Description
Today the financial market is becoming a single world market where everyone can participate in the market with different investment needs and they can invest as per required time period.
A Grand Project Report on
In partial Fulfillment of MBA programme of Gujarat University
(Batch 2008-10)
Submitted By Submitted To
Mehul Chauhan (08017) Prof. Dharmesh Shah
Manish Keshwani (08047) Prof. Viral Pandya
N.R. Institute of Business Management
Fundamental Operations in Forex
Technical and Fundamental Analysis
2010
I
Preface
Today the financial market is becoming a single world market where
everyone can participate in the market with different investment needs and
they can invest as per required time period. Foreign exchange market has
been a important part of the financial market. To satisfy the need if the
global business organizations and the financial institution, every country has
adopted the free trading system for Forex market as good as the security
market. As management students we have tried to spot some light in the
area of Forex market.
During our course of M.B.A we contributed significant time period of around
four months to this study.
In august 2008, Indian stock exchanges started trading in the Forex markets
as well. NSE launched the Currency derivatives with USD/INR contracts in
August in 2008 and other three pair i.e. EUR/INR, GBP/INR and JPY/INR in
February 2010 till today trading in the derivatives has been increased to
significant level. Looking toward these circumstances we have conducted the
study in Forex market that may have significant impact on the decision
investor and may help investors for decision.
Forecasting the prices of financial instrument is difficult as well as in Forex
market. We have tried to put some insights in forecasting the prices of the
Forex rates. We have used technical approach and fundamental approach to
find out the factors affecting the Forex rates and to forecast the future
prices.
Technical approach is used for short term i.e. week of months even it is use
for intraday trading. We have studied the different trend indicators and
II
patterns of technical charts forecast the trend and estimate the future prices
in Forex markets. On the bases of the past trends we can forecast the future
prices and take decision about investment, arbitrage and hedging.
Fundamental analysis is based on the economic indicators of the particular
country. In fundamental analysis we have considers different events
happening in the economies and other quantifiable factored like interest
rates.
Our scope of study is limited to three major currencies traded in the Indian
Forex market i.e. USD, EUR and GBP.
III
Acknowledgement
Working on this project has been a great learning experience. Numerous
individuals helped us a lot with all sort of queries that we had. We would like
to use this opportunity to thank our college N. R. Institute of Business
Management for proving us necessary infrastructure and technology
required for this project work.
We also thank Prof. Dharmesh Shah and Prof. Viral Pandya, our guide
for giving us constant support and encouragement which proved as a fuel for
us to drive through this project.
We must say about all the people again that their presence made a
difference to us. And thank our friends & the great almighty God who was
giving us blessings all the time, without this task was not possible.
We hope that our work will give some insight in management studies.
Mehul Chauhan
Manish Keshwani
Table of Contains
Sr. No. Chapter Title Page No.
Preface I
Acknowledgement III
1 Chapter 1 Research Methodology 1
2
Chapter 2
The Foreign Exchange Market 3
2.1 What Is Foreign Exchange 3
2.2 Why We Need Foreign Exchange 3
2.3 Role Of The Exchange Rate 4
2.4 It Is A 24 Hrs Market 5
2.5 International Market Consists International Network Of Dealers 6
2.6 Most Widely Traded Currency: Dollar 7
2.7 Other Major Currency 8
3 Chapter 3 Evolution Of Forex Market 10
3.1 Exchange Rate System 10
3.2 The Gold Standard 10
3.3 Bretton Wood System 11
3.4 Floating Rate System 12
3.5 Current Exchange Rate Agreement 12
4
Chapter 4
Forex Spot Market 15
4.1 Bid And Ask Price 15
4.2 Base Currency And Terms Currency 16
4.3 Bid And Ask Are For Base Currency 17
4.4 Quotes Are In Bases Point 17
5 Chapter 5 Exchange Traded Currency Futures 18
5.1 Purpose 18
5.2 Similarities With Forward Contracts 18
5.3 Difference With Forward Contracts 19
5.4 Organized Market 19
5.5 standardize contracts 19
5.6 the clearing corporation 20
5.7 mark to market 20
5.8 Purpose Of Mark To Market 21
5.9 Margin Requirement 21
5.10 Impact Of Futures On Spot And Forward Market 22
5.11 Investment Strategies Using Currency Futures 23
5.12 Recent Forex Market In India 29
5.13 Status Check On Currency Futures In India 29
5.14 Most Current Benchmark 30
5.15 Success Rate Of Currency Futures 31
6
Chapter 6
Forecasting The Exchange Rate 32
6.1 Technical Approach 32
6.2 Fundamental Approach 34
7 Chapter 7 Technical Analysis 38
7.1 Price Chart Types 38
7.2 Technical Indicators Types 39
7.3 Parameters Used In Study 40
7.4 The Candle Stick Chart 47
7.5 Fibonacci Retracement 49
7.6 Technical Analysis Of The Currency: Quarterly Period 52
7.7 Yearly Trend Analysis Of Currency 75
7.8 Pattern Indicators In Candle Stick Chart 91
7.9 Use Of Fibonacci Retracement 97
8 Chapter 8 Fundamental Analysis 105
8.1 Economic Calendar 105
8.2 Interest Rate Parity 106
8.3 Economic Event And Its Impact On Exchange Rates 107
8.4 Interest Rate Parity And Exchange Rate Forecast 109
Conclusion 111
Recommendation 114
Bibliography 115
List of Exhibits
Sr. No. Exhibit
Title
Page No.
1 5.1 payoff long position futures 24
2 5.2 payoff short position futures 26
3 5.3 total volume traded in India in Forex futures : MCX-SX 30
4 7.1 Bollinger bands 41
5 7.2 MACD 43
6 7.3 Relative Strength Index 44
7 7.4 Stochastic Oscillator 46
8 7.5 Fibonacci Retracement 51
9 7.6 USD/INR technical Indicators: April-June 52
10 7.7 USD/INR technical Indicators: July-September 54
11 7.8 USD/INR technical Indicators: October-December 56
12 7.9 USD/INR technical Indicators: January-march 58
13 7.10 EUR/INR technical Indicators: April-June 60
14 7.11 EUR/INR technical Indicators: July-September 62
15 7.12 EUR/INR technical Indicators: October-December 64
16 7.13 EUR/INR technical Indicators: January-March 66
17 7.14 GBP/INR technical Indicators: April-June 68
18 7.15 GBP/INR technical Indicators: July-September 70
19 7.16 GBP/INR technical Indicators: October-November 72
20 7.17 GBP/INR technical Indicators: December-March 73
21 7.18 USD/INR technical Indicators: 2007-08 75
22 7.19 USD/INR technical Indicators: 2008-09 76
23 7.20 USD/INR technical Indicators: 2009-10 78
24 7.21 EUR/INR technical Indicators: 2007-08 80
25 7.22 EUR/INR technical Indicators: 2008-09 82
26 7.23 EUR/INR technical Indicators: 2009-10 84
27 7.24 GBP/INR technical Indicators: 2007-08 86
28 7.25 GBP/INR technical Indicators: 2008-09 88
29 7.26 GBP/INR technical Indicators: 2009-10 89
30 7.27 EUR/INR candlestick: The Doji 91
31 7.28 EUR/INR candlestick: The Doji 2 92
32 7.29 EUR/INR candlestick: Long Wicks 93
33 7.30 GBP/INR candlestick: The Doji 94
34 7.31 GBP/INR candlestick: Cup Formation 95
35 7.32 EUR/INR candlestick: The Doji 3 96
36 7.33 USD/INR candlestick: Fibonacci April-June 97
37 7.34 USD/INR candlestick: Fibonacci January-March 98
38 7.35 EUR/INR candlestick: Fibonacci April-June 99
39 7.36 EUR/INR candlestick: Fibonacci July-September 100
40 7.37 GBP/INR candlestick: Fibonacci April-June 101
41 7.38 GBP/INR candlestick: Fibonacci July-September 102
42 7.39 GBP/INR candlestick: Fibonacci January-March 103
43 8.1 Calculation of Future Rates 110
Chapter 1 Research Methodology
1
Chapter 1 Research Methodology
1.1 Introduction and statement of the problem
What are the Factors affecting the Forex market in India and how should
we forecast the Forex rates?
1.2 Research Objectives
To find out the factors affecting the Exchange rates of the currencies in
Indian Perspective and on the bases of Technical and Fundamental
indicators, forecast the Foreign Exchange Rates.
1.3 Scope
Scope of our study is limited to technical and fundamental approach in
foreign exchange market. We have conducted study on the three major
currencies traded in Indian markets against Rupee, i.e. USD, EUR and
GBP.
1.4 Research Design
The research approach followed in this project is Descriptive Approach. On
the basis of data collected from web sites and articles, we have done the
analysis.
We have used various approaches and methods in our research. There are
too many tools that can be used for studying the Forex market. Our
research is based on Indian Forex market; Forex spot market and Forex
derivatives available in India.
We have implied following technical indicators in this study:
? Bollinger Bands
? Moving Average Convergence/Divergence (MACD)
? Relative Strength Index
? Stochastic Oscillator
Chapter 1 Research Methodology
2
In addition to above trend indicators we have used following patterns of
Candlestick Chart:
? The Doji
? Cup Formation
? Long Wickes etc.
1.5 Data Sources
Secondary data is collected from various magazines, newspapers and
internet websites.
1.6 Limitations
1. Time constraints of the semester. Report may require more time
than the time permitted.
2. By not being in the organization it may cause the quality of report.
3. The report is based on the secondary data only.
3
Chapter 2 The Foreign Exchange Market
2.1 What Is Foreign Exchange?
?Foreign exchange? refers to money denominated in the currency of
another nation or a group of nations. Any person who exchanges money
denominated in his own nation's currency for money denominated in
another nation's currency acquires foreign exchange.
This holds true whether the amount of the transaction is equal to a few
rupees or to billions of rupees; whether the person involved is a tourist
cashing a traveller's cheque in a restaurant abroad or an investor
exchanging hundreds of millions of rupees for the acquisition of a foreign
company; and whether the form of money being acquired is foreign
currency notes, foreign currency-denominated bank deposits, or other
short- term claims denominated in foreign currency.
A foreign exchange transaction is still a shift of funds or short- term
financial claims from one country and currency to another. Thus, within
India, any money denominated in any currency other than the Indian
rupees (INR) is, broadly speaking, ?foreign exchange.? Foreign exchange
can be cash, funds available on credit cards and debit cards, traveller's
cheques, bank deposits, or other short-term claims. It is still ?foreign
exchange? if it is a short-term negotiable financial claim denominated in a
currency other than INR.
2.2. Why Do You Need Foreign Exchange?
Almost every nation has its own national currency or monetary unit its
rupee, its dollar, its peso used for making and receiving payments within
its own borders. But foreign currencies are usually needed for payments
across national borders. Thus, in any nation whose residents conduct
business abroad or engage in financial transactions with persons in other
Chapter 2 The Foreign Exchange Market
4
countries, there must be a mechanism for providing access to foreign
currencies, so that payments can be made in a form acceptable to foreigners.
In other words, there is need for ?foreign exchange? transactions exchanges
of one currency for another.
2.3. Role of the Exchange Rate
The exchange rate is a price the number of units of one nation's currency that
must be surrendered in order to acquire one unit of other nation‘s currency.
There are scores of ?exchange rates? for INR and other currencies, say, US
Dollar. In the spot market there is an exchange rate for every other national
currency traded in that market, as well as for various composite currencies or
constructed monetary units such as the euro or the International Monetary
Fund's ?Special Drawing Rights (SDRs)?. There are also various ?trade ?
weighted or ?effective rates designed to show a currency movements against
an average of various other currencies (e.g. US dollar index, which is a
weighted index against world major currencies like euro, pound sterling,
yen, and Canadian dollar). Quite apart from the spot rates, there are
additional exchange rates for other delivery dates in the forward markets.
A market price is determined by the interaction of buyers and sellers in
that market, and a market exchange rate between two currencies is
determined by the interaction of the official and private participants in the
foreign exchange rate market. For a currency with an exchange rate that
is fixed, or set by the monetary authorities, the central bank or another
official body is a key participant in the market, standing ready to buy or sell
the currency as necessary to maintain the authorized pegged rate or
range. But in countries like the United States, which follows a complete
free floating regime, the authorities do not intervene in the foreign
exchange market on a continuous basis to influence the exchange rate.
The market participation is made up of individuals, non-financial firms,
banks, official bodies, and other private institutions from all over the world
that are buying and selling US dollars at that particular time.
The participants in the foreign exchange market are thus a
Chapter 2 The Foreign Exchange Market
5
heterogeneous group. The various investors, hedgers, and speculators
may be focused on any time period, from a few minutes to several years.
But, whatever is the constitution of participants, and whether their motive
is investing, hedging, speculating, arbitraging, paying for imports, or
seeking to influence the rate, they are all part of the aggregate demand for
and supply of the currencies involved, and they all play a role in determining
the market price at that instant. Given the diverse views, interests, and
time frames of the participants, predicting the future course of exchange
rates is a particularly complex and uncertain business. At the same time,
since the exchange rate influences such a vast array of participants and
business decisions, it is a pervasive and singularly important price in an
open economy, influencing consumer prices, investment decisions,
interest rates, economic growth, the location of industry, and much
else. The role of the foreign exchange market in the determination of that
price is critically important.
2.4 It's a 24-Hours Market
During the past quarter century, the concept of a 24-hour market has
become a reality. Somewhere on the planet, financial centres are open for
business, and banks and other institutions are trading the dollar and other
currencies every hour of the day and night, except for possible minor gaps
on weekends. In financial centres around the world, business hours
overlap; as some centres close, others open and begin to trade. The foreign
exchange market follows the sun around the earth.
Business is heavy when both the US markets and the major European
markets are open that is, when it is morning in New York and afternoon in
London. In the New York market, nearly two-thirds of the day's activity
typically takes place in the morning hours. Activity normally becomes
very slow in New York in the mid- to late afternoon, after European markets
have closed and before the Tokyo, Hong Kong, and Singapore markets
have opened.
Chapter 2 The Foreign Exchange Market
6
Given this uneven flow of business around the clock, market participants
often will respond less aggressively to an exchange rate development that
occurs at a relatively inactive time of day, and will wait to see whether the
development is confirmed when the major markets open. Some institutions
pay little attention to developments in less active markets. Nonetheless, the
24-hour market provides a continuous ?real-time? market assessment of the
ebb and flow of influences and attitudes with respect to the traded
currencies, and an opportunity for a quick judgment of unexpected events.
With many traders carrying pocket monitors, it has become relatively easy
to stay in touch with market developments at all times.
2.5. International Markets Are Made up of an International
Network of Dealers
The market consists of a limited number of major dealer institutions that
are particularly active in foreign exchange, trading with customers and
(more often) with each other. Most of these institutions, but not all, are
commercial banks and investment banks. These institutions are
geographically dispersed, located in numerous financial centres around
the world. Wherever they are located, these institutions are in close
communication with each other; linked to each other through telephones,
computers, and other electronic means.
Each nation's market has its own infrastructure. For foreign exchange
market operations as well as for other matters, each country enforces its
own laws, banking regulations, accounting rules, and tax code, and, as
noted above, it operates its own payment and settlement systems. Thus,
even in a global foreign exchange market with currencies traded on
essentially the same terms simultaneously in many financial centres, there
are different national financial systems and infrastructures through
which transactions are executed, and within which currencies are held.
With access to all of the foreign exchange markets generally open to
participants from all countries, and with vast amounts of market
information transmitted simultaneously and almost instantly to dealers
Chapter 2 The Foreign Exchange Market
7
throughout the world, there is an enormous amount of cross-border foreign
exchange trading among dealers as well as between dealers and their
customers.
At any moment, the exchange rates of major currencies tend to be virtually
identical in all of the financial centres where there is active trading. Rarely
are there such substantial price differences among major centres
as to provide major opportunities for arbitrage. In pricing, the
various financial centres that are open for business and active at any one
time are effectively integrated into a single market.
2.6 Most Widely Traded Currency is the Dollar
The dollar is by far the most widely traded currency. In part, the
widespread use of the dollar reflects its substantial international role
as ?investment? currency in many capital markets, ?reserve? currency
held by many central banks, ?transaction? currency in many international
commodity markets, ?invoice? currency in many contracts, and
?intervention? currency employed by monetary authorities in market
operations to influence their own exchange rates.
In addition, the widespread trading of the dollar reflects its use as a
?vehicle? currency in foreign exchange transactions, a use that reinforces,
and is reinforced by, its international role in trade and finance. For most
pairs of currencies, the market practice is to trade each of the two
currencies against a common third currency as a vehicle, rather than to
trade the two currencies directly against each other. The vehicle currency
used most often is the dollar, although very recently euro also has become
an important vehicle.
Thus, a trader wanting to shift funds from one currency to another, say
from Indian INR to Philippine pesos, will probably sell INR for US dollars
and then sell the US dollars for pesos. Although this approach results in
two transactions rather than one, it may be the preferred way, since the
dollar/INR market, and the dollar/Philippine peso market are much more
active and liquid and have much better information than a bilateral
Chapter 2 The Foreign Exchange Market
8
market for the two currencies directly against each other. By using the
dollar or some other currency as a vehicle, banks and other foreign
exchange market participants can limit more of their working balances to
the vehicle currency, rather than holding and managing many currencies,
and can concentrate their research and information sources on the vehicle.
Use of a vehicle currency greatly reduces the number of exchange rates that
must be dealt with in a multilateral system. In a system of 10 currencies, if
one currency is selected as vehicle currency and used for all transactions,
there would be a total of nine currency pairs or exchange rates to be dealt
with (i.e. one exchange rate for the vehicle currency against each of the
others), whereas if no vehicle currency were used, there would be 45
exchange rates to be dealt with. In a system of 100 currencies with no
vehicle currencies, potentially there would be 4,950 currency pairs or
exchange rates [the formula is: n(n-1)/2]. Thus, using a vehicle currency can
yield the advantages of fewer, larger, and more liquid markets with fewer
currency balances, reduced informational needs, and simpler operations.
The US dollar took on a major vehicle currency role with the introduction
of the Bretton Woods par value system, in which most nations met their
IMF exchange rate obligations by buying and selling US dollars to maintain
a par value relationship for their own currency against the US dollar. The
dollar was a convenient vehicle because of its central role in the exchange
rate system and its widespread use as a reserve currency. The dollar's
vehicle currency role was also due to the presence of large and liquid dollar
money and other financial markets, and, in time, the euro-dollar markets,
where the dollars needed for (or resulting from) foreign exchange
transactions could conveniently be borrowed (or placed).
2.7. Other Major Currencies
2.7.1 The Euro
The euro was designed to become the premier currency in trading by
simply being quoted in American terms. Like the US dollar, the euro has a
Chapter 2 The Foreign Exchange Market
9
strong international presence and over the years has emerged as a premier
currency, second only to the US dollar.
2.7.2 The Japanese Yen
The Japanese yen is the third most traded currency in the world. It has a
much smaller international presence than the US dollar or the euro. The
yen is very liquid around the world, practically around the clock
2.7.3 The British Pound
Until the end of World War II, the pound was the currency of reference.
The nickname cable is derived from the telegrams used to update the
GBP/USD rates across the Atlantic. The currency is heavily traded against
the euro and the US dollar, but it has a spotty presence against other
currencies. The two-year bout with the Exchange Rate Mechanism, between
1990 and 1992, had a soothing effect on the British pound, as it
generally had to follow the Deutsche mark's fluctuations, but the crisis
conditions that precipitated the pound's withdrawal from the ERM had a
psychological effect on the currency.
2.7.4 The Swiss Franc
The Swiss franc is the only currency of a major European country that
belongs neither to the European Monetary Union nor to the G-7
countries. Although the Swiss economy is relatively small, the Swiss
franc is one of the major currencies, closely resembling the strength and
quality of the Swiss economy and finance. Switzerland has a very close
economic relationship with Germany, and thus to the euro zone.
10
Chapter 3 Evolution of Forex Market
3.1 Exchange Rate System
Countries of the world have been exchanging goods and services amongst
themselves. This has been going on from time immemorial. The world has
come a long way from the days of barter trade. With the invention of
money the figures and problems of barter trade have disappeared. The
barter trade has given way to exchanged of goods and services for
currencies instead of goods and services.
The rupee was historically linked with pound sterling. India was a founder
member of the IMF. During the existence of the fixed exchange rate
system, the intervention currency of the Reserve Bank of India (RBI) was
the British pound, the RBI ensured maintenance of the exchange rate by
selling and buying pound against rupees at fixed rates. The interbank rate
therefore ruled the RBI band. During the fixed exchange rate era, there
was only one major change in the parity of the rupee- devaluation in June
1966.
Different countries have adopted different exchange rate system at
different time. The following are some of the exchange rate system
followed by various countries.
3.2 The Gold Standard
Many countries have adopted gold standard as their monetary system
during the last two decades of the 19
th
century. This system was in vogue
till the outbreak of World War 1. Under this system the parities of
currencies were fixed in term of gold. There were two main types of gold
standard:
Chapter 3 Evolution of Forex Market
11
3.2.1 Gold specie standard
Gold was recognized as means of international settlement for receipts and
payments amongst countries. Gold coins were an accepted mode of
payment and medium of exchange in domestic market also. A country
was stated to be on gold standard if the following condition were
satisfied:
? Monetary authority, generally the central bank of the country,
guaranteed to buy and sell gold in unrestricted amounts at the fixed
price.
? Melting gold including gold coins, and putting it to different uses
was freely allowed.
? Import and export of gold was freely allowed.
? The total money supply in the country was determined by the
quantum of gold available for monetary purpose.
3.2.2 Gold Bullion Standard
Under this system, the money in circulation was either partly of entirely
paper and gold served as reserve asset for the money supply.. However,
paper money could be exchanged for gold at any time. The exchange rate
varied depending upon the gold content of currencies. This was also
known as ? Mint Parity Theory ? of exchange rates.
The gold bullion standard prevailed from about 1870 until 1914, and
intermittently thereafter until 1944. World War I brought an end to the
gold standard.
3.3 Bretton Woods System
During the world wars, economies of almost all the countries suffered. In
order to correct the balance of payments disequilibrium, many countries
devalued their currencies. Consequently, the international trade suffered
a deathblow. In 1944, following World War II, the United States and most
of its allies ratified the Bretton Woods Agreement, which set up an
Chapter 3 Evolution of Forex Market
12
adjustable parity exchange-rate system under which exchange rates were
fixed (Pegged) within narrow intervention limits (pegs) by the United
States and foreign central banks buying and selling foreign currencies.
