survey. We looked at the correlation of all of these indices to the national NAPM and found substantial differences in their forecasting ability. The winners are...drum roll please...Chicago and Philadelphia, in that order.
The Chicago NAPM index, which is released on the last business day of the month (with data for the same month), has an impressive 91% correlation with the national NAPM. The Philadelphia Fed index, which is released on the third Thursday of the month (with data for the same month), was a distant second at 76%. Philly Fed's performance improved slightly to 78% when Briefing measured its results using the NAPM methodology. The Philly index as released is not a composite of its subindices, as the NAPM is. Instead, the Philly Fed survey asks many questions, but the total index is based on the general question "are business conditions better or worse than last month." It is often the case that a weighted measure of the individual questions on specifics such as new orders and production moves in a different direction than the index based on the general question.
The rest of the regional indices fared poorly, ranging from correlations as poor as 55% (APICS) to 73% (Milwaukee). Chicago was the clear winner, but the Philly Fed index definitely deserves recognition, particularly since it is released so much earlier than the rest. In the future, then, we would recommend setting aside most of the regional manufacturing surveys and focussing on just Philly and Chicago, which offer the best hope of predicting the national index. And when you look at the Philly index, improve your chances by looking at the Philly numbers calculated on an NAPM basis, which Briefing will be happy to provide.
Personal Income & Consumption
Importance (A-F): This release merits a C+.
Source: The Bureau of Economic Analysis of the Department of Commerce.
Release Time: 8:30 ET around the first business day of the month (data for two months prior).
Raw Data Available At: www.bea.gov -- see personal income release.
Personal income measures income from all sources. The largest component of total income is wages and salaries, a figure which can be estimated using payrolls and earnings data from the employment report. Beyond that, there are many other categories of income, including rental income, government subsidy payments, interest income, and dividend income. Personal income is a decent indicator of future consumer demand, but it is not perfect. Recessions usually occur when consumers stop spending, which then drives down income growth. Looking solely at income growth, one may therefore miss the turning point when consumers stop spending.
The income report also includes a section covering personal consumption expenditures, also known as PCE. PCE is comprised of three categories: durables, nondurables, and services. The retail sales report will provide a good read on durable and nondurable consumption, while service purchases tend to grow at a fairly steady pace, making this a relatively predictable report, and ranking it well below retail sales in terms of market importance.
Source: The Bureau of Economic Analysis of the Department of Commerce.
Release Time: 8:30 ET around the first business day of the month (data for two months prior).
Raw Data Available At: www.bea.gov -- see personal income release.
Personal income measures income from all sources. The largest component of total income is wages and salaries, a figure which can be estimated using payrolls and earnings data from the employment report. Beyond that, there are many other categories of income, including rental income, government subsidy payments, interest income, and dividend income. Personal income is a decent indicator of future consumer demand, but it is not perfect. Recessions usually occur when consumers stop spending, which then drives down income growth. Looking solely at income growth, one may therefore miss the turning point when consumers stop spending.
The income report also includes a section covering personal consumption expenditures, also known as PCE. PCE is comprised of three categories: durables, nondurables, and services. The retail sales report will provide a good read on durable and nondurable consumption, while service purchases tend to grow at a fairly steady pace, making this a relatively predictable report, and ranking it well below retail sales in terms of market importance.
Non-Manufacturing NAPM
Importance (A-F): This release merits an D-.
Source: National Association of Purchasing Managers.
Release Time: 10:00 ET on the third business day of the month for the prior month.
Raw Data Available At: http://www.napm.org.
In Brief
The non-manufacturing NAPM report is a national survey of purchasing managers which covers new orders, employment, inventories, supplier delivery times, prices, backlog orders, export orders, and import orders. Diffusion indices are produced for each of these categories, with a reading over 50% indicating expansion relative to the prior month, and a sub-50% reading indicating contraction.
The index should be far more indicative of the broader economy given its inclusion of service-producing as well as good-producing sectors outside of manufacturing. However, the short history of the index dates to only July 1997 and doesn't provide the insight of a longer period inclusive of varied economic climates. The seasonal adjustment of the index didn't begin until January 2001 with only 3 of the 9 components seasonally adjusted as of April 2001. The lack of historical data and lack of a tight correlation to the non-manufacturing economy leaves the relatively poor "D" rating compared to the "A-" rating of the well-respected manufacturing NAPM index.
In Depth
The Non-Manufacturing NAPM Report on Business is a newcomer not yet closely followed by the private sector.
Who and What It Surveys
The Non-Manufacturing NAPM index (sometimes refered to as the NAPM Service index) is the result of a monthly survey of over 370 companies. The survey queries respondents on a number of monthly indicators, including orders, employment, inventories, supplier delivery times, prices paid, order backlogs, export orders, and import orders. Respondents are asked to characterize each indicator as higher, lower, or unchanged for the month (or faster/slower in the case of delivery times). They are not asked for specific numbers - only a thumbs up or down.