This agreement, fostered by a new spirit of international cooperation, was
in response to financial chaos that had reigned before and during the war.
In addition to setting up fixed exchange parities (par values) of currencies
in relationship to gold, the agreement established the International
Monetary Fund (IMF) to act as the ?custodian? of the system.
Under this system there were uncontrollable capital flows, which lead to
major countries suspending their obligation to intervene in the market
and the Bretton Wood System, with its fixed parities, was effectively
buried. Thus, the world economy has been living through an era of
floating exchange rates since the early 1970.
3.4 Floating Rate System
In a truly floating exchange rate regime, the relative prices of currencies
are decided entirely by the market forces of demand and supply. There is
no attempt by the authorities to influence exchange rate. Where
government interferes‘ directly or through various monetary and fiscal
measures in determining the exchange rate, it is known as managed of
dirty float.
3.5 Current Exchange Rate Arrangement
Although the most actively traded currencies of the world, such as the
dollar, the yen, the pound, and the euro, may be fluctuating against each
other, a significant number of the world‘s currencies are pegged to single
currencies, particularly the U.S. dollar and the euro, or baskets of
currencies such as the SDR. The current exchange rate arrangements as
classified by the IMF are provided in Exhibit 2.4. As can be seen from the
exhibit, the IMF currently classifies exchange rate arrangements into eight
separate regimes:
Chapter 3 Evolution of Forex Market
13
3.5.1 Exchange arrangements with no separate legal tender: The
currency of another country circulates as the sole legal tender or the
country belongs to a monetary or currency union in which the same legal
tender is shared by the members of the union. Examples include Ecuador,
El Salvador, and Panama using the U.S. dollar and the 12 euro zone
member countries (like France, Germany, and Italy) sharing the common
currency, the euro.
3.5.2 Currency board arrangements: A monetary regime based on an
explicit legislative commitment to exchange domestic currency for a
specified foreign currency at a fixed exchange rate, combined with
restrictions on the issuing authority to ensure the fulfillment of its legal
obligation. Examples include Hong Kong fixed to the U.S. dollar and
Estonia fixed to the euro.
3.5.3 Other conventional fixed peg arrangement: The country pegs
its currency (formally or de facto) at a fixed rate to a major currency or a
basket of currencies where the exchange rate fluctuates within a narrow
margin of less than 1 percent, plus or minus, around a central rate.
Examples include Morocco, Saudi Arabia, and Ukraine.
3.5.4 Pegged exchange rates within horizontal bands: The value of
the currency is maintained within margins of fluctuation around a formal
or de facto fixed peg that are wider than at least 1 percent, plus or minus,
around a central rate. Examples include Denmark, Slovenia, and Hungary.
3.5.5 Crawling pegs: The currency is adjusted periodically in small
amounts at a fixed, preannounced rate or in response to changes in
selective quantitative indicators. Examples are Bolivia, Costa Rica, and
Tunisia
Chapter 3 Evolution of Forex Market
14
3.5.6 Exchange rates within crawling bands: The currency is
maintained within certain fluctuation margins around a central rate that is
adjusted periodically at a fixed preannounced rate or in response to
changes in selective quantitative indicators. Examples are Belarus and
Romania.
3.5.7 Managed floating with no preannounced path for the
exchange rate: The monetary authority influences the movements of the
exchange rate through active intervention in the foreign exchange market
without specifying, or recommitting to, a preannounced path for the
exchange rate. Examples include Algeria, China, P.R., Czech Republic,
India, Russia, Singapore, and Thailand.
3.5.8 Independent floating: The exchange rate is market determined,
with any foreign exchange intervention aimed at moderating the rate of
change and preventing undue fluctuations in the exchange rate rather
than at establishing a level for it. Examples include Australia, Brazil,
Canada, Korea, Mexico, the U.K., Japan, Switzerland, and the United
States.
15
Chapter 4 Forex Spot Market
A General Overview
A spot transaction is a ?straightforward? (outright) exchange of one
currency for another. The spot rate is the current market price, the
benchmark price.
Spot transactions do not require immediate settlement or payment ?on the
spot.? By convention, the ?settlement date? (value date), is the second
business day after the ?deal date? (trade date) on which the transaction is
agreed to by the two traders. The two-day period provides ample time
for the two parties to confirm the agreement and arrange the clearing and
necessary debiting and crediting of bank accounts in various international
locations.
Exceptionally, spot transactions between the Canadian dollar and the US
dollar are settled conventionally one business day after the deal, rather
than two business days later, since Canada is in the same time zone as
the US and an earlier value date is feasible. A spot transaction represents a
direct exchange of one currency for another, and when executed, leads to
transfers through the payment systems of the two countries whose
currencies are involved. In a typical spot transaction, Bank A in New York
will agree on June 1 to sell USD 1 million for INR to Bank B in Mumbai at
the rate of, say, INR 43.50 per dollar for value June 3. On June 3, Bank B
will pay INR 43.50 million for credit to Bank A's account at a bank in
Mumbai, and Bank A will pay $1 million for credit to Bank B's account at a
bank in the United States. The execution of the two payments completes
the transaction.
4.1 Bid Price and an Ask Price
In the foreign exchange market there are always two prices for every
currency one price at which sellers of that currency want to sell, and another
price at which buyers want to buy. A market maker is expected to quote
Chapter 4 Forex Spot Market
16
simultaneously for his customers a price at which he is willing to sell and a
price at which he is willing to buy standard amounts of any currency for
which he is making a market.
4.2 Base Currency and a Terms Currency
Every foreign exchange transaction involves two currencies and it is
important to keep straight which is the base currency (or fixed currency)
and which is the terms currency (or counter currency). A trader always
buys or sells a fixed amount of the ?base? currency as noted above, most
often the dollar and adjusts the amount of the ?terms? currency as the
exchange rate changes.
The terms currency is thus the numerator and the base currency is the
denominator. When the numerator increases, the base currency
strengthens and becomes more expensive; when the numerator decreases,
the base currency weakens and becomes cheaper.
In oral communications, the base currency is always stated first. For
example, a quotation for ?dollar-rupee? means the dollar is the base and
the denominator, and the rupee is the terms currency and the numerator
and ?dollar-yen? means that the Japanese yen is the terms currency.
Currency codes are also used to denote currency pairs, with the base
currency usually presented first, followed by an oblique. Thus ?dollar-
rupee? is USD/INR, ?dollar-yen? is USD/YEN, and, ?pound sterling-dollar?
is GBP/USD.
You would buy the pair if you believe the base currency will appreciate (go
up) relative to the quote currency. You would sell the pair if you think the
base currency will depreciate (go down) relative to the quote currency.
Chapter 4 Forex Spot Market
17
4.3 Bids and Offers Are for the Base Currency
Traders always think in terms of how much it costs to buy or sell the base
currency. A market maker's quotes are always presented from the market
maker's point of view, so the bid price is the amount of terms currency that
the market maker will pay for a unit of the base currency; the offer price is
the amount of terms currency the market maker will charge for a unit of the
base currency. A market maker asked for a quote on ?dollar-rupee? might
respond ?43.5125-35,? indicating a bid price of INR 43.5125 per dollar
and an offer price of INR 43.5135 per dollar. Usually the market maker will
simply give the quote as ?25-35,? and assume that the counter party knows
that the ?big figure? is 43.51. The bid price always is offered first (the
number on the left), and is lower (a smaller amount of terms currency)
than the offer price (the larger number on the right). This differential is
the dealer's spread.
4.4 Quotes Are in Basis Points
For most currencies, bid and offer quotes are presented to the forth decimal
place that is, to one-hundredth of one percent or 1/10000 of the terms
currency unit, usually called a ?pip‘. However, for few currency units those are
relatively small in absolute value, such as Indonesian Rupiah, quotes may be
carried to two decimal places and a ?pip‘ is 1/100 of the terms currency unit.
In many market, a ?pip‘ or ?tick‘ is the smallest amount by which a price can
move in that market and in the foreign market ?pip‘ is the term commonly
used.
Chapter 5 Exchange Traded Currency Futures
18
Chapter 5 Exchange Traded Currency Futures
Futures contracts are standardized forward contracts. The quality and
quantity of the underlying asset is standardized. Futures contracts are
transferable in nature. For all practical purposes, a forward contract
becomes a futures contract if the quality and quantity are standardized and
the contract is traded on a derivatives exchange. This provides for offsetting
deals to square off the open position. Futures contracts have the
Following basic features:
? They are exchange-traded versions of forward contracts
? Time, place, and delivery price fixed between buyer and seller
? Buyer takes a long position
? Seller takes a short position
? Contracts of standard specifications
? Bring in hedgers, speculators, and those who want to discover
prices
? Margin system reduces risk, provides liquidity, and reduces volatility
5.1 Purpose
Futures are similar to forward contracts, except that
? Default risk is reduced in a different way by marking to market. This
introduces a (small) difference between a Future price and a
Forward Price
? Secondary dealing is facilitated.
5.2 Similarities with Forward Contract
? Contracts to deliver a given number of currency units on a given date
and at a pre-specified price to be paid ?later on?.
? Zero initial market value
Chapter 5 Exchange Traded Currency Futures
19
5.3 Differences with Forward Contract
? Organized markets
? Standardized contracts
? The Clearing Corporation
? Marking to Market
? Margin Requirements
5.4 Organized Markets
Futures contracts:
? Traded on organized exchanges, Price is result of a centralized,
organized confrontation between demand and supply.
? ?Open outcry? system
? Computerized Public Limit Order Book
? Price and transaction information
? Secondary market
5.5 Standardized Contracts
? Contract Size: Contract size is standardized and well defined in the
contract specification.
? Expiration dates: Typically last business day of the month. Traditionally,
only the three nearest contracts are traded.
? Tick size: Exchange specifies the minimum size of the price movement
and in some cases also impose a minimum price change during a day.
? Trading stops two business days before the expiration date, and actual
delivery takes place on the second business day after the expiration
date.
Chapter 5 Exchange Traded Currency Futures
20
Example:
Category Description
Underlying Rate of exchange between 1 USD and INR
Contract Size USD 1000
Contract Months 12 near calendar months
Expiration Date and Time Last business day of the month
Min Price fluctuation 0.25 paisa or INR 0.0025
Settlement Cash settled in INR on relevant RBI reference rate
5.6 The Clearing Corporation (CC)
A clearing house guarantees transactions on organized exchanges; a
default by an intermediary is unlikely to lead to losses for market users.
? When A ?sells? to B, A sells to CC, and CC sells to B. Thus, CC
guarantees the contract (and has reserves).
? The clearing house also ?clears?: if A buys from B and then some time
later sells to C, the clearing house cancels out both of A's contracts,
and only the contracts with B and C remain outstanding.
5.7 Mark to Market (MTM)
Mark to market at the end of the trading session: All outstanding contracts
are re-priced at the settlement price for that session. Margin account of
those who made losses is debited and those who gained are credited.
Suppose on August 10 one holds a view that INR will depreciate against
USD, caused by India's sharply rising import bill and hence buys an
October delivery Futures contract at a price of Rs. 43.50 per USD or Rs.
43,500 (43.5 x 1000) per contract. Next day, the price decreases and at the
end of the trading on August 11, the settlement price is 44.00. So s/he has
made a gain of Rs. 500 (44,000 43,500)and this is credited to his/her
margin account (can be immediately withdrawn) and now the contract is
re-priced at USD/INR 44.00 or 44,000 per contract. MTM creates an
important difference between forward and futures. In forward contract,
Chapter 5 Exchange Traded Currency Futures
21
gains and losses arouse only on maturity. There are no immediate cash
lows; in a futures contract, even though the overall gain/loss is same, the
time profile of its accrual is different the total gains and losses are
broken up into a daily series of gains and losses that clearly have different
present value.
5.8 Purpose of marking to market
? By defaulting, the investor merely avoids the latest mark-to-market
outflow. All previous losses have already been settled in cash.
? Thus, compared to a forward contract, the incentive to default on a
futures contract is smaller.
? Advantage of defaulting is even smaller than latest price change, as
there are margin requirements.
5.9 Margin Requirements
? Initial margin of, say, 3%
? Maintenance margin: account for daily MTM. Small losses will be
allowed to accumulate until margin drops below maintenance level.
Then margin is restored (in cash) (margin call). If there are gains,
any amount exceeding the maintenance margin can be withdrawn.
? Example
? Rs. 43,500 contract with Initial margin INR
1305 and Maintenance margin say INR 1050.
? The initial INR 1305 margin is the initial ?equity? in the account.
? The buyer's equity increases (decreases) when prices rise (fall).
? As long as the investor's losses do not exceed INR 255, equity
remains above 1050, and no margin call will be issued.
? If the equity however falls below INR 1050,
must add variation margin that restores the equity
to INR 1305.
Chapter 5 Exchange Traded Currency Futures
22
5.10 Impact of Futures on Spot and Forward Markets
There are concerns about the impact of currency futures price on the spot
price or vice versa. There is no clear evidence to suggest that currency
futures result in enhancement of volatility in the spot exchange rates in a
causal sense. Empirical evidence is ambiguous as to whether currency
futures afford distinctly higher speculation than is possible without them.
In theory, futures price would largely operate on a premise similar to
forward markets, i.e. it should largely reflect interest rate differentials. In
India, as in most countries, even the forward prices do not stick to that
script most of the time but are susceptible to the influence of sentiments.
An appropriate term structure of forward premium is yet to develop in India.
As such, while theoretically futures prices should reflect similar interest rate
expectations, the real effect on prices remains to be seen.
Worldwide, the currency futures market remains small, though rapidly
growing in relation to the size of OTC spot as well as forward market. The
average daily turnover in 2004, exchange-traded currency contracts was
USD 23 billion in a total foreign exchange turnover of USD 1,880 billion, which
included the USD 621 billion in the spot foreign exchange market. According to
the preliminary results of the just released Triennial Central Bank Survey of
Foreign Exchange and Derivatives Market Activity in 2007, the average daily
turnover in exchange-traded currency contract has trebled since then to
USD 110 Billion in 2009. However it is still small in relation to USD 3,220
billion total foreign exchange turnover, which includes around USD 2000
billion daily spot turn over in 2009. The exchange-traded currency contracts
comprise futures as well as options and options on futures. As such,
currency futures still comprise less than 2 per cent of the foreign exchange
market. Therefore, the currency futures market is far from becoming a
significant segment of the foreign exchange market and can be seen merely
as an add-on to risk management kit and a tool for furthering transparent price
discovery.
Chapter 5 Exchange Traded Currency Futures
23
It may, nevertheless, be stated that the importance of futures market in
price discovery might actually be larger than its share in turnover would
indicate. This is so, because typical players such as hedgers could have
considerable private information. Also, for individuals, SMEs, and small
exporters, currency \futures could bring in transparency and coupled with
anonymity accompanying the order matching trading format can help
reduce information asymmetry in the foreign exchange market, bringing in
better price discovery.
5.11 Investment Strategies Using Currency Futures
The Role of Speculation in Futures Markets
Speculators play a vital role in the futures markets. Futures are designed
primarily to assist hedgers in managing their exposure to price risk;
however, this would not be possible without the participation of
speculators. Speculators, or traders, assume the price risk that hedgers
attempt to lay off in the markets. In other words, hedgers often depend on
speculators to take the other side of their trades and to add depth and
liquidity to the markets that is vital for the functioning of a futures market.
Speculation is also not similar to manipulation. A manipulator tries to
push prices in the reverse direction of the market equilibrium while the
speculator forecasts the movement in prices and this effort eventually
brings the prices closer to the market equilibrium. If the speculator does
not adhere to the relevant fundamental factors of the spot market, they
would not survive since their correlation with the underlying spot market
would be nonexistent.
Speculators can also be classified into two categories: long and short
speculators. Long speculators are those who expect the exchange rate to
rise above the current level and assume risks by buying futures contracts
where as short speculators are those who expect the exchange rate to fall
and consequently sell futures contracts. In futures market, the total short
selling position, made up of short hedgers and short speculators, and the
Chapter 5 Exchange Traded Currency Futures
24
EXHIBIT 5.1 Payoff long position in Futures
total long buying position, made up of long hedgers and long speculators,
must always be equal.
5.11.1 Long Position in Futures
Long position in a currency futures contract without any exposure in the
cash market is called a speculative transaction. Long position in futures for
speculative purpose means buying futures contract in anticipation of
strengthening of the exchange rate (which actually means buy the base
currency and sell the quote currency and you want the base currency to
rise in value and then you would sell it back at a higher price). If the
exchange rate strengthens before the expiry of the contract then the trader
makes a profit on squaring off the position, and if the exchange rate weakens
then the trader makes loss.
The graph above depicts
the pay-off of a long
position in a future
contract, which does
demonstrate that the pay-
off of a short trader is
linear derivative, that is, he
makes unlimited profit if the
market moves as per his directional view, and if the market goes against,
he has equal risk of making unlimited losses if he doesn't choose to stop
out his position.
Example: Long positions in futures
On May 1, 2008, an active trader in the currency futures market expects INR
will depreciate against USD caused by India's sharply rising import bill and
poor FII equity flows. On the basis of his view about the USD/INR
movement, he buys 1 USD/INR August contract at the prevailing RBI
reference rate of Rs. 40.5800.
Chapter 5 Exchange Traded Currency Futures
25
He decides to hold the contract till expiry and during the holding period
USD/INR futures actually moves as per his anticipation and the RBI.
Reference rate increases to USD/INR 42.46 on May 30, 2008. He squares
off his position and books a profit of Rs 1880 (42.4600x1000 -
40.5800x1000) on 1 contract of USD/INR futures contract.
Observation: The trader has effectively analyzed the market conditions and
has taken a right call by going long on futures and thus has made a decent
gain of Rs. 1,880.
5.11.2 Short Position in Futures
Short position in a currency futures contract without any exposure in the
cash market is called a speculative transaction. Short position in futures
for speculative purposes means selling a futures contract in
anticipation of decline in the exchange rate (which actually means sell
the base currency (USD) and buy the quote currency (INR) and you want
the base currency to fall in value and then you would buy it back at a lower
price). If the exchange rate weakens before the expiry of the contract then
the trader makes a profit on squaring off the position, and if the exchange
rate strengthens then the trader makes loss.
Chapter 5 Exchange Traded Currency Futures
26
EXHIBIT 5.2 Payoff Short position in Futures
The graph depicts the pay-
off of a short position in a
future contract which does
exhibit that the pay-off of a
short trader is a linear
derivative, that is, he makes
unlimited profit if the market
moves as per his directional
view (goes down) and if the market goes against his view he has equal risk
of making unlimited loss if he doesn't choose to stop out his position.
Example: Short positions in futures
On August 1, 2008, an active trader in the currency futures market
expects INR will appreciate against USD, caused by softening of crude oil
prices in the international market and hence helping India's trade balance.
On the basis of his view about the USD/INR movement, he sells 1
USD/INR August contract at the prevailing RBI reference rate of Rs.
42.3600.
On August 6, 2008, USD/INR October futures contract actually moves as
per his anticipation and declines to 41.9999. He decides to square off
his position and earns a profit of Rs. 360.10000 (42.3600x1000
/41.9999x1000) on squaring off the short position of 1 USD/INR August
futures contract.
Observation: The trader has effectively analyzed the market conditions
and has taken a right call by going short on futures and thus has made a
decent gain of Rs. 360 per contract with small investment of say a margin
of 3%, which comes to Rs. 1270.8 in a span of 6 days.
Chapter 5 Exchange Traded Currency Futures
27
5.11.3 Trading Spread Using Currency Futures
In the current scenario, no one likes to lose an opportunity to make
money out of volatility, if predictable; the same holds good if one can
predict spread movement, and hence can capitalize on that.
Spread refers to difference in prices of two futures contracts. An
understanding of spread relation in terms of fair spread is essential to earn
speculative profit. Considerable knowledge of a particular currency pair is
also necessary to enable the trader to use spread trading strategy.
Spread movement is based on following factors:
? Interest Rate Differentials
? Liquidity in Banking System
? Monetary Policy Decision (Repo, Reverse Repo and CRR)
? Inflation
Intra-Currency Pair Spread: An intra-currency pair spread consists of one
long futures and one short futures. Both have the same underlying but
different maturities.
Inter-Currency Pair Spread: An inter-currency pair spread is a long-short
position in futures on different underlying currency pairs. Both typically
have the same maturity.
Example: Mr. X is an active trader in the currency futures market. In
September 2008, Mr. X gets an opportunity for spread trading in currency
futures. He is of the view that in the current environment of high inflation
and high interest rate the premium will higher and hence USD will
appreciate for more than the indication in the currency quotes, i.e. spread
will widen. On the basis of his views, he decides to buy December currency
future at 47.00 and at the same time sell October Future contract at 46.80,
the spread between the two contracts is 0.20
Let's say after 30 days the spread widens actually as per his expectation
and now the October futures contract is trading at 46.90 and December
futures contract is trading at 47.25, the spread now stands at 0.35. He
decides to square off his position making a gain of Rs. 150.
Chapter 5 Exchange Traded Currency Futures
28
5.11.4 Arbitrage
Arbitrage means locking in a profit by simultaneously entering into
transactions in two or more markets. If the relation between forward prices
and futures prices differs, it gives rise to arbitrage opportunities. Difference
in the equilibrium prices determined by the demand and supply at two
different markets also gives opportunities to arbitrage.
Example: Let's say the spot rate for USD/INR is quoted @ Rs. 44.325
and one month forward is quoted at 3 paisa premium to spot @ 44.3550
while at the same time one month currency futures is trading @ Rs.
44.4625. An active arbitrager realizes that there is an arbitrage opportunity
as the one month futures price is more than the one month forward price.
He implements the arbitrage trade where he;
Sells in futures @ 44.4625 levels (1 month) Buys in forward @ 44.3250 + 3
paisa premium = 44.3550 (1 month) with the same term period On the date
of future expiry he buys in forward and delivers the same on exchange
platform In the process, he makes a Net Gain of 44.4625-44.3550 =0.1075
i.e. Approx 11 Paisa arbitrage Profit per contract =107.5 (0.1075x1000)
Observation: The discrepancies in the prices between the two markets have
given him an opportunity to implement riskless arbitrage. As more and
more market players will realize this opportunity, they may also
implement the arbitrage strategy and in the process will enable market to
come to a level of equilibrium.
Many people are attracted toward futures market speculation after hearing
stories about the amount of money that can be made by trading futures.
While there are success s, and many people have achieved a more modest
level of success in futures trading. The keys to their success are typically
hard work, a disciplined approach, and a dedication to master their trade.
An investor should always remember the trade that he has initiated has
the equal probability of going wrong and must therefore apply meticulous
risk management practices to ensure the safety of his hard-earned capital.
Chapter 5 Exchange Traded Currency Futures
29
5.12 Recent Forex Market in India
It is almost one and a half years since the introduction of currency futures
under the currency derivatives segment of Indian stock exchanges. The
volumes have increased tremendously on NSE and its arch rival MCX-SX,
the two dominant exchanges of trading in currency futures; while on BSE
practically there have been no volumes in the last six months or so.
Trading in currency futures had started by NSE on August 29, 2008. This
article examines the volumes traded on these and explains the basics of
currency futures in a comprehensive manner. NSE and MCX Stock
Exchange are launching futures trading in three new currency pairs,
namely, EUR-INR, GBP-INR and JPY-INR on February 1, 2010 following
the decision of RBI to introduce the additional pairs. RBI and SEBI had
issued their guidelines for these three pairs on January 19, 2010.
5.13 Status Check On Currency Futures in India
As of now, the combined average daily turnover of the currency futures
contracts in all the three exchanges increased from USD 1.1 billion in
March 2009 to 2.5 billion in September 2009 – which means a growth of
more than 125 per cent in just six months period. These developments
are very good from the market point of view. More volumes result in
better price discovery and more opportunities for traders, investors,
genuine hedgers, speculators and arbitrageurs.
As can be seen from the following Graph, the trading volumes on MCX-SX
exchange traded currency futures have risen tremendously in the last 18
months. Let us take note of the volume increase between December 2008
and July 2009. The daily volumes have surged by four times during that
period from Rs. 970 crore to about 3808 crore. The cumulative volume
between August 2008 and July 2009 works out to Rs. 401428.2 crore on
MCX-SX only. During FY 2008-09, total traded volume was only Rs 869
crore on BSE; practically this exchange is out of the currency futures
market. In the last six months of the current financial year, there are
Chapter 5 Exchange Traded Currency Futures
30
practically no volumes on BSE. Today total daily volume take place about
Rs. 20000 Cr.
5.14 Most Current Benchmarks
? The turnover in the currency future segment in the MCX‘SX touched
a record high of Rs 10,798 crore on October 7 2009.
? The turnover of the 15-month old currency futures market in the
country on exceeded the cash equity segment by over a whopping
48 per cent to Rs 34,453 crore.
? While the turnover of over a century-year old cash equity market at
the end January 18, 2010 trade stood only at Rs 23,227 crore
EXHIBIT 5.3 Total Volume traded in India in Forex market Futures: MCX-SX
Chapter 5 Exchange Traded Currency Futures
31
5.15 Success Rate of the Currency Futures
If one goes by the spectacular rise in volumes traded on the stock
exchanges, one can argue that the introduction of currency futures has
been a success. However, volumes alone may not be sufficient to judge
the success of this new derivative product in India. Other criteria could be
the depth of the markets, participation from the various kinds of
investors, corporate, and other stakeholders of the market. Still there are
some creases to be ironed out with regard to Currency Futures.
FIIs and NRIs are still not allowed; even after the new product has been
introduced more than a year back. As stated in the first page of this
document, RBI has now only permitted three more currency pairs – Euro-
INR, Japanese Yen-INR and Pound Sterling-INR also, in addition to US
Dollar-INR which was already permitted. It remains to be seen how these
three pairs would perform.
If one compares the daily volume of more than USD 40 billion on the OTC
market, the daily volume of less than USD 2.50 billion on the exchange-
traded currency futures is small. But, over a period of time, with
increased participation and more currencies, the currency futures may
become a force to reckon with on their own – the dominance of
exchange-traded derivatives is the norm in international markets.
32
Chapter 6 Forecasting The Exchange Rate
Since the advent of the flexible exchange rate system in 1973, exchange
rates have become increasingly more volatile and erratic. At the same
time, the scope of business activities has become highly international.
Consequently, many business decisions are now made based on forecasts,
implicit or explicit, of future exchange rates. Understandably, forecasting
exchange rates as accurately as possible is a matter of vital importance
for currency traders who are actively engaged in speculating, hedging,
and arbitrage in the foreign exchange markets. It is also a vital concern
for multinational corporations that are formulating international sourcing,
production, financing, and marketing strategies. The quality of these
corporate decisions will critically depend on the accuracy of exchange rate
forecasts. Some corporations generate their own forecasts, while others
subscribe to outside services for a fee. While forecasters use a wide
variety of forecasting techniques, most can be classified into three distinct
approaches:
? Technical approach
? Fundamental approach
Let us briefly examine each of these approaches.
6.1 Technical Approach
The Forex technical analysis is concerned with what has actually
happened in the Forex market, rather than what should happen.
A technical analyst will study the price and volume movements and from
that data create charts (derived from the actions of the market players)
to use as his primary tool. The technical analyst is not much concerned
with any of the ?bigger picture? factors affecting the market, as is the
fundamental analyst, but concentrates on the activity of that instrument‘s
market.
Chapter 6 Forecasting The Exchange Rate
33
6.1.1 Technical analysis is based on three underlying principles
6.1.1.1 Market action discounts everything
This means that the actual price is a reflection of everything that is known
to the market that could affect it, for example, supply and demand,
political factors and market sentiment. The pure technical analyst is only
concerned with price movements, not with the reasons for any changes.
6.1.1.2 Prices move in trends
Technical analysis is used to identify patterns of market behaviour which
have long been recognized as significant. For many given patterns there
is a high probability that they will produce the expected results. Also
there are recognized patterns which repeat themselves on a consistent
basis.
6.1.1.3 History repeats itself
Chart patterns have been recognized and categorized for over 10 years
and the manner in which many patterns are repeated leads to the
conclusion that human psychology changes little with time.
6.1.2 List of categories of the technical analysis theory:
? Indicators (RSI, MACD, Bollinger Bands, etc.)
? Number theory (Fibonacci numbers
? Gaps (High-Low, Open-Closing)
? Trends (Following Moving Average)
? Chart formations (The Doji, Morning/Evening star, cups, etc.)
Use of all mentioned technical indicators, we will see in the following
chapters of the report.
Chapter 6 Forecasting The Exchange Rate
34
6.2 Fundamental Approach
The underlying elements affecting the economy of the subject is studied
by Forex fundamental analysis. According to this method, the analysis of
economic indicators, social factors and government policy of a business
cycle can forecast price movement and trends of the market. The
fundamentals of any country, multinational industry or trading bloc lie in
the combination of factors like social, political and economic influences.
Though, it is rather hard to stay aside from all these variable factors. So,
the sphere of complicated and subtle market fundamental lets the
explorer know and understand more details of a dynamic global market
during the analyzing.
It is possible to predict the conditions of the economy but unlikely the
market prices by using the fundamental analysis. You should have a
certain plan of action concerning the ways of using the information as
entry and exit spots in a certain strategy of trading. Forex fundamental
analysis is a fundamental strategy of trading widely used by online trader
of Forex. This strategy contains some estimations where the different
basic criteria, except for the price movement, are taken into consideration
during currency trading. The economic conditions in the currency native
country along with a number of other factors are the obligatory elements
of these criteria. Any fundamental part of the economy is included into
the fundamental analysis. A decent Forex fundamental analysis includes a
number of macroeconomic factors like economic growth rates, interest
rates, inflation, unemployment level and others. The market supply and
demand coming from political and social powers is the aim of fundamental
analysis. The market supply and demand balance forms the currencies
prices. The interest rates and the overall economy strength are the two
key factors that influence the supply-demand balance. The overall health
of the economy can be understood through a number of economic
indicators like GDP. The frequent inability of online Forex fundamental
analyses to find the entry and exit points is Forex fundamental analysis
Chapter 6 Forecasting The Exchange Rate
35
key problem. Due to this factor the risk control, especially provided with
the leverage, gets quite complicated. Only a piece of an enormous
amount of information coming every day is considerable. The interest
rates and international trade are the factors analyzed the most carefully.
In order to create the Forex trading strategy fundamentalist traders
create models. The empirical data is gathered in these models for further
forecasting the possible price trends and market behavior basing on the
key economic indicators.
Sometimes it happens that two analysts possessing the same data come
to different conclusions about the market behavior. Still you should
research the fundamental data and find out their best fitting to the style
of trading and expectations before getting down to any analysis. Any data
making the country tick is considered as fundamental by forex traders.
The fundamentals are the combination of certain plans, unpredictable
behaviors and unforeseen events found out from the factors like interest
rates and the policy of central bank and even natural disasters. That's
why it's better to be aware of the affective contributors of all these factors
than to all the fundamentals listed.
6.2.1 Fundamental elements of the economy
The Basic Concept
The economy will be affected by the investment performance. The
expected returns may change due to inflation or deflation influence.
That's why it is important to take the economy trends into consideration
while planning the strategies of investment.
6.2.1.1 The Business Cycle
The activity of the economy is generally shown by the business cycle. The
business cycle consists of four stages: recovery (also known as
expansion), peak, contraction (also called recession), and trough.
The growth of business activity, the increase of demand and production
as well as the expansion of employment can be seen. The interest rates
Chapter 6 Forecasting The Exchange Rate
36
generally rise during this phase due to money borrowing by businesses
and consumers for their expansion.
6.2.1.2 Inflation
At the moment of business cycle peak the amount of goods on demand
gets higher than the one on offer which is followed by the prices increase
and makes the inflation. At the inflationary environment the amount of
money offered for the goods is too high and it makes the conditions for
the prices to rise. This lowers the customer's ability for purchasing.
The demand declines lowering the economic activity due to the prices
increase. The recessionary phase follows this process.
6.2.1.3 Deflation
During deflation the economical activity lowers making the employers fire
the workers and lowering the demand. This is generally followed by the
prices lowering that turn into deflation. The trough phase comes after
that. Deflation is characterized as a process of strong and prolonged
prices reduction. The following demand rise is caused by low prices and
creates the conditions for the economy to come into the expansion phase.
6.2.1.4 Gross National Product (GNP)
Gross National Product is one of the key indicators of the economic
activity. All the services provided and the goods produced within the US
economy form the GNP. There are 4 components included in the GNP.
They are: consumer spending, government spending, investments, and
net exports. Gross National Product adjusted for inflation (Real GNP)
being in decline during two successive quarters is a sign of recession.
6.2.1.5 Indicators of the Business Cycle
Three types of indicators describing the economy movements during its
entering into a certain phase of the business cycle are generally used by
the economists: leading, coincident, and lagging indicators.
Chapter 6 Forecasting The Exchange Rate
37
6.2.1.6 The business cycle's effect in Forex
Forex market is sensitive to the economy changes and reacts during its
movement through any of the phases. It is important for the investors to
monitor these changes and take right decisions in order to get benefits
out of these changes.
The US dollar movements in the Forex market are usually trending the
opposite direction to the interest rates. For instance, the increase of
incomes caused by the interest rates up trending declines the US dollar
index accordingly.
6.2.1.7 Monetary Policy
The control of money and credit supply within the economy is the general
aim on the monetary policy. The interest rates are affected by these
processes and cause the economic activity decline. The monetary policy is
mainly interested in the inflation control.
6.2.1.8 The activity of the Central Banks
The monetary policy is directed by the Central Banks of any country. The
nation's central bank, In India we have Reserve Bank of India, in USA it is
Federal Reserve Board and similarly Bank of England in UK and European
Central Bank in Euro Zone. We should keep watching the movements
within the central banks to estimate future trends.
In Chapter 8 we will see that how we can use all these indicators to now
the future trend of the Forex rate.
38
Chapter 7 Technical Analysis
Technical analysis is the technique use to forecast short term Forex rate
in the Forex market. In the technical analysis there are many trend
indicators; on that basis we can forecast the future trends.
Most traders use technical analysis to get a "big picture" on an
investment's price history. Even fundamental traders will glance at a chart
to see if they're buying at a fair price, selling at a cyclical top or entering
a choppy, sideways market.
Get in and get out - at the right time
Traders rely on price charts, volume charts and other mathematical
representations of market data (called studies) to find the ideal entry and
exit points for a trade. Some studies help identify a trend, while others
help determine the strength and sustainability of that trend over time.
Technical analysis can add discipline and minimize emotion in your
trading plan. It can be hard to screen out fundamental impressions and
stick with your entry and exit points as planned. While no system is
perfect, technical analysis helps you see your trading plan through more
objectively and dispassionately.
7.1 Price chart types
7.1.1 Bar Charts
The Bar Chart is the most common type of chart showing price action,
Each bar represents a period of time - a "period" as short as 1 minute or
as long as several years. Over time, bar charts show distinct price
patterns.
Chapter 7 Technical Analysis
39
7.1.2 Candlestick Charts
Instead of a simple bar, each candlestick shows the high, low, opening
and closing price for that period of time it represents. Candlestick
patterns provide greater visual detail as they develop.
7.1.3 Point & Figure Charts
Point & figure patterns resemble bar chart patterns, except Xs and Os are
used to mark changes in price direction. Point & figure charts make no
use of time scale to associate a certain day with a certain price action.
7.2 Technical Indicator Types
7.2.1 Trend
Trend indicators smooth price data out, so that a persistent up, down or
sideways trend can be easily seen. (Examples: moving averages, trend
lines)
7.2.2 Strength
Strength indicators describe the intensity of market opinion on a certain
price by examining the market positions taken by various market
participants. Volume or open interest are the basic ingredients of strength
indicators.
7.2.3 Volatility
"Volatility" refers to the magnitude of day-to-day price fluctuations,
whatever their directional trend. Changes in volatility tend to anticipate
changes in prices. (Example: Bollinger Bands.
7.2.4 Cycle
Cycle indicators indicate repeating market patterns from recurrent events
such as seasons or elections. Cycle indicators determine the timing of a
particular market pattern. (Example: Elliott Wave)
Chapter 7 Technical Analysis
40
7.2.5 Support/Resistance
Support and resistance describes the price levels where markets
repeatedly rise or fall and then reverse. This phenomenon is attributed to
basic supply and demand. (Example: Trend Lines)
7.2.6 Momentum
Momentum indicators determine the strength or weakness of a trend as it
progresses over time. Momentum is highest when a trend starts and
lowest when the trend changes. When price and momentum diverge, it
suggests weakness. If price extremes occur with weak momentum, it
signals an end of movement in that direction. If momentum is trending
strongly and prices are flat, it signals a potential change in price direction.
(Example: Stochastic, MACD, RSI)
Using all the parameters in a study is not possible for us. We have used
following parameters in our study.
7.3 Parameters used in study
1. Bollinger Bands
2. Moving Average Convergence/Divergence (MACD)
3. Relative strength index
4. Stochastic
Here we have given the brief discretion about each technical indicator.
7.3.1 Bollinger Bands
Bollinger Bands are very popular technical indicators among Forex
traders. The man responsible for the idea is John Bollinger – he created
this technical trading tool in early 1980s. The primary idea of Bollinger
Bands is to sell when price reaches the upper Bollinger band and buy
Chapter 7 Technical Analysis
41
when it falls down to the bottom Bollinger band. In Forex market where
price movements are going up and down this technique works well for
determining your next trading strategy.
In the above graph we can see the Bollinger Bands. The distance changes
along with the price movements. When there is not much changes in price
movement the bands are close from one another, but when the price goes
up, the distance between two lines increases. Bollinger bands add and
subtract a standard deviation calculation that measures the instability of
price movements enclosing at least 80% of the price inside the "tunnel"
the bands create.
There is a lot of mathematics behind this, but we will not go too much
into details. All you have to know is that
1. An upper band is the simple moving average plus 2 standard
deviations.
2. A lower band is the simple moving average minus 2 standard
deviations.
EXHIBIT 7.1 Bollinger Bands
Chapter 7 Technical Analysis
42
This definition should be enough! Your forex broker trading platform
should have this tool available for you and so here we will discuss the
application of Bollinger bounce rather then the actual calculations.
7.3.1.1 Bollinger Bounce
The price can bounce from one band to another, each time creating
trading possibility. Think of Bollinger bands as two pin-pong players and
the middle line (simple moving average) as their ball. When the simple
moving average (our pin pong ball) is getting closer to one of the band
(one of the excited players) it bounces off – just like the pin pong ball
would do when one of the players hits it back!
Now we know where the word bounce in "Bollinger bounce" comes from.
Now what? It is useful to understand that when you see the simple
moving average approaching one of the bands it will almost certainly
bounce back off!
7.3.1.2 Bollinger Squeeze
Another imaginary example – let's say that the simple moving average
(the middle line) is a gas and the Bollinger bands form a sealed gallon.
When you squeeze the gallon with a dangerous gas at some point the
gallon explodes and the gas gets out. So, that's exactly what happens
with Bollinger squeeze – when Bollinger bands squeeze close to each
other there is a great chance that there will be an "explosion"! If the
middle line (the simple moving average) breaks through one of the
bands, either the top or the bottom) it is believed that Forex trend will
continue in that fashion.
7.3.2 Moving Average Convergence/Divergence (MACD)
Developed by Gerald Appel, Moving Average Convergence/Divergence
MACD is one of the simplest and most reliable indicators available. MACD
uses moving averages, which are lagging indicators, to include some
trend-following characteristics. These lagging indicators are turned into a
momentum oscillator by subtracting the longer moving average from the
Chapter 7 Technical Analysis
43
shorter moving average. The resulting plot forms a line that oscillates
above and below zero, without any upper or lower limits. MACD is a
centered oscillator and the guidelines for using centered oscillators apply.
7.3.2.1 MACD Bullish Signals
A Positive Divergence occurs when MACD begins to advance and the
security is still in a downtrend and makes a lower reaction low. MACD can
either form as a series of higher Lows or a second Low that is higher than
the previous Low. Positive Divergences are probably the least common of
the three signals, but are usually the most reliable, and lead to the
biggest moves.
7.3.2.2 MACD Bearish Signals
A Negative Divergence forms when the security advances or moves
sideways, and the MACD declines. The Negative Divergence in MACD can
take the form of either a lower High or a straight decline. Negative
Divergences are probably the least common of the three signals, but are
usually the most reliable, and can warn of an impending peak.
Bullish Signal
Bearish Signal
EXHIBIT 7.2 MACD
Chapter 7 Technical Analysis
44
7.3.3 Relative strength index (RSI)
Developed by J. Welles Wilder and introduced in his 1978 book, New
Concepts in Technical Trading Systems, the RSI is an extremely useful
and popular momentum oscillator. The RSI compares the magnitude of a
stock's recent gains to the magnitude of its recent losses and turns that
information into a number that ranges from 0 to 100. It takes a single
parameter, the number of time periods to use in the calculation. In his
book, Wilder recommends using 14 periods.
The RSI's full name is actually rather unfortunate as it is easily confused
with other forms of RSI analysis such as John Murphy's "Relative
strength" charts and IBD's "Relative strength" rankings. Most other kinds
of "Relative strength" stuff involve using more than one stock in the
calculation. Like most true indicators, the RSI only needs one stock to be
computed. In order to avoid confusion, many people avoid using the RSI's
full name and just call it "the RSI."
EXHIBIT 7.3 Relative Strength Index
Chapter 7 Technical Analysis
45
7.3.3.1 Overbought/Oversold
Wilder recommended using 70 and 30 and overbought and oversold levels
respectively. Generally, if the RSI rises above 30 it is considered bullish
for the underlying stock. Conversely, if the RSI falls below 70, it is a
bearish signal. Some traders identify the long-term trend and then use
extreme readings for entry points. If the long-term trend is bullish, then
oversold readings could mark potential entry points.
7.3.3.2 Divergences
Buy and sell signals can also be generated by looking for positive and
negative divergences between the RSI and the underlying stock. For
example, consider a falling stock whose RSI rises from a low point of (for
example) 15 back up to say, 55. Because of how the RSI is constructed,
the underlying stock will often reverse its direction soon after such a
divergence. As in that example, divergences that occur after an
overbought or oversold reading usually provide more reliable signals.
7.3.3.3 Centerline Crossover
The centerline for RSI is 50. Readings above and below can give the
indicator a bullish or bearish tilt. On the whole, a reading above 50
indicates that average gains are higher than average losses and a reading
below 50 indicates that losses are winning the battle. Some traders look
for a move above 50 to confirm bullish signals or a move below 50 to
confirm bearish signals.
7.3.4 Stochastic Oscillator
Developed by George C. Lane in the late 1950s, the stochastic Oscillator
is a momentum indicator that shows the location of the current close
relative to the high/low range over a set number of periods. Closing levels
that are consistently near the top of the range indicate accumulation
(buying pressure) and those near the bottom of the range indicate
distribution (selling pressure).
Chapter 7 Technical Analysis
46
Readings below 20 are considered oversold and readings above 80 are
considered overbought. However, Lane did not believe that a reading
above 80 was necessarily bearish or a reading below 20 bullish. A security
can continue to rise after the stochastic Oscillator has reached 80 and
continue to fall after the stochastic Oscillator has reached 20. Lane
believed that some of the best signals occurred when the oscillator moved
from overbought territory back below 80 and from oversold territory back
above 20.
Buy and sell signals can also be given when %K crosses above or below
%D. However, crossover signals are quite frequent and can result in a lot
of whipsaws.
One of the most reliable signals is to wait for a divergence to develop
from overbought or oversold levels. Once the oscillator reaches
overbought levels, wait for a negative divergence to develop and then a
cross below 80. This usually requires a double dip below 80 and the
second dip results in the sell signal. For a buy signal, wait for a positive
divergence to develop after the indicator moves below 20. This will
usually require a trader to disregard the first break above 20. After the
EXHIBIT 7.4 Stochastic Oscillator
Chapter 7 Technical Analysis
47
positive divergence forms, the second break above 20 confirms the
divergence and a buy signal is given.
Now in the technical analysis some patterns of chars also used for very
short term forecast of the prices. We have used the candle stick chart
patterns for forecasting the prices base on the spot price of currencies
against the Rupee. Here we have used The Doji, Cup Formation, and
Fibonacci etc in our analysis.