Presenting the Numbers
Based on these responses, the NAPM calculates diffusion indices for each of the components. These diffusion indices are calculated by adding the half of the percentage of respondents answering "unchanged" to the full percentage answering "higher" (or "slower" for deliveries). These diffusion indices do not yield estimates of specific magnitudes of strength or weakness, but the more respondents who are indicating trends in the same direction - the better the chance that the magnitude of that move is larger.
A diffusion index of 50% is the theoretical breakeven mark - with readings above indicating strength and below indicating weakness. The total index is seasonally adjusted but only 3 of the 9 components are currently adjusted for seasonality.
The total index is the result of a separate question regarding general business conditions (unlike the Manufacturing NAPM which is calculated from some of the components). The business index is calculated using the same diffusion calculation used in the components then adjusted for seasonality.
Source: National Association of Purchasing Managers.
Release Time: 10:00 ET on the third business day of the month for the prior month.
Raw Data Available At: http://www.napm.org.
In Brief
The non-manufacturing NAPM report is a national survey of purchasing managers which covers new orders, employment, inventories, supplier delivery times, prices, backlog orders, export orders, and import orders. Diffusion indices are produced for each of these categories, with a reading over 50% indicating expansion relative to the prior month, and a sub-50% reading indicating contraction.
The index should be far more indicative of the broader economy given its inclusion of service-producing as well as good-producing sectors outside of manufacturing. However, the short history of the index dates to only July 1997 and doesn't provide the insight of a longer period inclusive of varied economic climates. The seasonal adjustment of the index didn't begin until January 2001 with only 3 of the 9 components seasonally adjusted as of April 2001. The lack of historical data and lack of a tight correlation to the non-manufacturing economy leaves the relatively poor "D" rating compared to the "A-" rating of the well-respected manufacturing NAPM index.
In Depth
The Non-Manufacturing NAPM Report on Business is a newcomer not yet closely followed by the private sector.
Who and What It Surveys
The Non-Manufacturing NAPM index (sometimes refered to as the NAPM Service index) is the result of a monthly survey of over 370 companies. The survey queries respondents on a number of monthly indicators, including orders, employment, inventories, supplier delivery times, prices paid, order backlogs, export orders, and import orders. Respondents are asked to characterize each indicator as higher, lower, or unchanged for the month (or faster/slower in the case of delivery times). They are not asked for specific numbers - only a thumbs up or down.
Presenting the Numbers
Based on these responses, the NAPM calculates diffusion indices for each of the components. These diffusion indices are calculated by adding the half of the percentage of respondents answering "unchanged" to the full percentage answering "higher" (or "slower" for deliveries). These diffusion indices do not yield estimates of specific magnitudes of strength or weakness, but the more respondents who are indicating trends in the same direction - the better the chance that the magnitude of that move is larger.
A diffusion index of 50% is the theoretical breakeven mark - with readings above indicating strength and below indicating weakness. The total index is seasonally adjusted but only 3 of the 9 components are currently adjusted for seasonality.
The total index is the result of a separate question regarding general business conditions (unlike the Manufacturing NAPM which is calculated from some of the components). The business index is calculated using the same diffusion calculation used in the components then adjusted for seasonality.
11 mar 2010
New Home Sales
Importance (A-F): This release merits a C+.
Source: The Census Bureau of the Department of Commerce.
Release Time: 10:00 ET around the last business day of the month (data for month prior).
Raw Data Available At: http://www.census.gov/const/newressales.pdf
The report indicates the level of new privately owned one-family houses sold and for sale. New home sales usually have a lagged reaction to changing mortgage rates. They also tend to be stronger early in the business cycle when pent-up demand is strong, and they fade later in the cycle as the demand for housing is sated. In addition to home sales, the market monitors the number of homes for sale relative to the current sales pace. As this inventory measure falls (rises), housing starts tend to rise (fall). Finally, the median home price provides an indication of inflation in the housing sector, though only year/year changes provide any meaningful information.
The home sales report is quite volatile and subject to huge revisions, making any one month's reading very unreliable. The report rarely prompts a market reaction. The market prefers the existing home sales report, which has a sample data pool four times as large and is released earlier in the month.
Source: The Census Bureau of the Department of Commerce.
Release Time: 10:00 ET around the last business day of the month (data for month prior).
Raw Data Available At: http://www.census.gov/const/newressales.pdf
The report indicates the level of new privately owned one-family houses sold and for sale. New home sales usually have a lagged reaction to changing mortgage rates. They also tend to be stronger early in the business cycle when pent-up demand is strong, and they fade later in the cycle as the demand for housing is sated. In addition to home sales, the market monitors the number of homes for sale relative to the current sales pace. As this inventory measure falls (rises), housing starts tend to rise (fall). Finally, the median home price provides an indication of inflation in the housing sector, though only year/year changes provide any meaningful information.
The home sales report is quite volatile and subject to huge revisions, making any one month's reading very unreliable. The report rarely prompts a market reaction. The market prefers the existing home sales report, which has a sample data pool four times as large and is released earlier in the month.
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