First of all we understand the candlestick charts, how should we read the
candles, what indicates the different types of candles etc. so let‘s learn
about the basics of the candle stick chart.
7.4 The Candle Stick Chart
For a candlestick chart, the open, high, low and close are all required. A
daily candlestick is based on the open price, the intraday high and low,
and the close. A weekly candlestick is based on Monday's open, the
weekly high-low range and Friday's close.
Many investors believe that candlestick charts are easy to read because of
the relationship between the open and the close. White (clear)
candlesticks form when the close is higher than the open and black (solid)
candlesticks form when the close is lower than the open. The white and
black portion formed from the open and close is called the body (white
body or black body). The lines above and below are called shadows and
represent the high and low.
Chapter 7 Technical Analysis
48
Candlestick charts are the most popular charts among chartists. It gives
valuable insight into the trading patterns and can help in capturing the
signals more accurately and timely. There are various patterns within the
formation of candlestick charts itself which are very useful if understood
properly.
Different Kinds of Formation of Candlesticks
7.4.1 Long Candlesticks
Long candlesticks denote a high volatility during trading session and
whether the buyers or sellers were controlling the trading during the
session. Long white candles indicate that buyers controlled the period
initially and drew prices up to close at a higher price at during the trading
session. While long black candlesticks indicate that sellers dominated the
trading period and pushed the prices down resulting in a lower close.
7.4.2 Long Wicks
Long wicks indicate a trading period where there was a lot of action
during the trading period but the prices close relatively closer to the
opening price of the trading period. The 1
st
(left) long wick is a candle
stick which indicates that the sellers were initially in control of the trading
Chapter 7 Technical Analysis
49
period which resulted in a steep low during the trading session but the
buyers bounced back to close the stock closer to the opening level.
The 2
nd
(right) long wick candlestick chart indicates that the buyers
controlled the period initially and later the sellers took control of the
period and brought down the prices to close at levels lower than what
would have actually been.
7.4.3 Doji Candlestick Pattern
The difference between Doji and Spinning top is that doji
indicates a trading period where the closing price was
very close or exactly equal to the opening price. Doji is
considered a stronger signal than the spinning top. Doji
candlesticks if formed during a range bound market
represent a lot of indecision in the market. However, if a
doji candlestick forms during a trend then it gives a strong signal about a
possible reversal. But as said earlier all technical analysis should be done
with use of other indicators to avoid whipsaws.
7.5 Fibonacci Retracement
Fibonacci retracement is a very popular tool among technical traders and
is based on the key numbers identified by mathematician Leonardo
Fibonacci in the thirteenth century. However, Fibonacci's sequence of
numbers is not as important as the mathematical relationships, expressed
as ratios, between the numbers in the series. In technical
analysis, Fibonacci retracement is created by taking two extreme points
(usually a major peak and trough) on a stock chart and dividing the
vertical distance by the key Fibonacci ratios of 23.6%, 38.2%, 50%,
61.8% and 100%. Once these levels are identified, horizontal lines are
drawn and used to identify possible support and resistance levels. Before
we can understand why these ratios were chosen, we need to have a
better understanding of the Fibonacci number series.
The Fibonacci sequence of numbers is as follows: 0, 1, 1, 2, 3, 5, 8, 13,
21, 34, 55, 89, 144, etc. Each term in this sequence is simply the sum
Chapter 7 Technical Analysis
50
of the two preceding terms and sequence continues infinitely. One of the
remarkable characteristics of this numerical sequence is that each number
is approximately 1.618 times greater than the preceding number. This
common relationship between every number in the series is the
foundation of the common ratios used in retracement studies.
The key Fibonacci ratio of 61.8% - also referred to as "the golden
ratio" or "the golden mean" - is found by dividing one number in the
series by the number that follows it. For example: 8/13 = 0.6153, and
55/89 = 0.6179.
The 38.2% ratio is found by dividing one number in the series by the
number that is found two places to the right. For example: 55/144 =
0.3819.
The 23.6% ratio is found by dividing one number in the series by the
number that is three places to the right. For example: 8/34 = 0.2352.
For reasons that are unclear, these ratios seem to play an important role
in the stock market, just as they do in nature, and can be used to
determine critical points that cause an asset's price to reverse. The
direction of the prior trend is likely to continue once the price of the asset
has retraced to one of the ratios listed above. The following chart
illustrates how Fibonacci retracement can be used. Notice how the price
changes direction as it approaches the support/resistance levels.
Chapter 7 Technical Analysis
51
In addition to the ratios described above, many traders also like using the
50% and 78.6% levels. The 50% retracement level is not really a
Fibonacci ratio, but it is used because of the overwhelming tendency for
an asset to continue in a certain direction once it completes a 50%
retracement.
In the next section we will see the technical analysis of the USDINR,
EURINR and GBPINR pairs of currencies. We have used above concepts of
technical analysis to forecast future trend and the price levels between
three pairs of currencies mentioned above.
We have taken quarterly trends for each currency pair for our analysis
and then we will compare it with the yearly trend of the same.
EXHIBIT 7.5 Fibonacci Retracement
Chapter 7 Technical Analysis
52
7.6 Technical analysis of Currencies: quarterly periods
7.6.1 USD/INR Technical Analysis 2009-10
Bollinger Bands
Bollinger band in the above depicted chart has increased volatility. On
13
th
June, the Bollinger band has contrasted indicating that there will be
high volatility in the upcoming future. As the Dollar has touched to the
average there is right strategy to watch rather then taking any action.
Moving Average Convergence/Divergence (MACD)
When MACD (12, 26) crossed to the MACD (9) while moving upward, it
indicates that there will be increase in the price of the dollar. Similar trend
Exhibit 7.6 USD/INR technical indicators: April-June
Chapter 7 Technical Analysis
53
observed on the date 21
st
April. Similarly when there is reverse the
position, there will be downward trend in he price of the Dollar. If we
predict the future of the Dollar price by considering the MACD ,then we
can say that there will be downward trend of the Dollar price as the
MACD(26,12) intersects the MACD(9) and moves downward after that.
Relative strength index
Relative price index also gives the prediction with same accuracy as the
MACD but it gives result earlier than MACD. The increase in the dollar
price was reflected by MACD on 6
th
June, the same was indicated by the
RSI on 25
th
may.
Stochastic
The stochastic in the above chart ends at the point 30,it is indication of
not taking any action though there are high chances that there will be
upward trend but the right step here is to wait for formation of pattern.
Chapter 7 Technical Analysis
54
Bollinger Bands
On august 17
th
there was the huge buying pressure in the Forex market
hence the price of the dollar crossed the upper bound of the Bollinger
band. Further there will be increase in the price of the Dollar in the
upcoming future is required to move upwards as there is slowly
decreasing the selling pressure and there is more buying of the Dollar. On
August 2 the Price line fell below the lower band, it gives strong signal
that the price of dollar will raise in next session.
Exhibit 7.7 USD/INR technical indicators: July-September
Chapter 7 Technical Analysis
55
Moving Average Convergence/Divergence (MACD)
The MACD in the above depicted chart indicates the huge amount of the
volatility in the price of the Dollar. The MACD indicated the price of the
Dollar to go up right from the 17
th
July. Further showing upward trend
beginning from the 14
th
august.
Relative Strength Index
The RSI has shown fluctuations relatively more as there has not been
formation of any particular trend. Hence further the safe option is to wait
and watch rather than entering r exiting from the market.
Stochastic
The fast stochastic had gone par up the 80% limit on July 3 to July 13
that shows the buying pressure and indicates the prices to fell. This is the
time not to purchase more dollars because the prices will start falling
soon. Hence we should start selling the dollars to encash our profit.
Chapter 7 Technical Analysis
56
Bollinger bands
The Bollinger band in the above chart indicates that, the Bollinger band is
contrasting which means that there have been fewer fluctuations in the
price of the Dollar. Further there are high chances of moving the dollar
prices in the upcoming future to increase sharply in the either direction
with high chances of moving upward.
Exhibit 7.8 USD/INR technical indicators: October-December
Chapter 7 Technical Analysis
57
Moving Average Convergence/Divergence (MACD)
The MACD in the above chart shows that there have been fewer
fluctuations in the dollar prices. Further there are high chances of Dollar
to move upward in the shorter period of time. On October 22, the MACD
line crossed the EMA line upward, so the prices had to rise in future, and
the same thing happened in next few days. So our analysis proved right.
We may rely on this type of technical analysis to find the future trend of
the price.
Relative Strength Index
There has been high Buying pressure on the date till October 19
th
. Hence
it was clear that there will be increase in the price of the Dollar. Other
thing in RSI is not clear since it is in the middle of the upper and lower
limits in this period.
Stochastic
The fast stochastic had gone par up the 80% limit on October 27 to
November 3 that shows the buying pressure and indicates the prices to
fell. This is the time not to purchase more dollars because the prices will
start falling soon. Hence we should start selling the dollars to encash our
profit.
Chapter 7 Technical Analysis
58
Bollinger Bands
Bollinger band in the above mentioned chart indicates that the Dollar
price has touched to the lower Bollinger band and has shown upward
trend after that it means that there will be increase in the Dollar price.
Moving Average Convergence/Divergence (MACD)
The MACD (12, 26) crossed to MACD (9) on January 20
th
hence the price
of the Dollar increased from there. Further the price started to decrease
after February 15
th
. The Dollar price has touched to the lower bound of
the Bollinger Band hence there are high chances that there will be
increase in the Dollar price. Hence the right strategy is to long the future.
Exhibit 7.9 USD/INR technical indicators: January-March
Chapter 7 Technical Analysis
59
Relative Strength Index
The RSI indicated the selling pressure on January 10
th
hence there was
sharp fall in the Dollar price. The future trend from the above indicators
can be predicted as that there will be increase in the price of the Dollar.
Stochastic
The fast stochastic in the above chart is indicating that the red line is
below 20 percentile hence there are chances that there will be upward
movement of the Dollar price. Further the red line is crossing to blue line
and after that showing upward trend hence it is also indicating that there
will be correction in the market.
Chapter 7 Technical Analysis
60
7.6.2 EUR/INR Technical Analysis 2009-10
Bollinger Bands
The Bollinger band in the above indicated chart shows that there has been
contraction and expansion of the Bollinger band. When the Euro price
touched to the upper bound of the Bollinger band, there was sharp
decrease in the Euro price within two days from more than 67 to almost
65. Hence there was clear indication of rise in the Euro price.
Further on June 25
th was
rise in the Euro price sharply it means that there
was over buying of the Euro which gave rise to over valuation of Euro.
Hence it made it clear that there was going to be decrease in the Euro
price gradually.
Exhibit 7.10 EUR/INR technical indicators: April-June
Chapter 7 Technical Analysis
61
Moving Average Convergence/Divergence (MACD)
The MACD showed downward trend till 27
th
April. After that there was
increase in the Euro price. The MACD showed the fluctuations of the Euro
prices.
Relative strength Index
RSI has never shown the buying or selling pressure hence it was difficult
to predict the movement of the Euro prices. At the end of the period also
the Euro remained near to the average price. Hence the best strategy
here is to wait for a few days to determine the trend of the Euro price and
after that take the decision.
Stochastic
The stochastic in the above chart is almost at 60 percentile. Hence there
are chances that there will be downward movement of the price.
Chapter 7 Technical Analysis
62
Bollinger Bands
The Bollinger band in the above chart shows that there was upward trend
of the Euro price but it touched to the lower bound of the Bollinger band.
It is indication of the future upper side movement of the Euro.
Moving Average Convergence/Divergence (MACD)
The MACD shows that there has been continuous and gradual upward
movement of the Euro over the span of two months. But the MACD in this
chart is providing the contradictory picture compare to Bollinger band.
MACD indicates that there will be downward trend in the Euro price.
Exhibit 7.11 EUR/INR technical indicators: July-September
Chapter 7 Technical Analysis
63
Relative Strength Index
RSI showed the upward movement on 24
th
august and 14
th
September
respectively. Hence it made clear the downward movement of the Euro in
the upcoming period.
But at the end of the period the price remained below average it means
that the price will come upwards.
Stochastic
Stochastic in the above chart shows that there will be downward
movement of the Euro as the red line is moving downward after touching
to the blue line.
Chapter 7 Technical Analysis
64
Bollinger Bands
The Bollinger band in the above chart shows that it contrasted on 1
st
December it means that there was going to be the one side movement of
Euro price. But to determine what will be the direction of the movement,
MACD or RSI is used. If MACD or RSI shows buying pressure then there
will be increase in the price and vice versa.
Moving Average Convergence/Divergence (MACD)
The MACD in the above chart shows that there has been continuous
downward movement of the Euro. But as the MACD (12, 26) has crossed
to MACD (9) there are high chances that there will be upward movement
of the Euro price.
Exhibit 7.12 EUR/INR technical indicators: October-December
Chapter 7 Technical Analysis
65
Relative Strength Index
This indicator is also indicating that there will be upward movement of the
Euro price but it gives result on December 20
th
which is far ahead than
the result provided by the MACD.
Stochastic
Stochastic in the above chart shows that there will be still downward
movement of the Euro price as the red line is below the blue line, it
makes it clear that there might be chances that the same downward trend
may continue in the upcoming future also.
Chapter 7 Technical Analysis
66
Bollinger Bands
In above chart there has been downward trend of the Euro rice. There has
been constant decrease in it. The Euro was not able to touch to even the
average price. But at the end of the period it came back to the average. It
shows that there are high chances of Euro to show upward movement in
the future.
Moving Average Convergence/Divergence (MACD)
The MACD is also showing that there are fair chances that there will be
increase in the Euro price. The Euro price remained downward moving
over three months.
Exhibit 7.13 EUR/INR technical indicators: January-March
Chapter 7 Technical Analysis
67
Relative Strength Index
It shows that every time after touching to resistance level, Euro price
tried to go up but once again it came downward. This chain was repeated
for so many times in the period of three months. But at last it increased
considerably to believe that it will go up in the forth coming future.
Stochastic
Here the fast stochastic goes above the 60 percentile level at last so we
may see the fall in price of EURINR in coming day. If such thing happens,
it means that our pervious analysis is correct and we are establishing
relationship between trend of rice and future forecast.
Chapter 7 Technical Analysis
68
7.6.3 GBP/INR technical analysis
Bollinger Bands
The above chart shows the upward trend in the first quarter of the
selected period i.e. April 2009 to June 2009. Looking toward the Bollinger
bands, in the mid April chart line touches the upper band, it means that
the exchange rate GBPINR may fall from Rs. 74.5/£. This prediction
seems to be true watching further rates in the same quarter which fell to
just above Rs. 72/£ level. It means price of GBP fell around 2.5 rupee in
few days. The same thing happened in early June. The price line went
above the upper band it means it is high time to start selling the GBP and
wait to fall the prices. The prices were going to fall sharply. On June 2
Exhibit 7.14 GBP/INR technical indicators: April-June
Chapter 7 Technical Analysis
69
price was Rs. 77.5/£ it fell to 75.2/£ on June 5. at end of the quarter the
price line is in middle around the average. So to predict we should look to
other indicator.
Moving Average Convergence/Divergence (MACD)
In MACD at the end of the quarter the red line crosses the blue line of
EMA from above. It shows that the prices of GBP will fall in coming period.
The effect of such indicator is shown in the same period and price begun
to fall.
Relative Strength Index
RSI indicates the volume of buying by market makers more than
expected or average. Here the RSI line touched the resistance line on 2
nd
June same as the Bollinger Bands. It shows the over bought situation in
market. Thus prices are going to fell. And that happened in few days.
Prices came back to 75.2 from 77.5.
Stochastic
In this quarter the stochastic line looks like zigzag, and there is more
price volatility than average movement. So forecasting prices from here is
very difficult. MACD shows that prices may fall in coming days. We should
consider that.
Chapter 7 Technical Analysis
70
Bollinger Bands
In this quarter the Bollinger band had contrasted. This shows that the
there will be more volatility in the prices of GBP against INR. The high
price was Rs.81.75 on August 5. After that the prices fell to 75.99 at the
end of quarter. Thus when Bollinger Bands contrasts we see more
volatility in the market. In the end the price line fell bellow the Bollinger
bands thus now it is time to rise in price of GBP. In next few days it is
sure that prices will rise.
Exhibit 7.15 GBP/INR technical indicators: July-September
Chapter 7 Technical Analysis
71
Moving Average Convergence/Divergence (MACD)
The MACD (12, 26) crossed EMA line from above in the latter period. On
September 18, both lines in intersects. It shows that this is time to sell
the GBP or we can short the GBP contract in the future, because it
indicates that prices would go down. On the September 30, price has
fallen to considerable level. Now we can start purchasing the GBP or long
the future. In future when price will raise we can square off our position
and have some gain out of it.
Relative Strength Index
Here the RSI is in the middle of the upper and lower level resistant in the
3 month period. But in the end it is bellow the 20 percentile level, it
means the prices should go up now in next periods. It shows the same
results as the MACD. Thus we can go long in future because it is seems
that price will rise.
Stochastic
In this quarter the stochastic line looks like zigzag, and there is more
price volatility than average movement. So forecasting prices from here is
very difficult. MACD shows that prices may fall in coming days. We should
consider that
Chapter 7 Technical Analysis
72
Bollinger Bands
Here the Bollinger bands are contrasting after November 16, 2009. The
contraction of bands shows that there will be more volatility in the
market. But the was no volatility as expected. Thus this time we may
prove wrong.
Moving Average Convergence/Divergence (MACD)
In the beginning of the period, the MACD shows the positive divergence.
Thus we may expect the bullish trend in the GBPINR market in coming
days. As per our expectation there were the positive signals in the
market.
Exhibit 7.16 GBP/INR technical indicators: October-December
Chapter 7 Technical Analysis
73
Relative Strength Index
In alien with the other two indicators, RSI also shows the bullish signal.
On October 10 the trend goes upward. RSI gives the signals before other
indicator as seen in the chart. RSI gives positive signal before the MACD.
Here in MACD we can see that the red line (MACD) coming closer to blue
line (EMA) it may cross blue line from up to down and it is sign of bearish
trend in the GBP market.
Exhibit 7.17 GBP/INR technical indicators: Jnuary-March
Chapter 7 Technical Analysis
74
In mid of January Fast Stochastic line crosses the 80% limit. Thus it is the
sign of the coming bearish trend in the market because the marker rate
has gone far up than the average and the price that should be in the
market.
Chapter 7 Technical Analysis
75
7.7 Yearly Trend Analysis of Currencies for last 3 years
7.7.1 USD/INR yearly analysis
Bollinger Bands
The Bollinger Bands in the above mentioned chart makes it clear that the
Dollar price in the financial year 2007-08 has plummet down for the first
quarter of the year but afterwards t remained fluctuating. In August, the
bands came very close to each other and so that we saw the volatility n
next period in the market.
Exhibit 7.18 USD/INR technical indicators: 2007-08
Chapter 7 Technical Analysis
76
Moving Average Convergence/Divergence (MACD)
The MACD chart is also making true to our assumption of downward
movement of the Dollar price. The red line which is MACD is crossing to
the EMA and afterwards moves downwards it shows that there will be
downward trend of the Dollar.
Relative Strength Index
RSI is also making the picture of downward trend clear but it is providing
the picture far before the MACD. It touched to the higher bound hence it
was clear that there will be downward trend. Hence the right strategy
here would be to sell the future at the higher price.
7.19 USD/INR Technical Analysis 2008-09
Chapter 7 Technical Analysis
77
Bollinger Bands
The Bollinger band in the above chart shows that Dollar is below the EMA
further the price is at the median hence it can be predicted that there will
be downward movement of the Dollar price the reason being it is below its
moving average.
Moving Average Convergence/Divergence (MACD)
MACD in the above chart is also showing that there will be downward
movement of the Dollar as the red line is moving below the blue line. But
this trend will continue for the short period of time as the red line is likely
to cross to the blue line.
Relative Strength Index
RSI at the end of the march shows that there will be downward trend
reason being it shows that the Dollar price has been above the upper limit
of the RSI hence there will be downward trend.
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78
Bollinger band
The Dollar price in the above chart has touched to the lower bound of the
Bollinger band. Hence it can be said that there will be upward correction
in the Dollar price. Over all over the period of one year there was
downward trend in the Dollar price.
Exhibit 7.20 USD/INR technical indicators: 2009-10
Chapter 7 Technical Analysis
79
Moving Average Convergence/Divergence (MACD)
MACD in the above chart also supports the prediction of upward
movement. As the MACD line is likely to cross the EMA line.
Relative Strength Index
RSI also shows that as it has touched to the lower bound of it it will show
upward trend in the upcoming year.
Chapter 7 Technical Analysis
80
7.7.2 EUR/INR yearly technical Analysis
Bollinger Bands
The Euro price in the above chart shows that the price of the Euro
remained stable till February but after that it showed upward trend by
leaps and bounds. As the Euro has touched to the EMA there can not be
any specific prediction about it as there are chances of movement of the
Euro in either direction.
Exhibit 7.16 EUR/INR technical indicators: 2007-08 Exhibit 7.21 EUR/INR technical indicators: 2007-08
Chapter 7 Technical Analysis
81
Moving Average Convergence/Divergence (MACD)
The above mentioned MACD chart shows that downward movement of the
Euro may continue in the upcoming future as the MACD that is the red
line is continuing to be below the blue line.
Relative Strength Index
The RSI in the above chart shows that it crossed to the upper bound in
starting of the December. Hence it was sure that there will be downward
movement of the Euro in the future. Similarly in the march also it
surpassed to the upper bound hence it can be said that there might be
correction in the market and Euro might fall down.
Chapter 7 Technical Analysis
82
Bollinger Bands
The chart depicted above shows that there has been huge amount of
fluctuations during the financial year. The Euro fluctuated from 68 to 60.
Hence it can be said that there was huge amount of the fluctuations. If we
consider the future prediction of the Euro price it is likely to come down.
Hence the right step to be taken here should be to sell the future of the
Euro.
Exhibit 7.22 EUR/INR technical indicators: 2008-09
Chapter 7 Technical Analysis
83
Moving Average Convergence/Divergence (MACD)
MACD crossed the upper bound four times in the year and touched to
lower bound twice the year. Hence there were huge fluctuations in the
Euro. Further if we consider that what should be the future trend then it
can be said that as the MACD line is crossing to EMA line and afterwards
moving down hence it can be said that there will be downward trend.
Relative Strength Index
If we consider the RSI then at the end of the march it touched almost to
the upper bound. That shows that there has been huge amount of long
contracts in the Euro market. Hence the better option here is to sell the
future.
Chapter 7 Technical Analysis
84
Bollinger Bands
The Bollinger band in the above chart shows that there has been creation
of two trends over the span of two years. Firstly there has been upward
movement of the Euro and afterwards there is downward trend. If we
consider what will be the future trend of the Euro then it can be said that
there will be upward movement of the Euro the reason being it has
started to recover from the support further it has crossed to the EMA that
shows that there will be correction in the market in the forthcoming
future.
Exhibit 7.23 EUR/INR technical indicators: 2009-10
Chapter 7 Technical Analysis
85
Moving Average Convergence/Divergence (MACD)
The MACD in the above chart is also giving the positive signals for the
Euro in the future. The MACD has shown the huge amount of fluctuations
in the financial year. But at the end the MACD crosses to the EMA hence
there will be upward trend in the Euro price.
Relative Strength Index
The RSI is also indicating that there will be correction in the Euro market
as it touched to the lower bound and recovered from the same
successfully hence there are bright chances of the Euro to reach back to
the level which it attained in the September.
Chapter 7 Technical Analysis
86
7.7.3 GBP/INR yearly analysis
Bollinger Bands
The Bollinger band in the above chart shows that there have been
fluctuations in the pound prices over the span of the year. But at the end
of the year there has been reduction in the pound price. If we consider
the Bollinger band and try to predict the future status of the pound price
then it can be said that there will be upward movement of the pound. The
reason for the same can be regarded that the pound has touched to the
lower bound and further it has recovered from the same point. Hence the
best strategy here is to long the future at the lower price so that while
Exhibit 7.24 GBP/INR technical indicators: 2007-08
Chapter 7 Technical Analysis
87
price has moved upwards the position can be squared off and the fruits of
the profit can be taken.
Moving Average Convergence/Divergence (MACD)
The MACD in the above chart also shows that there has been mixed
trends in the pound prices. If we take into consideration the MACD to
predict the future then it can be said that the MACD is moving below the
EMA but there are high chances that MACD will cross to EMA and will
move above it hence there will be correction in the pound price.
Relative Strength Index
RSI shows that there has been continuous downward trend of the pound,
there has been touching of the RSI to downward bound and further
upward movement but there is no strong upward support hence there was
no scope for entering into the market but at last there has been
considerable support to increase the price.
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88
Bollinger Bands
Taking into consideration the Bollinger band and EMA it can be said that
there has been considerable amount of downward trend in the price of
pound. But after 15
th
January there has been stable in the price of the
pound and after that there has been buying signals and there has been
signal of upward trend. The pound has touched to the EMA and after that
it has moved upwards hence there will be upward trend. The right step
here would be to buy the future.
Exhibit 7.25 GBP/INR technical indicators: 2008-09
Chapter 7 Technical Analysis
89
Moving Average Convergence/Divergence (MACD)
The MACD and EMA are moving and crossing each other. From that it can
be said that there will be huge amount of ups and downs in the upcoming
year. But if we consider the long term future then it can be said that there
will be upward movement.
Relative Strength Index
RSI in the above chart indicates that it touched to the central line and
after that it moved upwards hence pound is more likely to move upwards
rather downwards.
Exhibit 7.26 GBP/INR technical indicators: 2009-10
Chapter 7 Technical Analysis
90
Bollinger Bands
The above chart shows that there has been huge amount of volatility in
the pound. It fluctuated from RS.82/£ to RS.68.7/£. Hence there has
been huge price range. But if we consider the prediction of future then it
can be said that as pound has moved upwards after touching to the
resistance, it can be concluded that there will be strong upward
movement of the pound.
Moving Average Convergence/Divergence (MACD)
The red line indicating the MACD shows that it is about to touch and to
cross the blue line that is EMA; hence in the upcoming year there will be
upward movement of the pound.
Relative Strength Index
The RSI moved downward in the beginning of the march and remained
there till 15
th
of the march. But after that there was correction in the
market and RSI moved upwards and touched to the lower bound means
broke the support hence there is new support for the pound and there are
chances that it will go up.
The right step here would be to long the future to gain from increase in
the pound price.
This was the trend analysis of the prices of currencies. Now let‘s see some
patter of charts that we have mentioned earlier in the chapter. We will
see how we can use candle stick chart patterns to forecast the future
trend of the market prices.
Chapter 7 Technical Analysis
91
7.8 Pattern indicators in Candlestick chart
In above section we have seen the trend indicators, which are useful to
forecast price trend in future. We can use some patterns of graphs to
forecast price trend as well as to know the level of prices up to what price
could move in future bases of averages and open, high, low, close of the
previous period‘s prices.
Here we have used The Doji, hammers, hangingman fibonacci
retracement to forecast prices trend and targets.
The Doji is the indication of reversal trend in the technical charts. If we
consider the above chart then it can be seen that whether Doji is bullish
or bearish is immaterial. In the above chart the bearish Doji has occurred.
But it causes the trend to move upward. Further the cup formed here
from Doji to end of the period makes it clear that there will be downturn
in the market for the upcoming future.
Exhibit 7.27 EUR/INR candlestick-The Doji
Chapter 7 Technical Analysis
92
In the above Chart the Euro price has plummet down after occurrence of
Doji. There has been huge amount of decrease in the Euro price. It has
plummet down to almost RS.66.6880/ Euro from RS. 70.0000. There was
upward trend in the Euro price after reaching to the level of RS.68.0000
but there was no proper formation of the cup means price touched to
RS.70 but could not touch to the previous resistance level. Hence there
was not completion of cup therefore Euro couldn‘t touch to the new levels.
If we consider the future trend of the Euro market then it can be said that
as the Euro has broken three resistances, there are high chances that
there will be further decrease in the Euro price. Hence better strategy
here will be to sell the future at the higher price.
Exhibit 7.28 EUR/INR candlestick-The Doji 2
Chapter 7 Technical Analysis
93
There has been continuous downward trend in the Euro price. On
February 9
th
, there was record increase in the Euro price, but such
positive trend couldn‘t resist the decrease in Euro prices. On February 8,
there is long wick in the chart. It shows the high price fluctuation during
the day, but at end of the day it closed near to the previous one only.
There was little high close but long wick indicates that the trend will
continue in spite of little higher close on particular day.
Exhibit 7.29 EUR/INR candlestick-Long Wicks
Chapter 7 Technical Analysis
94
The above chart shows that there was occurrence of the Doji which
resulted into the indication of reversal trend. Further there was complete
formation of the cup which started from September 1
st
and completed on
September 17
th
hence it was reverse cup formation. It is indication of the
bearish trend and hence there was sharp decrease in the Pound price. As
there are no signals of market to move upward, the better strategy here
is to wait for the market to show any signals and then enter into it.
Exhibit 7.30 GBP/INR candlestick-The Doji
Chapter 7 Technical Analysis
95
The above chart shows that as there was complete formation of the cup
during the first month of the year, there was sharp increase in the Pound
price. Further at the end of the quarter also there was formation of the
chart and hence if the Pound price moves down and breaks the resistance
level of RS. 69.5, then there are high chances of downward movement of
the Pound price therefore the right strategy at that time will be to short
the future.
Exhibit 7.31 GBP/INR candlestick-Cup formation
Chapter 7 Technical Analysis
96
The above chart shows that there were two incidents where there was
occurrence of the Doji were there. At the end of the quarter there was
occurrence of the Doji hence it is indicating that there will be upward
movement in the Dollar price. Hence the right strategy here would be to
long the future of the Dollar.
We have used above indicators to take decision about short term future
trends. Now by using Fibonacci we can set the target prices in future for
given currency. In the following section we have tried to give target prices
for next period using Fibonacci Retracement.
Exhibit 7.32 EUR/INR candlestick-The Doji
Chapter 7 Technical Analysis
97
7.9 Use of Fibonacci Retracement
The above chart shows that the next target price for the Dollar will be at
the resistance level RS. 48.1469, if such resistance level is broken
effectively then it can reach to further to the next target price at
RS.48.6305 and the last target will be RS.49.1142. the stop loss limit
price here would be the support level that is the level of RS.46.5813 and
if such level is broken then there can be high downward movement in the
Dollar price. When the dollar prices cross the first target of Rs. 49.1142
we should not wait and we should sell dollars if we are having, because it
shows that, now prices will fall further.
Exhibit 7.33 USD/INR candlestick-Fibonacci Retracement April-June
Chapter 7 Technical Analysis
98
The target price for the Dollar price at the end of the March can be said
that it will be RS.45.8378, and the second target can be at the resistance
level RS.46.3402, and further the third target would be at 46.7463 and
above. The stop loss limit price can be established at the current support
level RS.45.0257.
Exhibit 7.34 USD/INR candlestick-Fibonacci Retracement: January-March
Chapter 7 Technical Analysis
99
The above chart shows that as Euro is already at the high level the first
target for the Euro is at RS.67.5334, and the second target will be the
resistance level at RS.68.5691, further there would be stop loss level at
Rs.65. 5691. We can see that when EUR prices crossed the first two
target prices, it went above it up to Rs. 68.5691 level. Thus it is proved
that we can use this as the best indicator of price in future.
Exhibit 7.35 EUR/INR candlestick-Fibonacci Retracement: April-June
Chapter 7 Technical Analysis
100
The above chart makes it clear that there are high chances for the Euro to
come down from the level established at the end of the period, the reason
being there has been complete formation of the cup and further Euro has
broken two resistance levels sharply. The first target for the Euro is at
Rs.70.2511 and second target will be at Rs.71.2511, but as there are high
chances for decline in Euro the better option is to short the future.
Exhibit 7.36 EUR/INR candlestick-Fibonacci Retracement: July-September
Chapter 7 Technical Analysis
101
From the above chart it can be predicted that the first target price for the
Pound will be at Rs. 78.6968, and second target will be at 80.4086 and
above, further the stop loss limit price will be at Rs.77.3529. At the end of
this quarter there are equal opportunities for up as well as downward
movement.
Exhibit 7.37 GBP/INR candlestick-Fibonacci Retracement: April-June
Chapter 7 Technical Analysis
102
The above chart shows that there has been correction in the market and
hence there are high chances of further upward movement of the Pound
price. If we consider the target price then it can be said that the first
target will be at 77.9379, the second target will be 76.8693 and the third
target will be at 79.2600 and above. Further the stop loss limit will be
72.3416 as at this level there will be completion of the cup formation at
the downward trend, there will be further decrease in the Pound if such
level is achieved.
Exhibit 7.38 GBP/INR candlestick-Fibonacci Retracement: July-September
Chapter 7 Technical Analysis
103
The above chart gives the first target at 70.5715, the second target at
71.5567 and finally the third target at 72.5479 and above. Further the
sop loss limit would be at 67.3820. but if the pound reaches to 67.3820
then there will be high chances of downward trend in the Pound. Now in
next days if the price the GBP against INR crosses 70.5715 then we
should hold the GBP and wait till it cross next level and then we should
start selling it. Let‘s see what happens in the next days of the month.
Exhibit 7.39 GBP/INR candlestick-Fibonacci Retracement: January-March
Chapter 7 Technical Analysis
104
Summery
In above short term analysis we found that the Bollinger Bands is the
strong indicator of the coming volatility in the market. Each time when two
bands comes near to each other we have found that the prices moved in the
either direction sharply. To know in which direction price will move we can
use other indicator like MACD.
MACD can be used to know to direction of the price movement. Whenever
MACD line crossed the EMA line we have seen the reversal trend in the
market prices for each currency.
RSI gives signals about the over bough and over sold of particular currency.
Whenever RSI line went over 80 percentile level or bellow 20 percentile level
we have seen reversal trend. RSI gives earlier signal then other indicator
about the coming trend in the market
We can use Stochastic indicator for the taking buying or selling decision at
particular level of price. It can be used similar to RSI. But it gives more clear.
result in short term.
After formation of The Doji the prices move in reverse direction every time,
so when we see the doji in the candle stick chart we should consider as signal
of reverse trend in the future.
From above analysis we can say that we can use Fibonacci Retracement to
wet the target prices at the various levels. When price crosses two level in
either direction then it goes further in the same direction. It strong indicator
of the future price.
We also concluded that the cup formation can help to find out the further
Upward or down word trend in the market. We can use only candle stick chart
for forecast of the future prices in the market.
105
Chapter 8 Fundamental Analysis
Fundamental analysis
The fundamental analysis is based on the various macro economic factors
of the two countries of the pair of currency as we have mentioned in
Chapter 6. Here we have used the same fundamental indicators like
economic events and the Interest rate parity relations of the two
countries to forecast the future rates.
For economic events, let‘s first discuss about the widely used tool- The
Economic calendar. The economic calendar is the list of events happening
in the countries, on the bases of these events we can judge where the
prices should go in future because of particular event.
8.1 Economic Calendar
Impact factor — suggests how much influence current economic data is
expected to bring along.
It is important to know the time of High impact data release if you trade
affected currency pair.
During actual news release market becomes volatile. The strength of the
volatility depends on the "factor of surprise" brought in the news. "Factor
of surprise" can be defined as a level of unexpectedness, where traders
compare Forecast data to actually released data.
Medium impact economic data should also be kept in mind in case the
factor of surprise turns to be high. Low impact data most of the time do
not shift Forex market significantly.
Column Previous in Forex Calendar — provides data from last release.
Column Forecast indicates numbers that economists are predicting and
expecting for the upcoming release today.
Chapter 8 Fundamental Analysis
106
Column Actual is updated only after the data is out. At the very second
when data becomes available it is instantly compared against Forecast
values, and depending on overall positiveness or negativeness of the
news for the currency plus taking into consideration the factor of surprise,
price dips or rises in a matter of seconds.
Economic News impact — increased market volatility — usually lasts for
1-3 minutes (highest volatility); next 5-10 minutes market experiences
corrective/adaptive volatility, where price settles in summarizing new
market shift.
8.2 Interest rate Parity
It is a theory that the interest rate differential between two countries is
equal to the differential between the forward exchange rate and the spot
exchange rate. Interest rate parity plays an essential role in foreign
exchange markets, connecting interest rates, spot exchange rates and
foreign exchange rates.
The relationship can be seen when you follow the two methods an
investor may take to convert foreign currency into U.S. dollars. Option A
would be to invest the foreign currency locally at the foreign risk-free rate
for a specific time period. The investor would then simultaneously enter
into a forward rate agreement to convert the proceeds from the
investment into U.S. dollars, using a forward exchange rate, at the end of
the investing period. Option B would be to convert the foreign currency to
U.S. dollars at the spot exchange rate, then invest the dollars for the
same amount of time as in option A, at the local (U.S.) risk-free rate.
When no arbitrage opportunities exist, the cash flows from both options
are equal.
To find forward rate we can use this formula:
Fundamental analysis on the bases of the Economic Calendar; Here we
have consider few events and its effect on the foreign exchange rate.
Chapter 8 Fundamental Analysis
107
8.3 Event and impact on exchange rate
8.3.1 Manufacturing PMI in Europe
Here the Manufacturing PMI turn out less than the forecasted one, thus
there should be negative impact on the EUR prices. But it is not necessary
that each event has the expected impact on the prices.
8.4.2 Interest Rate Decision of European Central Bank
The interest rates has great impact on the exchange rate. When the
government hikes the interest rate, the money supply in the market
decreases and the price of perticular currency increases.
Chapter 8 Fundamental Analysis
108
8.3.3 Unemployment in USA
On December 4 2009, unemployment rate turned lower than expected,
this is a good sign for USA economy. It means, it is the sign that USD will
be stronger in world markets. Prices of USD may rise in coming days. And
as our expectation USDINR went up from Rs. 46.0448/USD on December
3 to 46.52/USD on December 7, 2009.
8.3.4 USA Budget Balance
USA government‘s budget balance came positive then the expected on
December 10 2009. Thus we may consider it as positive sign for the USD.
After that day, USD shown the upward movement against INR.
Chapter 8 Fundamental Analysis
109
8.3.5 M4 Money supply in UK
In UK M4 money supply remain as per the expectation of the people and
government of UK. Thus there will be neutral effect on the prices of GBP
in market. We have to see towards other indicators to forecast the price.
8.4 Interest Rates and Foreign Exchange Forecast
We can use the prevailing interest tares in the both countries to forecast
the exchange rates. If the interest rates parities do not hold between two
countries then there will be an arbitrage opportunity for the investors.
Suppose the prevailing future price in the market for the particular date is
higher than the price that we get by calculating the interest rate parity
relations, it means the actual spot price on that day will be lower than the
today‘s Future price. In this situation we can sell future contract today
and on expiry date we could settle our position at the lower price.
Here we have calculated the expected theoretical future price, on the
bases of that we can forecast the future rate.
To calculate future prices we have used MIBOR Mumbai Inter Bank Offer
Rate for Rupee and LIBOR for USD, GBP and EUR.
Following table shows the expected future price on the March 28, 2010 on
day of settlement of contract on NSE and MCX-SX.
Chapter 8 Fundamental Analysis
110
We have calculated the expected prices by using this formula:
Here we can see that on March 19, 2010; the expected future price is Rs.
45.5225/USD in the market for March 28. But according to our calculation
it should be Rs. 45.5136/USD on March 28. Thus we can sell future
contract at higher price available in the market, and if our expectation
would turns right, we might be able to settle our position at lower price.
The same situation exists in EURINR market. The EUR has been selling at
lower future price that it should be. Thus we can use the same strategy as
mentioned for USD.
On March 19, in INRGBP market the situation is different. GBP has been
selling at higher in future market than our expected price in the Futures.
Thus we should short the Future contract. By doing the same we will be
selling GBP at higher and we could settle the position at the lower price.
USD
Date
Future
Price
Spot
Price MIBOR LIBOR
Theoretical Expected
Future Price
19-Mar-10 45.5225 45.4800 3.5741 0.8756 45.5136
2-Mar-10 46.0500 46.0200 3.3455 0.8394 46.1160
1-Jan-10 46.8800 46.6500 3.3292 0.9938 46.9217
EUR
Date
Future
Price
Spot
Price MIBOR LIBOR
Theoretical Expected
Future Price
19-Mar-10 62.1800 61.8900 3.5741 1.19500 61.9303
2-Mar-10 62.4200 62.3100 3.3455 1.19750 61.8662
GBP
Date
Future
Price
Spot
Price MIBOR LIBOR
Theoretical Expected
Future Price
19-Mar-10 69.3600 69.0925 3.5741 1.3156 69.1352
2-Mar-10 68.7400 68.7217 3.3455 1.2975 68.8388
Exhibit 8.1 Calculation of Future Rates
111
Conclusion
Technical Analysis can prove to be a very powerful tool for knowing the
direction or near term behavior of any underlying instrument. If a person
has the proper knowledge of the nature of moving averages, price chart
patterns and other technical indicators then he/she can effectively use
technical analysis to benefit from it.
Technical analysis though has proved to be effective in most of the cases;
it still can lead to many whipsaws if any person jumps the gun without
confirming a current move he/she is analyzing.
we find it very effective to predict the price with the help of ,candlestick
reversal pattern, RSI, MACD ,stochastic ,support resistance & crossover
with EMA20, pivot level Fibonacci retrenchment levels our accuracy for
predicting the price is about 70-75% in all cases I had not included the
charts which are failed as per the prediction but in general view we Would
say it‘s a very useful tool for investing in stock market Limitation which I
find is that finding varies from person to person , it is because of
dependence on visual identification of pattern so we need good practice of
it and sometimes bias view can come for making some pattern which our
mind want to see or mind want to create.
Bollinger band
Bollinger band in the technical analysis can be used as the support and
resistance for the scrip or the currency, the upper side of the Bollinger
band serves the resistance level above which there is indication of
overbought and which makes it clear that there are high chances that
there will be fall in the underlying asset.
In majority of the part of the analysis it can be seen that whenever and
wherever there has been contraction in the Bollinger band there has been
wide fluctuations in the price. Further the down limit of the Bollinger band
Conclusion
112
serves as the resistance below which there will be high probability for the
asset to increase in price.
Moving Average Convergence/Divergence (MACD)
MACD in all the above charts of the report has served as an important
tool whenever it has intersected to EMA and moved upward upward after
that then there is positive movement in the currency. Similarly when it
turns downward after intersecting to the EMA then there has been
occurrence of downward trend.
Relative Strength Index
RSI is also the most important technical indicator for determining the
movement of the currency prices. It has given the result quickly then the
MACD all the times.
Stochastic
Stochastic in the all the charts have given the prediction for very next
trading session; hence it is used generally for the short term compare to
long term.
Patterns
In technical patterns, it can be seen that the most accurate pattern was
cup formation. It gave the accurate result al the times.
Further the Doji is also useful for interpretation of the future trend of the
currency.
Hammer and hangman are hard to see in the currency market.
The morning and Evening star are also important measures. But they are
also difficult to see in the currency market as it is 24X7 markets.
Conclusion
113
Fibonacci Retracement
Fibonacci is useful for determining the target prices and stop loss prices of
the currency. It proves accurate enough to determine these prices. The
investor can take decision when to enter in the contract and when to exit
from the standing position.
Correlation among three currencies
If we consider the correlation among the three dominant currencies then
it can be observed from the charts and patterns that there is positive
correlation between the Euro and Pound price. Whereas there is no
significant correlation between Dollar and pound or Dollar and Euro price.
Fundamental analysis
Fundamental Analysis includes the various economic indicators and the
events happening in the countries. Fundamental factors have been a
great impact on the prices of the particular currency. The trader should
consider these factors as a determinant of the trends of prices.
In India we have managed float system, because of government‘s
interference, many times, in spite of having strong signals for change in
prices of currency from economic indicators; we may not see that
changes.
Still Traders can use all these indicators to take decision about hedging
and arbitrage opportunity.
114
Recommendation
? Before a person starts using technical analysis he/she should be
aware of the entire gamut of technical indicators and its drawbacks.
? The person should know which indicator suits which pattern and
gives what kind of signals.
? The best use is to club Technical Analysis with Fundamental
Analysis. Both together help in gauging a better picture of price
chart movements. · Multiple indicators should be used for analysis
to avoid whipsaws. · Each person should make his/her moves as per
his/her risk appetite and based on his/her own discretion.
? The best strategy is to trade with the primary trend and not against
it.
115
Bibliography
ADVFN INDIA. (n.d.). Live Charts. Retrieved march 1, 2010, from ADVFN Iindia:http://in.advfn.com/p.php?pid=fxcharts&cb=1269330582&symbol=FX^USDINR
&redir=1&from_login=1&java_vm=sun&java_vm_ver=1.6.0_17
CCIL-MIDBID/MIBOR Rate. (n.d.). Retrieved March 19, 2010, from ccilindia.com:http://www.ccilindia.com/RSCH_MBOR.aspx
Chandra, P. (2008). Technical Analysis. In P. Chandra, Investment Analysis and
Portfolio Management (pp. 302-395). Nwe Delhi: McGraw Hill.
Chart School. (n.d.). Candlestick Pattern Dictionary. Retrieved March 1, 2010,
from StockCharts.com:http://stockcharts.com/school/doku.php?id=chart_school:chart_analysis:candles
tick_pattern
Eun, C., & Resnick, B. (2008). International Financial Management. New Delhi:
Tata McGraw-Hill .
Forex Realm. (n.d.). About Fundamental Analysis. Retrieved March 2, 2010,
from Forex realm-Your Guide to Forex:http://www.forexrealm.com/fundamental-analysis/about-fundamental-
analysis.html
Hull, J. C. (2008). Fundamentals of Optyions and Futures. New Delhi: PRENTICE
HALL.
Market Data. (n.d.). Retrieved March 15, 2010, from MCX-SX.com:http://www.mcx-sx.com/SitePages/mkt_data.aspx
MCX stock Exchange Ltd. (2009). Premer on Currency Futures. Mumbai: MCX
stock Exchange Ltd.
National Stock Exchange of India Ltd. (2010). Currency Derivatives: A biginer's
Module. Mumbai: National Stock Exchange of India Ltd.
NSE FX Tracker. (n.d.). Retrieved March 19, 2010, from nseindia.com:http://www.nseindia.com/marketinfo/fxTracker/fxTracker.jsp#
Reference Rate Archive. (n.d.). Retrieved March 3, 2010, from Reserve Bank of
India:http://www.rbi.org.in/scripts/ReferenceRateArchive.aspx
Welcome to bbalibor. (n.d.). Retrieved March 4, 2010, from bbalibor.com:http://www.bbalibor.com/bba/jsp/polopoly.jsp?d=1621
doc_133864844.pdf
Today the financial market is becoming a single world market where everyone can participate in the market with different investment needs and they can invest as per required time period.
A Grand Project Report on
In partial Fulfillment of MBA programme of Gujarat University
(Batch 2008-10)
Submitted By Submitted To
Mehul Chauhan (08017) Prof. Dharmesh Shah
Manish Keshwani (08047) Prof. Viral Pandya
N.R. Institute of Business Management
Fundamental Operations in Forex
Technical and Fundamental Analysis
2010
I
Preface
Today the financial market is becoming a single world market where
everyone can participate in the market with different investment needs and
they can invest as per required time period. Foreign exchange market has
been a important part of the financial market. To satisfy the need if the
global business organizations and the financial institution, every country has
adopted the free trading system for Forex market as good as the security
market. As management students we have tried to spot some light in the
area of Forex market.
During our course of M.B.A we contributed significant time period of around
four months to this study.
In august 2008, Indian stock exchanges started trading in the Forex markets
as well. NSE launched the Currency derivatives with USD/INR contracts in
August in 2008 and other three pair i.e. EUR/INR, GBP/INR and JPY/INR in
February 2010 till today trading in the derivatives has been increased to
significant level. Looking toward these circumstances we have conducted the
study in Forex market that may have significant impact on the decision
investor and may help investors for decision.
Forecasting the prices of financial instrument is difficult as well as in Forex
market. We have tried to put some insights in forecasting the prices of the
Forex rates. We have used technical approach and fundamental approach to
find out the factors affecting the Forex rates and to forecast the future
prices.
Technical approach is used for short term i.e. week of months even it is use
for intraday trading. We have studied the different trend indicators and
II
patterns of technical charts forecast the trend and estimate the future prices
in Forex markets. On the bases of the past trends we can forecast the future
prices and take decision about investment, arbitrage and hedging.
Fundamental analysis is based on the economic indicators of the particular
country. In fundamental analysis we have considers different events
happening in the economies and other quantifiable factored like interest
rates.
Our scope of study is limited to three major currencies traded in the Indian
Forex market i.e. USD, EUR and GBP.
III
Acknowledgement
Working on this project has been a great learning experience. Numerous
individuals helped us a lot with all sort of queries that we had. We would like
to use this opportunity to thank our college N. R. Institute of Business
Management for proving us necessary infrastructure and technology
required for this project work.
We also thank Prof. Dharmesh Shah and Prof. Viral Pandya, our guide
for giving us constant support and encouragement which proved as a fuel for
us to drive through this project.
We must say about all the people again that their presence made a
difference to us. And thank our friends & the great almighty God who was
giving us blessings all the time, without this task was not possible.
We hope that our work will give some insight in management studies.
Mehul Chauhan
Manish Keshwani
Table of Contains
Sr. No. Chapter Title Page No.
Preface I
Acknowledgement III
1 Chapter 1 Research Methodology 1
2
Chapter 2
The Foreign Exchange Market 3
2.1 What Is Foreign Exchange 3
2.2 Why We Need Foreign Exchange 3
2.3 Role Of The Exchange Rate 4
2.4 It Is A 24 Hrs Market 5
2.5 International Market Consists International Network Of Dealers 6
2.6 Most Widely Traded Currency: Dollar 7
2.7 Other Major Currency 8
3 Chapter 3 Evolution Of Forex Market 10
3.1 Exchange Rate System 10
3.2 The Gold Standard 10
3.3 Bretton Wood System 11
3.4 Floating Rate System 12
3.5 Current Exchange Rate Agreement 12
4
Chapter 4
Forex Spot Market 15
4.1 Bid And Ask Price 15
4.2 Base Currency And Terms Currency 16
4.3 Bid And Ask Are For Base Currency 17
4.4 Quotes Are In Bases Point 17
5 Chapter 5 Exchange Traded Currency Futures 18
5.1 Purpose 18
5.2 Similarities With Forward Contracts 18
5.3 Difference With Forward Contracts 19
5.4 Organized Market 19
5.5 standardize contracts 19
5.6 the clearing corporation 20
5.7 mark to market 20
5.8 Purpose Of Mark To Market 21
5.9 Margin Requirement 21
5.10 Impact Of Futures On Spot And Forward Market 22
5.11 Investment Strategies Using Currency Futures 23
5.12 Recent Forex Market In India 29
5.13 Status Check On Currency Futures In India 29
5.14 Most Current Benchmark 30
5.15 Success Rate Of Currency Futures 31
6
Chapter 6
Forecasting The Exchange Rate 32
6.1 Technical Approach 32
6.2 Fundamental Approach 34
7 Chapter 7 Technical Analysis 38
7.1 Price Chart Types 38
7.2 Technical Indicators Types 39
7.3 Parameters Used In Study 40
7.4 The Candle Stick Chart 47
7.5 Fibonacci Retracement 49
7.6 Technical Analysis Of The Currency: Quarterly Period 52
7.7 Yearly Trend Analysis Of Currency 75
7.8 Pattern Indicators In Candle Stick Chart 91
7.9 Use Of Fibonacci Retracement 97
8 Chapter 8 Fundamental Analysis 105
8.1 Economic Calendar 105
8.2 Interest Rate Parity 106
8.3 Economic Event And Its Impact On Exchange Rates 107
8.4 Interest Rate Parity And Exchange Rate Forecast 109
Conclusion 111
Recommendation 114
Bibliography 115
List of Exhibits
Sr. No. Exhibit
Title
Page No.
1 5.1 payoff long position futures 24
2 5.2 payoff short position futures 26
3 5.3 total volume traded in India in Forex futures : MCX-SX 30
4 7.1 Bollinger bands 41
5 7.2 MACD 43
6 7.3 Relative Strength Index 44
7 7.4 Stochastic Oscillator 46
8 7.5 Fibonacci Retracement 51
9 7.6 USD/INR technical Indicators: April-June 52
10 7.7 USD/INR technical Indicators: July-September 54
11 7.8 USD/INR technical Indicators: October-December 56
12 7.9 USD/INR technical Indicators: January-march 58
13 7.10 EUR/INR technical Indicators: April-June 60
14 7.11 EUR/INR technical Indicators: July-September 62
15 7.12 EUR/INR technical Indicators: October-December 64
16 7.13 EUR/INR technical Indicators: January-March 66
17 7.14 GBP/INR technical Indicators: April-June 68
18 7.15 GBP/INR technical Indicators: July-September 70
19 7.16 GBP/INR technical Indicators: October-November 72
20 7.17 GBP/INR technical Indicators: December-March 73
21 7.18 USD/INR technical Indicators: 2007-08 75
22 7.19 USD/INR technical Indicators: 2008-09 76
23 7.20 USD/INR technical Indicators: 2009-10 78
24 7.21 EUR/INR technical Indicators: 2007-08 80
25 7.22 EUR/INR technical Indicators: 2008-09 82
26 7.23 EUR/INR technical Indicators: 2009-10 84
27 7.24 GBP/INR technical Indicators: 2007-08 86
28 7.25 GBP/INR technical Indicators: 2008-09 88
29 7.26 GBP/INR technical Indicators: 2009-10 89
30 7.27 EUR/INR candlestick: The Doji 91
31 7.28 EUR/INR candlestick: The Doji 2 92
32 7.29 EUR/INR candlestick: Long Wicks 93
33 7.30 GBP/INR candlestick: The Doji 94
34 7.31 GBP/INR candlestick: Cup Formation 95
35 7.32 EUR/INR candlestick: The Doji 3 96
36 7.33 USD/INR candlestick: Fibonacci April-June 97
37 7.34 USD/INR candlestick: Fibonacci January-March 98
38 7.35 EUR/INR candlestick: Fibonacci April-June 99
39 7.36 EUR/INR candlestick: Fibonacci July-September 100
40 7.37 GBP/INR candlestick: Fibonacci April-June 101
41 7.38 GBP/INR candlestick: Fibonacci July-September 102
42 7.39 GBP/INR candlestick: Fibonacci January-March 103
43 8.1 Calculation of Future Rates 110
Chapter 1 Research Methodology
1
Chapter 1 Research Methodology
1.1 Introduction and statement of the problem
What are the Factors affecting the Forex market in India and how should
we forecast the Forex rates?
1.2 Research Objectives
To find out the factors affecting the Exchange rates of the currencies in
Indian Perspective and on the bases of Technical and Fundamental
indicators, forecast the Foreign Exchange Rates.
1.3 Scope
Scope of our study is limited to technical and fundamental approach in
foreign exchange market. We have conducted study on the three major
currencies traded in Indian markets against Rupee, i.e. USD, EUR and
GBP.
1.4 Research Design
The research approach followed in this project is Descriptive Approach. On
the basis of data collected from web sites and articles, we have done the
analysis.
We have used various approaches and methods in our research. There are
too many tools that can be used for studying the Forex market. Our
research is based on Indian Forex market; Forex spot market and Forex
derivatives available in India.
We have implied following technical indicators in this study:
? Bollinger Bands
? Moving Average Convergence/Divergence (MACD)
? Relative Strength Index
? Stochastic Oscillator
Chapter 1 Research Methodology
2
In addition to above trend indicators we have used following patterns of
Candlestick Chart:
? The Doji
? Cup Formation
? Long Wickes etc.
1.5 Data Sources
Secondary data is collected from various magazines, newspapers and
internet websites.
1.6 Limitations
1. Time constraints of the semester. Report may require more time
than the time permitted.
2. By not being in the organization it may cause the quality of report.
3. The report is based on the secondary data only.
3
Chapter 2 The Foreign Exchange Market
2.1 What Is Foreign Exchange?
?Foreign exchange? refers to money denominated in the currency of
another nation or a group of nations. Any person who exchanges money
denominated in his own nation's currency for money denominated in
another nation's currency acquires foreign exchange.
This holds true whether the amount of the transaction is equal to a few
rupees or to billions of rupees; whether the person involved is a tourist
cashing a traveller's cheque in a restaurant abroad or an investor
exchanging hundreds of millions of rupees for the acquisition of a foreign
company; and whether the form of money being acquired is foreign
currency notes, foreign currency-denominated bank deposits, or other
short- term claims denominated in foreign currency.
A foreign exchange transaction is still a shift of funds or short- term
financial claims from one country and currency to another. Thus, within
India, any money denominated in any currency other than the Indian
rupees (INR) is, broadly speaking, ?foreign exchange.? Foreign exchange
can be cash, funds available on credit cards and debit cards, traveller's
cheques, bank deposits, or other short-term claims. It is still ?foreign
exchange? if it is a short-term negotiable financial claim denominated in a
currency other than INR.
2.2. Why Do You Need Foreign Exchange?
Almost every nation has its own national currency or monetary unit its
rupee, its dollar, its peso used for making and receiving payments within
its own borders. But foreign currencies are usually needed for payments
across national borders. Thus, in any nation whose residents conduct
business abroad or engage in financial transactions with persons in other
Chapter 2 The Foreign Exchange Market
4
countries, there must be a mechanism for providing access to foreign
currencies, so that payments can be made in a form acceptable to foreigners.
In other words, there is need for ?foreign exchange? transactions exchanges
of one currency for another.
2.3. Role of the Exchange Rate
The exchange rate is a price the number of units of one nation's currency that
must be surrendered in order to acquire one unit of other nation‘s currency.
There are scores of ?exchange rates? for INR and other currencies, say, US
Dollar. In the spot market there is an exchange rate for every other national
currency traded in that market, as well as for various composite currencies or
constructed monetary units such as the euro or the International Monetary
Fund's ?Special Drawing Rights (SDRs)?. There are also various ?trade ?
weighted or ?effective rates designed to show a currency movements against
an average of various other currencies (e.g. US dollar index, which is a
weighted index against world major currencies like euro, pound sterling,
yen, and Canadian dollar). Quite apart from the spot rates, there are
additional exchange rates for other delivery dates in the forward markets.
A market price is determined by the interaction of buyers and sellers in
that market, and a market exchange rate between two currencies is
determined by the interaction of the official and private participants in the
foreign exchange rate market. For a currency with an exchange rate that
is fixed, or set by the monetary authorities, the central bank or another
official body is a key participant in the market, standing ready to buy or sell
the currency as necessary to maintain the authorized pegged rate or
range. But in countries like the United States, which follows a complete
free floating regime, the authorities do not intervene in the foreign
exchange market on a continuous basis to influence the exchange rate.
The market participation is made up of individuals, non-financial firms,
banks, official bodies, and other private institutions from all over the world
that are buying and selling US dollars at that particular time.
The participants in the foreign exchange market are thus a
Chapter 2 The Foreign Exchange Market
5
heterogeneous group. The various investors, hedgers, and speculators
may be focused on any time period, from a few minutes to several years.
But, whatever is the constitution of participants, and whether their motive
is investing, hedging, speculating, arbitraging, paying for imports, or
seeking to influence the rate, they are all part of the aggregate demand for
and supply of the currencies involved, and they all play a role in determining
the market price at that instant. Given the diverse views, interests, and
time frames of the participants, predicting the future course of exchange
rates is a particularly complex and uncertain business. At the same time,
since the exchange rate influences such a vast array of participants and
business decisions, it is a pervasive and singularly important price in an
open economy, influencing consumer prices, investment decisions,
interest rates, economic growth, the location of industry, and much
else. The role of the foreign exchange market in the determination of that
price is critically important.
2.4 It's a 24-Hours Market
During the past quarter century, the concept of a 24-hour market has
become a reality. Somewhere on the planet, financial centres are open for
business, and banks and other institutions are trading the dollar and other
currencies every hour of the day and night, except for possible minor gaps
on weekends. In financial centres around the world, business hours
overlap; as some centres close, others open and begin to trade. The foreign
exchange market follows the sun around the earth.
Business is heavy when both the US markets and the major European
markets are open that is, when it is morning in New York and afternoon in
London. In the New York market, nearly two-thirds of the day's activity
typically takes place in the morning hours. Activity normally becomes
very slow in New York in the mid- to late afternoon, after European markets
have closed and before the Tokyo, Hong Kong, and Singapore markets
have opened.
Chapter 2 The Foreign Exchange Market
6
Given this uneven flow of business around the clock, market participants
often will respond less aggressively to an exchange rate development that
occurs at a relatively inactive time of day, and will wait to see whether the
development is confirmed when the major markets open. Some institutions
pay little attention to developments in less active markets. Nonetheless, the
24-hour market provides a continuous ?real-time? market assessment of the
ebb and flow of influences and attitudes with respect to the traded
currencies, and an opportunity for a quick judgment of unexpected events.
With many traders carrying pocket monitors, it has become relatively easy
to stay in touch with market developments at all times.
2.5. International Markets Are Made up of an International
Network of Dealers
The market consists of a limited number of major dealer institutions that
are particularly active in foreign exchange, trading with customers and
(more often) with each other. Most of these institutions, but not all, are
commercial banks and investment banks. These institutions are
geographically dispersed, located in numerous financial centres around
the world. Wherever they are located, these institutions are in close
communication with each other; linked to each other through telephones,
computers, and other electronic means.
Each nation's market has its own infrastructure. For foreign exchange
market operations as well as for other matters, each country enforces its
own laws, banking regulations, accounting rules, and tax code, and, as
noted above, it operates its own payment and settlement systems. Thus,
even in a global foreign exchange market with currencies traded on
essentially the same terms simultaneously in many financial centres, there
are different national financial systems and infrastructures through
which transactions are executed, and within which currencies are held.
With access to all of the foreign exchange markets generally open to
participants from all countries, and with vast amounts of market
information transmitted simultaneously and almost instantly to dealers
Chapter 2 The Foreign Exchange Market
7
throughout the world, there is an enormous amount of cross-border foreign
exchange trading among dealers as well as between dealers and their
customers.
At any moment, the exchange rates of major currencies tend to be virtually
identical in all of the financial centres where there is active trading. Rarely
are there such substantial price differences among major centres
as to provide major opportunities for arbitrage. In pricing, the
various financial centres that are open for business and active at any one
time are effectively integrated into a single market.
2.6 Most Widely Traded Currency is the Dollar
The dollar is by far the most widely traded currency. In part, the
widespread use of the dollar reflects its substantial international role
as ?investment? currency in many capital markets, ?reserve? currency
held by many central banks, ?transaction? currency in many international
commodity markets, ?invoice? currency in many contracts, and
?intervention? currency employed by monetary authorities in market
operations to influence their own exchange rates.
In addition, the widespread trading of the dollar reflects its use as a
?vehicle? currency in foreign exchange transactions, a use that reinforces,
and is reinforced by, its international role in trade and finance. For most
pairs of currencies, the market practice is to trade each of the two
currencies against a common third currency as a vehicle, rather than to
trade the two currencies directly against each other. The vehicle currency
used most often is the dollar, although very recently euro also has become
an important vehicle.
Thus, a trader wanting to shift funds from one currency to another, say
from Indian INR to Philippine pesos, will probably sell INR for US dollars
and then sell the US dollars for pesos. Although this approach results in
two transactions rather than one, it may be the preferred way, since the
dollar/INR market, and the dollar/Philippine peso market are much more
active and liquid and have much better information than a bilateral
Chapter 2 The Foreign Exchange Market
8
market for the two currencies directly against each other. By using the
dollar or some other currency as a vehicle, banks and other foreign
exchange market participants can limit more of their working balances to
the vehicle currency, rather than holding and managing many currencies,
and can concentrate their research and information sources on the vehicle.
Use of a vehicle currency greatly reduces the number of exchange rates that
must be dealt with in a multilateral system. In a system of 10 currencies, if
one currency is selected as vehicle currency and used for all transactions,
there would be a total of nine currency pairs or exchange rates to be dealt
with (i.e. one exchange rate for the vehicle currency against each of the
others), whereas if no vehicle currency were used, there would be 45
exchange rates to be dealt with. In a system of 100 currencies with no
vehicle currencies, potentially there would be 4,950 currency pairs or
exchange rates [the formula is: n(n-1)/2]. Thus, using a vehicle currency can
yield the advantages of fewer, larger, and more liquid markets with fewer
currency balances, reduced informational needs, and simpler operations.
The US dollar took on a major vehicle currency role with the introduction
of the Bretton Woods par value system, in which most nations met their
IMF exchange rate obligations by buying and selling US dollars to maintain
a par value relationship for their own currency against the US dollar. The
dollar was a convenient vehicle because of its central role in the exchange
rate system and its widespread use as a reserve currency. The dollar's
vehicle currency role was also due to the presence of large and liquid dollar
money and other financial markets, and, in time, the euro-dollar markets,
where the dollars needed for (or resulting from) foreign exchange
transactions could conveniently be borrowed (or placed).
2.7. Other Major Currencies
2.7.1 The Euro
The euro was designed to become the premier currency in trading by
simply being quoted in American terms. Like the US dollar, the euro has a
Chapter 2 The Foreign Exchange Market
9
strong international presence and over the years has emerged as a premier
currency, second only to the US dollar.
2.7.2 The Japanese Yen
The Japanese yen is the third most traded currency in the world. It has a
much smaller international presence than the US dollar or the euro. The
yen is very liquid around the world, practically around the clock
2.7.3 The British Pound
Until the end of World War II, the pound was the currency of reference.
The nickname cable is derived from the telegrams used to update the
GBP/USD rates across the Atlantic. The currency is heavily traded against
the euro and the US dollar, but it has a spotty presence against other
currencies. The two-year bout with the Exchange Rate Mechanism, between
1990 and 1992, had a soothing effect on the British pound, as it
generally had to follow the Deutsche mark's fluctuations, but the crisis
conditions that precipitated the pound's withdrawal from the ERM had a
psychological effect on the currency.
2.7.4 The Swiss Franc
The Swiss franc is the only currency of a major European country that
belongs neither to the European Monetary Union nor to the G-7
countries. Although the Swiss economy is relatively small, the Swiss
franc is one of the major currencies, closely resembling the strength and
quality of the Swiss economy and finance. Switzerland has a very close
economic relationship with Germany, and thus to the euro zone.
10
Chapter 3 Evolution of Forex Market
3.1 Exchange Rate System
Countries of the world have been exchanging goods and services amongst
themselves. This has been going on from time immemorial. The world has
come a long way from the days of barter trade. With the invention of
money the figures and problems of barter trade have disappeared. The
barter trade has given way to exchanged of goods and services for
currencies instead of goods and services.
The rupee was historically linked with pound sterling. India was a founder
member of the IMF. During the existence of the fixed exchange rate
system, the intervention currency of the Reserve Bank of India (RBI) was
the British pound, the RBI ensured maintenance of the exchange rate by
selling and buying pound against rupees at fixed rates. The interbank rate
therefore ruled the RBI band. During the fixed exchange rate era, there
was only one major change in the parity of the rupee- devaluation in June
1966.
Different countries have adopted different exchange rate system at
different time. The following are some of the exchange rate system
followed by various countries.
3.2 The Gold Standard
Many countries have adopted gold standard as their monetary system
during the last two decades of the 19
th
century. This system was in vogue
till the outbreak of World War 1. Under this system the parities of
currencies were fixed in term of gold. There were two main types of gold
standard:
Chapter 3 Evolution of Forex Market
11
3.2.1 Gold specie standard
Gold was recognized as means of international settlement for receipts and
payments amongst countries. Gold coins were an accepted mode of
payment and medium of exchange in domestic market also. A country
was stated to be on gold standard if the following condition were
satisfied:
? Monetary authority, generally the central bank of the country,
guaranteed to buy and sell gold in unrestricted amounts at the fixed
price.
? Melting gold including gold coins, and putting it to different uses
was freely allowed.
? Import and export of gold was freely allowed.
? The total money supply in the country was determined by the
quantum of gold available for monetary purpose.
3.2.2 Gold Bullion Standard
Under this system, the money in circulation was either partly of entirely
paper and gold served as reserve asset for the money supply.. However,
paper money could be exchanged for gold at any time. The exchange rate
varied depending upon the gold content of currencies. This was also
known as ? Mint Parity Theory ? of exchange rates.
The gold bullion standard prevailed from about 1870 until 1914, and
intermittently thereafter until 1944. World War I brought an end to the
gold standard.
3.3 Bretton Woods System
During the world wars, economies of almost all the countries suffered. In
order to correct the balance of payments disequilibrium, many countries
devalued their currencies. Consequently, the international trade suffered
a deathblow. In 1944, following World War II, the United States and most
of its allies ratified the Bretton Woods Agreement, which set up an
Chapter 3 Evolution of Forex Market
12
adjustable parity exchange-rate system under which exchange rates were
fixed (Pegged) within narrow intervention limits (pegs) by the United
States and foreign central banks buying and selling foreign currencies.
This agreement, fostered by a new spirit of international cooperation, was
in response to financial chaos that had reigned before and during the war.
In addition to setting up fixed exchange parities (par values) of currencies
in relationship to gold, the agreement established the International
Monetary Fund (IMF) to act as the ?custodian? of the system.
Under this system there were uncontrollable capital flows, which lead to
major countries suspending their obligation to intervene in the market
and the Bretton Wood System, with its fixed parities, was effectively
buried. Thus, the world economy has been living through an era of
floating exchange rates since the early 1970.
3.4 Floating Rate System
In a truly floating exchange rate regime, the relative prices of currencies
are decided entirely by the market forces of demand and supply. There is
no attempt by the authorities to influence exchange rate. Where
government interferes‘ directly or through various monetary and fiscal
measures in determining the exchange rate, it is known as managed of
dirty float.
3.5 Current Exchange Rate Arrangement
Although the most actively traded currencies of the world, such as the
dollar, the yen, the pound, and the euro, may be fluctuating against each
other, a significant number of the world‘s currencies are pegged to single
currencies, particularly the U.S. dollar and the euro, or baskets of
currencies such as the SDR. The current exchange rate arrangements as
classified by the IMF are provided in Exhibit 2.4. As can be seen from the
exhibit, the IMF currently classifies exchange rate arrangements into eight
separate regimes:
Chapter 3 Evolution of Forex Market
13
3.5.1 Exchange arrangements with no separate legal tender: The
currency of another country circulates as the sole legal tender or the
country belongs to a monetary or currency union in which the same legal
tender is shared by the members of the union. Examples include Ecuador,
El Salvador, and Panama using the U.S. dollar and the 12 euro zone
member countries (like France, Germany, and Italy) sharing the common
currency, the euro.
3.5.2 Currency board arrangements: A monetary regime based on an
explicit legislative commitment to exchange domestic currency for a
specified foreign currency at a fixed exchange rate, combined with
restrictions on the issuing authority to ensure the fulfillment of its legal
obligation. Examples include Hong Kong fixed to the U.S. dollar and
Estonia fixed to the euro.
3.5.3 Other conventional fixed peg arrangement: The country pegs
its currency (formally or de facto) at a fixed rate to a major currency or a
basket of currencies where the exchange rate fluctuates within a narrow
margin of less than 1 percent, plus or minus, around a central rate.
Examples include Morocco, Saudi Arabia, and Ukraine.
3.5.4 Pegged exchange rates within horizontal bands: The value of
the currency is maintained within margins of fluctuation around a formal
or de facto fixed peg that are wider than at least 1 percent, plus or minus,
around a central rate. Examples include Denmark, Slovenia, and Hungary.
3.5.5 Crawling pegs: The currency is adjusted periodically in small
amounts at a fixed, preannounced rate or in response to changes in
selective quantitative indicators. Examples are Bolivia, Costa Rica, and
Tunisia
Chapter 3 Evolution of Forex Market
14
3.5.6 Exchange rates within crawling bands: The currency is
maintained within certain fluctuation margins around a central rate that is
adjusted periodically at a fixed preannounced rate or in response to
changes in selective quantitative indicators. Examples are Belarus and
Romania.
3.5.7 Managed floating with no preannounced path for the
exchange rate: The monetary authority influences the movements of the
exchange rate through active intervention in the foreign exchange market
without specifying, or recommitting to, a preannounced path for the
exchange rate. Examples include Algeria, China, P.R., Czech Republic,
India, Russia, Singapore, and Thailand.
3.5.8 Independent floating: The exchange rate is market determined,
with any foreign exchange intervention aimed at moderating the rate of
change and preventing undue fluctuations in the exchange rate rather
than at establishing a level for it. Examples include Australia, Brazil,
Canada, Korea, Mexico, the U.K., Japan, Switzerland, and the United
States.
15
Chapter 4 Forex Spot Market
A General Overview
A spot transaction is a ?straightforward? (outright) exchange of one
currency for another. The spot rate is the current market price, the
benchmark price.
Spot transactions do not require immediate settlement or payment ?on the
spot.? By convention, the ?settlement date? (value date), is the second
business day after the ?deal date? (trade date) on which the transaction is
agreed to by the two traders. The two-day period provides ample time
for the two parties to confirm the agreement and arrange the clearing and
necessary debiting and crediting of bank accounts in various international
locations.
Exceptionally, spot transactions between the Canadian dollar and the US
dollar are settled conventionally one business day after the deal, rather
than two business days later, since Canada is in the same time zone as
the US and an earlier value date is feasible. A spot transaction represents a
direct exchange of one currency for another, and when executed, leads to
transfers through the payment systems of the two countries whose
currencies are involved. In a typical spot transaction, Bank A in New York
will agree on June 1 to sell USD 1 million for INR to Bank B in Mumbai at
the rate of, say, INR 43.50 per dollar for value June 3. On June 3, Bank B
will pay INR 43.50 million for credit to Bank A's account at a bank in
Mumbai, and Bank A will pay $1 million for credit to Bank B's account at a
bank in the United States. The execution of the two payments completes
the transaction.
4.1 Bid Price and an Ask Price
In the foreign exchange market there are always two prices for every
currency one price at which sellers of that currency want to sell, and another
price at which buyers want to buy. A market maker is expected to quote
Chapter 4 Forex Spot Market
16
simultaneously for his customers a price at which he is willing to sell and a
price at which he is willing to buy standard amounts of any currency for
which he is making a market.
4.2 Base Currency and a Terms Currency
Every foreign exchange transaction involves two currencies and it is
important to keep straight which is the base currency (or fixed currency)
and which is the terms currency (or counter currency). A trader always
buys or sells a fixed amount of the ?base? currency as noted above, most
often the dollar and adjusts the amount of the ?terms? currency as the
exchange rate changes.
The terms currency is thus the numerator and the base currency is the
denominator. When the numerator increases, the base currency
strengthens and becomes more expensive; when the numerator decreases,
the base currency weakens and becomes cheaper.
In oral communications, the base currency is always stated first. For
example, a quotation for ?dollar-rupee? means the dollar is the base and
the denominator, and the rupee is the terms currency and the numerator
and ?dollar-yen? means that the Japanese yen is the terms currency.
Currency codes are also used to denote currency pairs, with the base
currency usually presented first, followed by an oblique. Thus ?dollar-
rupee? is USD/INR, ?dollar-yen? is USD/YEN, and, ?pound sterling-dollar?
is GBP/USD.
You would buy the pair if you believe the base currency will appreciate (go
up) relative to the quote currency. You would sell the pair if you think the
base currency will depreciate (go down) relative to the quote currency.
Chapter 4 Forex Spot Market
17
4.3 Bids and Offers Are for the Base Currency
Traders always think in terms of how much it costs to buy or sell the base
currency. A market maker's quotes are always presented from the market
maker's point of view, so the bid price is the amount of terms currency that
the market maker will pay for a unit of the base currency; the offer price is
the amount of terms currency the market maker will charge for a unit of the
base currency. A market maker asked for a quote on ?dollar-rupee? might
respond ?43.5125-35,? indicating a bid price of INR 43.5125 per dollar
and an offer price of INR 43.5135 per dollar. Usually the market maker will
simply give the quote as ?25-35,? and assume that the counter party knows
that the ?big figure? is 43.51. The bid price always is offered first (the
number on the left), and is lower (a smaller amount of terms currency)
than the offer price (the larger number on the right). This differential is
the dealer's spread.
4.4 Quotes Are in Basis Points
For most currencies, bid and offer quotes are presented to the forth decimal
place that is, to one-hundredth of one percent or 1/10000 of the terms
currency unit, usually called a ?pip‘. However, for few currency units those are
relatively small in absolute value, such as Indonesian Rupiah, quotes may be
carried to two decimal places and a ?pip‘ is 1/100 of the terms currency unit.
In many market, a ?pip‘ or ?tick‘ is the smallest amount by which a price can
move in that market and in the foreign market ?pip‘ is the term commonly
used.
Chapter 5 Exchange Traded Currency Futures
18
Chapter 5 Exchange Traded Currency Futures
Futures contracts are standardized forward contracts. The quality and
quantity of the underlying asset is standardized. Futures contracts are
transferable in nature. For all practical purposes, a forward contract
becomes a futures contract if the quality and quantity are standardized and
the contract is traded on a derivatives exchange. This provides for offsetting
deals to square off the open position. Futures contracts have the
Following basic features:
? They are exchange-traded versions of forward contracts
? Time, place, and delivery price fixed between buyer and seller
? Buyer takes a long position
? Seller takes a short position
? Contracts of standard specifications
? Bring in hedgers, speculators, and those who want to discover
prices
? Margin system reduces risk, provides liquidity, and reduces volatility
5.1 Purpose
Futures are similar to forward contracts, except that
? Default risk is reduced in a different way by marking to market. This
introduces a (small) difference between a Future price and a
Forward Price
? Secondary dealing is facilitated.
5.2 Similarities with Forward Contract
? Contracts to deliver a given number of currency units on a given date
and at a pre-specified price to be paid ?later on?.
? Zero initial market value
Chapter 5 Exchange Traded Currency Futures
19
5.3 Differences with Forward Contract
? Organized markets
? Standardized contracts
? The Clearing Corporation
? Marking to Market
? Margin Requirements
5.4 Organized Markets
Futures contracts:
? Traded on organized exchanges, Price is result of a centralized,
organized confrontation between demand and supply.
? ?Open outcry? system
? Computerized Public Limit Order Book
? Price and transaction information
? Secondary market
5.5 Standardized Contracts
? Contract Size: Contract size is standardized and well defined in the
contract specification.
? Expiration dates: Typically last business day of the month. Traditionally,
only the three nearest contracts are traded.
? Tick size: Exchange specifies the minimum size of the price movement
and in some cases also impose a minimum price change during a day.
? Trading stops two business days before the expiration date, and actual
delivery takes place on the second business day after the expiration
date.
Chapter 5 Exchange Traded Currency Futures
20
Example:
Category Description
Underlying Rate of exchange between 1 USD and INR
Contract Size USD 1000
Contract Months 12 near calendar months
Expiration Date and Time Last business day of the month
Min Price fluctuation 0.25 paisa or INR 0.0025
Settlement Cash settled in INR on relevant RBI reference rate
5.6 The Clearing Corporation (CC)
A clearing house guarantees transactions on organized exchanges; a
default by an intermediary is unlikely to lead to losses for market users.
? When A ?sells? to B, A sells to CC, and CC sells to B. Thus, CC
guarantees the contract (and has reserves).
? The clearing house also ?clears?: if A buys from B and then some time
later sells to C, the clearing house cancels out both of A's contracts,
and only the contracts with B and C remain outstanding.
5.7 Mark to Market (MTM)
Mark to market at the end of the trading session: All outstanding contracts
are re-priced at the settlement price for that session. Margin account of
those who made losses is debited and those who gained are credited.
Suppose on August 10 one holds a view that INR will depreciate against
USD, caused by India's sharply rising import bill and hence buys an
October delivery Futures contract at a price of Rs. 43.50 per USD or Rs.
43,500 (43.5 x 1000) per contract. Next day, the price decreases and at the
end of the trading on August 11, the settlement price is 44.00. So s/he has
made a gain of Rs. 500 (44,000 43,500)and this is credited to his/her
margin account (can be immediately withdrawn) and now the contract is
re-priced at USD/INR 44.00 or 44,000 per contract. MTM creates an
important difference between forward and futures. In forward contract,
Chapter 5 Exchange Traded Currency Futures
21
gains and losses arouse only on maturity. There are no immediate cash
lows; in a futures contract, even though the overall gain/loss is same, the
time profile of its accrual is different the total gains and losses are
broken up into a daily series of gains and losses that clearly have different
present value.
5.8 Purpose of marking to market
? By defaulting, the investor merely avoids the latest mark-to-market
outflow. All previous losses have already been settled in cash.
? Thus, compared to a forward contract, the incentive to default on a
futures contract is smaller.
? Advantage of defaulting is even smaller than latest price change, as
there are margin requirements.
5.9 Margin Requirements
? Initial margin of, say, 3%
? Maintenance margin: account for daily MTM. Small losses will be
allowed to accumulate until margin drops below maintenance level.
Then margin is restored (in cash) (margin call). If there are gains,
any amount exceeding the maintenance margin can be withdrawn.
? Example
? Rs. 43,500 contract with Initial margin INR
1305 and Maintenance margin say INR 1050.
? The initial INR 1305 margin is the initial ?equity? in the account.
? The buyer's equity increases (decreases) when prices rise (fall).
? As long as the investor's losses do not exceed INR 255, equity
remains above 1050, and no margin call will be issued.
? If the equity however falls below INR 1050,
must add variation margin that restores the equity
to INR 1305.
Chapter 5 Exchange Traded Currency Futures
22
5.10 Impact of Futures on Spot and Forward Markets
There are concerns about the impact of currency futures price on the spot
price or vice versa. There is no clear evidence to suggest that currency
futures result in enhancement of volatility in the spot exchange rates in a
causal sense. Empirical evidence is ambiguous as to whether currency
futures afford distinctly higher speculation than is possible without them.
In theory, futures price would largely operate on a premise similar to
forward markets, i.e. it should largely reflect interest rate differentials. In
India, as in most countries, even the forward prices do not stick to that
script most of the time but are susceptible to the influence of sentiments.
An appropriate term structure of forward premium is yet to develop in India.
As such, while theoretically futures prices should reflect similar interest rate
expectations, the real effect on prices remains to be seen.
Worldwide, the currency futures market remains small, though rapidly
growing in relation to the size of OTC spot as well as forward market. The
average daily turnover in 2004, exchange-traded currency contracts was
USD 23 billion in a total foreign exchange turnover of USD 1,880 billion, which
included the USD 621 billion in the spot foreign exchange market. According to
the preliminary results of the just released Triennial Central Bank Survey of
Foreign Exchange and Derivatives Market Activity in 2007, the average daily
turnover in exchange-traded currency contract has trebled since then to
USD 110 Billion in 2009. However it is still small in relation to USD 3,220
billion total foreign exchange turnover, which includes around USD 2000
billion daily spot turn over in 2009. The exchange-traded currency contracts
comprise futures as well as options and options on futures. As such,
currency futures still comprise less than 2 per cent of the foreign exchange
market. Therefore, the currency futures market is far from becoming a
significant segment of the foreign exchange market and can be seen merely
as an add-on to risk management kit and a tool for furthering transparent price
discovery.
Chapter 5 Exchange Traded Currency Futures
23
It may, nevertheless, be stated that the importance of futures market in
price discovery might actually be larger than its share in turnover would
indicate. This is so, because typical players such as hedgers could have
considerable private information. Also, for individuals, SMEs, and small
exporters, currency \futures could bring in transparency and coupled with
anonymity accompanying the order matching trading format can help
reduce information asymmetry in the foreign exchange market, bringing in
better price discovery.
5.11 Investment Strategies Using Currency Futures
The Role of Speculation in Futures Markets
Speculators play a vital role in the futures markets. Futures are designed
primarily to assist hedgers in managing their exposure to price risk;
however, this would not be possible without the participation of
speculators. Speculators, or traders, assume the price risk that hedgers
attempt to lay off in the markets. In other words, hedgers often depend on
speculators to take the other side of their trades and to add depth and
liquidity to the markets that is vital for the functioning of a futures market.
Speculation is also not similar to manipulation. A manipulator tries to
push prices in the reverse direction of the market equilibrium while the
speculator forecasts the movement in prices and this effort eventually
brings the prices closer to the market equilibrium. If the speculator does
not adhere to the relevant fundamental factors of the spot market, they
would not survive since their correlation with the underlying spot market
would be nonexistent.
Speculators can also be classified into two categories: long and short
speculators. Long speculators are those who expect the exchange rate to
rise above the current level and assume risks by buying futures contracts
where as short speculators are those who expect the exchange rate to fall
and consequently sell futures contracts. In futures market, the total short
selling position, made up of short hedgers and short speculators, and the
Chapter 5 Exchange Traded Currency Futures
24
EXHIBIT 5.1 Payoff long position in Futures
total long buying position, made up of long hedgers and long speculators,
must always be equal.
5.11.1 Long Position in Futures
Long position in a currency futures contract without any exposure in the
cash market is called a speculative transaction. Long position in futures for
speculative purpose means buying futures contract in anticipation of
strengthening of the exchange rate (which actually means buy the base
currency and sell the quote currency and you want the base currency to
rise in value and then you would sell it back at a higher price). If the
exchange rate strengthens before the expiry of the contract then the trader
makes a profit on squaring off the position, and if the exchange rate weakens
then the trader makes loss.
The graph above depicts
the pay-off of a long
position in a future
contract, which does
demonstrate that the pay-
off of a short trader is
linear derivative, that is, he
makes unlimited profit if the
market moves as per his directional view, and if the market goes against,
he has equal risk of making unlimited losses if he doesn't choose to stop
out his position.
Example: Long positions in futures
On May 1, 2008, an active trader in the currency futures market expects INR
will depreciate against USD caused by India's sharply rising import bill and
poor FII equity flows. On the basis of his view about the USD/INR
movement, he buys 1 USD/INR August contract at the prevailing RBI
reference rate of Rs. 40.5800.
Chapter 5 Exchange Traded Currency Futures
25
He decides to hold the contract till expiry and during the holding period
USD/INR futures actually moves as per his anticipation and the RBI.
Reference rate increases to USD/INR 42.46 on May 30, 2008. He squares
off his position and books a profit of Rs 1880 (42.4600x1000 -
40.5800x1000) on 1 contract of USD/INR futures contract.
Observation: The trader has effectively analyzed the market conditions and
has taken a right call by going long on futures and thus has made a decent
gain of Rs. 1,880.
5.11.2 Short Position in Futures
Short position in a currency futures contract without any exposure in the
cash market is called a speculative transaction. Short position in futures
for speculative purposes means selling a futures contract in
anticipation of decline in the exchange rate (which actually means sell
the base currency (USD) and buy the quote currency (INR) and you want
the base currency to fall in value and then you would buy it back at a lower
price). If the exchange rate weakens before the expiry of the contract then
the trader makes a profit on squaring off the position, and if the exchange
rate strengthens then the trader makes loss.
Chapter 5 Exchange Traded Currency Futures
26
EXHIBIT 5.2 Payoff Short position in Futures
The graph depicts the pay-
off of a short position in a
future contract which does
exhibit that the pay-off of a
short trader is a linear
derivative, that is, he makes
unlimited profit if the market
moves as per his directional
view (goes down) and if the market goes against his view he has equal risk
of making unlimited loss if he doesn't choose to stop out his position.
Example: Short positions in futures
On August 1, 2008, an active trader in the currency futures market
expects INR will appreciate against USD, caused by softening of crude oil
prices in the international market and hence helping India's trade balance.
On the basis of his view about the USD/INR movement, he sells 1
USD/INR August contract at the prevailing RBI reference rate of Rs.
42.3600.
On August 6, 2008, USD/INR October futures contract actually moves as
per his anticipation and declines to 41.9999. He decides to square off
his position and earns a profit of Rs. 360.10000 (42.3600x1000
/41.9999x1000) on squaring off the short position of 1 USD/INR August
futures contract.
Observation: The trader has effectively analyzed the market conditions
and has taken a right call by going short on futures and thus has made a
decent gain of Rs. 360 per contract with small investment of say a margin
of 3%, which comes to Rs. 1270.8 in a span of 6 days.
Chapter 5 Exchange Traded Currency Futures
27
5.11.3 Trading Spread Using Currency Futures
In the current scenario, no one likes to lose an opportunity to make
money out of volatility, if predictable; the same holds good if one can
predict spread movement, and hence can capitalize on that.
Spread refers to difference in prices of two futures contracts. An
understanding of spread relation in terms of fair spread is essential to earn
speculative profit. Considerable knowledge of a particular currency pair is
also necessary to enable the trader to use spread trading strategy.
Spread movement is based on following factors:
? Interest Rate Differentials
? Liquidity in Banking System
? Monetary Policy Decision (Repo, Reverse Repo and CRR)
? Inflation
Intra-Currency Pair Spread: An intra-currency pair spread consists of one
long futures and one short futures. Both have the same underlying but
different maturities.
Inter-Currency Pair Spread: An inter-currency pair spread is a long-short
position in futures on different underlying currency pairs. Both typically
have the same maturity.
Example: Mr. X is an active trader in the currency futures market. In
September 2008, Mr. X gets an opportunity for spread trading in currency
futures. He is of the view that in the current environment of high inflation
and high interest rate the premium will higher and hence USD will
appreciate for more than the indication in the currency quotes, i.e. spread
will widen. On the basis of his views, he decides to buy December currency
future at 47.00 and at the same time sell October Future contract at 46.80,
the spread between the two contracts is 0.20
Let's say after 30 days the spread widens actually as per his expectation
and now the October futures contract is trading at 46.90 and December
futures contract is trading at 47.25, the spread now stands at 0.35. He
decides to square off his position making a gain of Rs. 150.
Chapter 5 Exchange Traded Currency Futures
28
5.11.4 Arbitrage
Arbitrage means locking in a profit by simultaneously entering into
transactions in two or more markets. If the relation between forward prices
and futures prices differs, it gives rise to arbitrage opportunities. Difference
in the equilibrium prices determined by the demand and supply at two
different markets also gives opportunities to arbitrage.
Example: Let's say the spot rate for USD/INR is quoted @ Rs. 44.325
and one month forward is quoted at 3 paisa premium to spot @ 44.3550
while at the same time one month currency futures is trading @ Rs.
44.4625. An active arbitrager realizes that there is an arbitrage opportunity
as the one month futures price is more than the one month forward price.
He implements the arbitrage trade where he;
Sells in futures @ 44.4625 levels (1 month) Buys in forward @ 44.3250 + 3
paisa premium = 44.3550 (1 month) with the same term period On the date
of future expiry he buys in forward and delivers the same on exchange
platform In the process, he makes a Net Gain of 44.4625-44.3550 =0.1075
i.e. Approx 11 Paisa arbitrage Profit per contract =107.5 (0.1075x1000)
Observation: The discrepancies in the prices between the two markets have
given him an opportunity to implement riskless arbitrage. As more and
more market players will realize this opportunity, they may also
implement the arbitrage strategy and in the process will enable market to
come to a level of equilibrium.
Many people are attracted toward futures market speculation after hearing
stories about the amount of money that can be made by trading futures.
While there are success s, and many people have achieved a more modest
level of success in futures trading. The keys to their success are typically
hard work, a disciplined approach, and a dedication to master their trade.
An investor should always remember the trade that he has initiated has
the equal probability of going wrong and must therefore apply meticulous
risk management practices to ensure the safety of his hard-earned capital.
Chapter 5 Exchange Traded Currency Futures
29
5.12 Recent Forex Market in India
It is almost one and a half years since the introduction of currency futures
under the currency derivatives segment of Indian stock exchanges. The
volumes have increased tremendously on NSE and its arch rival MCX-SX,
the two dominant exchanges of trading in currency futures; while on BSE
practically there have been no volumes in the last six months or so.
Trading in currency futures had started by NSE on August 29, 2008. This
article examines the volumes traded on these and explains the basics of
currency futures in a comprehensive manner. NSE and MCX Stock
Exchange are launching futures trading in three new currency pairs,
namely, EUR-INR, GBP-INR and JPY-INR on February 1, 2010 following
the decision of RBI to introduce the additional pairs. RBI and SEBI had
issued their guidelines for these three pairs on January 19, 2010.
5.13 Status Check On Currency Futures in India
As of now, the combined average daily turnover of the currency futures
contracts in all the three exchanges increased from USD 1.1 billion in
March 2009 to 2.5 billion in September 2009 – which means a growth of
more than 125 per cent in just six months period. These developments
are very good from the market point of view. More volumes result in
better price discovery and more opportunities for traders, investors,
genuine hedgers, speculators and arbitrageurs.
As can be seen from the following Graph, the trading volumes on MCX-SX
exchange traded currency futures have risen tremendously in the last 18
months. Let us take note of the volume increase between December 2008
and July 2009. The daily volumes have surged by four times during that
period from Rs. 970 crore to about 3808 crore. The cumulative volume
between August 2008 and July 2009 works out to Rs. 401428.2 crore on
MCX-SX only. During FY 2008-09, total traded volume was only Rs 869
crore on BSE; practically this exchange is out of the currency futures
market. In the last six months of the current financial year, there are
Chapter 5 Exchange Traded Currency Futures
30
practically no volumes on BSE. Today total daily volume take place about
Rs. 20000 Cr.
5.14 Most Current Benchmarks
? The turnover in the currency future segment in the MCX‘SX touched
a record high of Rs 10,798 crore on October 7 2009.
? The turnover of the 15-month old currency futures market in the
country on exceeded the cash equity segment by over a whopping
48 per cent to Rs 34,453 crore.
? While the turnover of over a century-year old cash equity market at
the end January 18, 2010 trade stood only at Rs 23,227 crore
EXHIBIT 5.3 Total Volume traded in India in Forex market Futures: MCX-SX
Chapter 5 Exchange Traded Currency Futures
31
5.15 Success Rate of the Currency Futures
If one goes by the spectacular rise in volumes traded on the stock
exchanges, one can argue that the introduction of currency futures has
been a success. However, volumes alone may not be sufficient to judge
the success of this new derivative product in India. Other criteria could be
the depth of the markets, participation from the various kinds of
investors, corporate, and other stakeholders of the market. Still there are
some creases to be ironed out with regard to Currency Futures.
FIIs and NRIs are still not allowed; even after the new product has been
introduced more than a year back. As stated in the first page of this
document, RBI has now only permitted three more currency pairs – Euro-
INR, Japanese Yen-INR and Pound Sterling-INR also, in addition to US
Dollar-INR which was already permitted. It remains to be seen how these
three pairs would perform.
If one compares the daily volume of more than USD 40 billion on the OTC
market, the daily volume of less than USD 2.50 billion on the exchange-
traded currency futures is small. But, over a period of time, with
increased participation and more currencies, the currency futures may
become a force to reckon with on their own – the dominance of
exchange-traded derivatives is the norm in international markets.
32
Chapter 6 Forecasting The Exchange Rate
Since the advent of the flexible exchange rate system in 1973, exchange
rates have become increasingly more volatile and erratic. At the same
time, the scope of business activities has become highly international.
Consequently, many business decisions are now made based on forecasts,
implicit or explicit, of future exchange rates. Understandably, forecasting
exchange rates as accurately as possible is a matter of vital importance
for currency traders who are actively engaged in speculating, hedging,
and arbitrage in the foreign exchange markets. It is also a vital concern
for multinational corporations that are formulating international sourcing,
production, financing, and marketing strategies. The quality of these
corporate decisions will critically depend on the accuracy of exchange rate
forecasts. Some corporations generate their own forecasts, while others
subscribe to outside services for a fee. While forecasters use a wide
variety of forecasting techniques, most can be classified into three distinct
approaches:
? Technical approach
? Fundamental approach
Let us briefly examine each of these approaches.
6.1 Technical Approach
The Forex technical analysis is concerned with what has actually
happened in the Forex market, rather than what should happen.
A technical analyst will study the price and volume movements and from
that data create charts (derived from the actions of the market players)
to use as his primary tool. The technical analyst is not much concerned
with any of the ?bigger picture? factors affecting the market, as is the
fundamental analyst, but concentrates on the activity of that instrument‘s
market.
Chapter 6 Forecasting The Exchange Rate
33
6.1.1 Technical analysis is based on three underlying principles
6.1.1.1 Market action discounts everything
This means that the actual price is a reflection of everything that is known
to the market that could affect it, for example, supply and demand,
political factors and market sentiment. The pure technical analyst is only
concerned with price movements, not with the reasons for any changes.
6.1.1.2 Prices move in trends
Technical analysis is used to identify patterns of market behaviour which
have long been recognized as significant. For many given patterns there
is a high probability that they will produce the expected results. Also
there are recognized patterns which repeat themselves on a consistent
basis.
6.1.1.3 History repeats itself
Chart patterns have been recognized and categorized for over 10 years
and the manner in which many patterns are repeated leads to the
conclusion that human psychology changes little with time.
6.1.2 List of categories of the technical analysis theory:
? Indicators (RSI, MACD, Bollinger Bands, etc.)
? Number theory (Fibonacci numbers
? Gaps (High-Low, Open-Closing)
? Trends (Following Moving Average)
? Chart formations (The Doji, Morning/Evening star, cups, etc.)
Use of all mentioned technical indicators, we will see in the following
chapters of the report.
Chapter 6 Forecasting The Exchange Rate
34
6.2 Fundamental Approach
The underlying elements affecting the economy of the subject is studied
by Forex fundamental analysis. According to this method, the analysis of
economic indicators, social factors and government policy of a business
cycle can forecast price movement and trends of the market. The
fundamentals of any country, multinational industry or trading bloc lie in
the combination of factors like social, political and economic influences.
Though, it is rather hard to stay aside from all these variable factors. So,
the sphere of complicated and subtle market fundamental lets the
explorer know and understand more details of a dynamic global market
during the analyzing.
It is possible to predict the conditions of the economy but unlikely the
market prices by using the fundamental analysis. You should have a
certain plan of action concerning the ways of using the information as
entry and exit spots in a certain strategy of trading. Forex fundamental
analysis is a fundamental strategy of trading widely used by online trader
of Forex. This strategy contains some estimations where the different
basic criteria, except for the price movement, are taken into consideration
during currency trading. The economic conditions in the currency native
country along with a number of other factors are the obligatory elements
of these criteria. Any fundamental part of the economy is included into
the fundamental analysis. A decent Forex fundamental analysis includes a
number of macroeconomic factors like economic growth rates, interest
rates, inflation, unemployment level and others. The market supply and
demand coming from political and social powers is the aim of fundamental
analysis. The market supply and demand balance forms the currencies
prices. The interest rates and the overall economy strength are the two
key factors that influence the supply-demand balance. The overall health
of the economy can be understood through a number of economic
indicators like GDP. The frequent inability of online Forex fundamental
analyses to find the entry and exit points is Forex fundamental analysis
Chapter 6 Forecasting The Exchange Rate
35
key problem. Due to this factor the risk control, especially provided with
the leverage, gets quite complicated. Only a piece of an enormous
amount of information coming every day is considerable. The interest
rates and international trade are the factors analyzed the most carefully.
In order to create the Forex trading strategy fundamentalist traders
create models. The empirical data is gathered in these models for further
forecasting the possible price trends and market behavior basing on the
key economic indicators.
Sometimes it happens that two analysts possessing the same data come
to different conclusions about the market behavior. Still you should
research the fundamental data and find out their best fitting to the style
of trading and expectations before getting down to any analysis. Any data
making the country tick is considered as fundamental by forex traders.
The fundamentals are the combination of certain plans, unpredictable
behaviors and unforeseen events found out from the factors like interest
rates and the policy of central bank and even natural disasters. That's
why it's better to be aware of the affective contributors of all these factors
than to all the fundamentals listed.
6.2.1 Fundamental elements of the economy
The Basic Concept
The economy will be affected by the investment performance. The
expected returns may change due to inflation or deflation influence.
That's why it is important to take the economy trends into consideration
while planning the strategies of investment.
6.2.1.1 The Business Cycle
The activity of the economy is generally shown by the business cycle. The
business cycle consists of four stages: recovery (also known as
expansion), peak, contraction (also called recession), and trough.
The growth of business activity, the increase of demand and production
as well as the expansion of employment can be seen. The interest rates
Chapter 6 Forecasting The Exchange Rate
36
generally rise during this phase due to money borrowing by businesses
and consumers for their expansion.
6.2.1.2 Inflation
At the moment of business cycle peak the amount of goods on demand
gets higher than the one on offer which is followed by the prices increase
and makes the inflation. At the inflationary environment the amount of
money offered for the goods is too high and it makes the conditions for
the prices to rise. This lowers the customer's ability for purchasing.
The demand declines lowering the economic activity due to the prices
increase. The recessionary phase follows this process.
6.2.1.3 Deflation
During deflation the economical activity lowers making the employers fire
the workers and lowering the demand. This is generally followed by the
prices lowering that turn into deflation. The trough phase comes after
that. Deflation is characterized as a process of strong and prolonged
prices reduction. The following demand rise is caused by low prices and
creates the conditions for the economy to come into the expansion phase.
6.2.1.4 Gross National Product (GNP)
Gross National Product is one of the key indicators of the economic
activity. All the services provided and the goods produced within the US
economy form the GNP. There are 4 components included in the GNP.
They are: consumer spending, government spending, investments, and
net exports. Gross National Product adjusted for inflation (Real GNP)
being in decline during two successive quarters is a sign of recession.
6.2.1.5 Indicators of the Business Cycle
Three types of indicators describing the economy movements during its
entering into a certain phase of the business cycle are generally used by
the economists: leading, coincident, and lagging indicators.
Chapter 6 Forecasting The Exchange Rate
37
6.2.1.6 The business cycle's effect in Forex
Forex market is sensitive to the economy changes and reacts during its
movement through any of the phases. It is important for the investors to
monitor these changes and take right decisions in order to get benefits
out of these changes.
The US dollar movements in the Forex market are usually trending the
opposite direction to the interest rates. For instance, the increase of
incomes caused by the interest rates up trending declines the US dollar
index accordingly.
6.2.1.7 Monetary Policy
The control of money and credit supply within the economy is the general
aim on the monetary policy. The interest rates are affected by these
processes and cause the economic activity decline. The monetary policy is
mainly interested in the inflation control.
6.2.1.8 The activity of the Central Banks
The monetary policy is directed by the Central Banks of any country. The
nation's central bank, In India we have Reserve Bank of India, in USA it is
Federal Reserve Board and similarly Bank of England in UK and European
Central Bank in Euro Zone. We should keep watching the movements
within the central banks to estimate future trends.
In Chapter 8 we will see that how we can use all these indicators to now
the future trend of the Forex rate.
38
Chapter 7 Technical Analysis
Technical analysis is the technique use to forecast short term Forex rate
in the Forex market. In the technical analysis there are many trend
indicators; on that basis we can forecast the future trends.
Most traders use technical analysis to get a "big picture" on an
investment's price history. Even fundamental traders will glance at a chart
to see if they're buying at a fair price, selling at a cyclical top or entering
a choppy, sideways market.
Get in and get out - at the right time
Traders rely on price charts, volume charts and other mathematical
representations of market data (called studies) to find the ideal entry and
exit points for a trade. Some studies help identify a trend, while others
help determine the strength and sustainability of that trend over time.
Technical analysis can add discipline and minimize emotion in your
trading plan. It can be hard to screen out fundamental impressions and
stick with your entry and exit points as planned. While no system is
perfect, technical analysis helps you see your trading plan through more
objectively and dispassionately.
7.1 Price chart types
7.1.1 Bar Charts
The Bar Chart is the most common type of chart showing price action,
Each bar represents a period of time - a "period" as short as 1 minute or
as long as several years. Over time, bar charts show distinct price
patterns.
Chapter 7 Technical Analysis
39
7.1.2 Candlestick Charts
Instead of a simple bar, each candlestick shows the high, low, opening
and closing price for that period of time it represents. Candlestick
patterns provide greater visual detail as they develop.
7.1.3 Point & Figure Charts
Point & figure patterns resemble bar chart patterns, except Xs and Os are
used to mark changes in price direction. Point & figure charts make no
use of time scale to associate a certain day with a certain price action.
7.2 Technical Indicator Types
7.2.1 Trend
Trend indicators smooth price data out, so that a persistent up, down or
sideways trend can be easily seen. (Examples: moving averages, trend
lines)
7.2.2 Strength
Strength indicators describe the intensity of market opinion on a certain
price by examining the market positions taken by various market
participants. Volume or open interest are the basic ingredients of strength
indicators.
7.2.3 Volatility
"Volatility" refers to the magnitude of day-to-day price fluctuations,
whatever their directional trend. Changes in volatility tend to anticipate
changes in prices. (Example: Bollinger Bands.
7.2.4 Cycle
Cycle indicators indicate repeating market patterns from recurrent events
such as seasons or elections. Cycle indicators determine the timing of a
particular market pattern. (Example: Elliott Wave)
Chapter 7 Technical Analysis
40
7.2.5 Support/Resistance
Support and resistance describes the price levels where markets
repeatedly rise or fall and then reverse. This phenomenon is attributed to
basic supply and demand. (Example: Trend Lines)
7.2.6 Momentum
Momentum indicators determine the strength or weakness of a trend as it
progresses over time. Momentum is highest when a trend starts and
lowest when the trend changes. When price and momentum diverge, it
suggests weakness. If price extremes occur with weak momentum, it
signals an end of movement in that direction. If momentum is trending
strongly and prices are flat, it signals a potential change in price direction.
(Example: Stochastic, MACD, RSI)
Using all the parameters in a study is not possible for us. We have used
following parameters in our study.
7.3 Parameters used in study
1. Bollinger Bands
2. Moving Average Convergence/Divergence (MACD)
3. Relative strength index
4. Stochastic
Here we have given the brief discretion about each technical indicator.
7.3.1 Bollinger Bands
Bollinger Bands are very popular technical indicators among Forex
traders. The man responsible for the idea is John Bollinger – he created
this technical trading tool in early 1980s. The primary idea of Bollinger
Bands is to sell when price reaches the upper Bollinger band and buy
Chapter 7 Technical Analysis
41
when it falls down to the bottom Bollinger band. In Forex market where
price movements are going up and down this technique works well for
determining your next trading strategy.
In the above graph we can see the Bollinger Bands. The distance changes
along with the price movements. When there is not much changes in price
movement the bands are close from one another, but when the price goes
up, the distance between two lines increases. Bollinger bands add and
subtract a standard deviation calculation that measures the instability of
price movements enclosing at least 80% of the price inside the "tunnel"
the bands create.
There is a lot of mathematics behind this, but we will not go too much
into details. All you have to know is that
1. An upper band is the simple moving average plus 2 standard
deviations.
2. A lower band is the simple moving average minus 2 standard
deviations.
EXHIBIT 7.1 Bollinger Bands
Chapter 7 Technical Analysis
42
This definition should be enough! Your forex broker trading platform
should have this tool available for you and so here we will discuss the
application of Bollinger bounce rather then the actual calculations.
7.3.1.1 Bollinger Bounce
The price can bounce from one band to another, each time creating
trading possibility. Think of Bollinger bands as two pin-pong players and
the middle line (simple moving average) as their ball. When the simple
moving average (our pin pong ball) is getting closer to one of the band
(one of the excited players) it bounces off – just like the pin pong ball
would do when one of the players hits it back!
Now we know where the word bounce in "Bollinger bounce" comes from.
Now what? It is useful to understand that when you see the simple
moving average approaching one of the bands it will almost certainly
bounce back off!
7.3.1.2 Bollinger Squeeze
Another imaginary example – let's say that the simple moving average
(the middle line) is a gas and the Bollinger bands form a sealed gallon.
When you squeeze the gallon with a dangerous gas at some point the
gallon explodes and the gas gets out. So, that's exactly what happens
with Bollinger squeeze – when Bollinger bands squeeze close to each
other there is a great chance that there will be an "explosion"! If the
middle line (the simple moving average) breaks through one of the
bands, either the top or the bottom) it is believed that Forex trend will
continue in that fashion.
7.3.2 Moving Average Convergence/Divergence (MACD)
Developed by Gerald Appel, Moving Average Convergence/Divergence
MACD is one of the simplest and most reliable indicators available. MACD
uses moving averages, which are lagging indicators, to include some
trend-following characteristics. These lagging indicators are turned into a
momentum oscillator by subtracting the longer moving average from the
Chapter 7 Technical Analysis
43
shorter moving average. The resulting plot forms a line that oscillates
above and below zero, without any upper or lower limits. MACD is a
centered oscillator and the guidelines for using centered oscillators apply.
7.3.2.1 MACD Bullish Signals
A Positive Divergence occurs when MACD begins to advance and the
security is still in a downtrend and makes a lower reaction low. MACD can
either form as a series of higher Lows or a second Low that is higher than
the previous Low. Positive Divergences are probably the least common of
the three signals, but are usually the most reliable, and lead to the
biggest moves.
7.3.2.2 MACD Bearish Signals
A Negative Divergence forms when the security advances or moves
sideways, and the MACD declines. The Negative Divergence in MACD can
take the form of either a lower High or a straight decline. Negative
Divergences are probably the least common of the three signals, but are
usually the most reliable, and can warn of an impending peak.
Bullish Signal
Bearish Signal
EXHIBIT 7.2 MACD
Chapter 7 Technical Analysis
44
7.3.3 Relative strength index (RSI)
Developed by J. Welles Wilder and introduced in his 1978 book, New
Concepts in Technical Trading Systems, the RSI is an extremely useful
and popular momentum oscillator. The RSI compares the magnitude of a
stock's recent gains to the magnitude of its recent losses and turns that
information into a number that ranges from 0 to 100. It takes a single
parameter, the number of time periods to use in the calculation. In his
book, Wilder recommends using 14 periods.
The RSI's full name is actually rather unfortunate as it is easily confused
with other forms of RSI analysis such as John Murphy's "Relative
strength" charts and IBD's "Relative strength" rankings. Most other kinds
of "Relative strength" stuff involve using more than one stock in the
calculation. Like most true indicators, the RSI only needs one stock to be
computed. In order to avoid confusion, many people avoid using the RSI's
full name and just call it "the RSI."
EXHIBIT 7.3 Relative Strength Index
Chapter 7 Technical Analysis
45
7.3.3.1 Overbought/Oversold
Wilder recommended using 70 and 30 and overbought and oversold levels
respectively. Generally, if the RSI rises above 30 it is considered bullish
for the underlying stock. Conversely, if the RSI falls below 70, it is a
bearish signal. Some traders identify the long-term trend and then use
extreme readings for entry points. If the long-term trend is bullish, then
oversold readings could mark potential entry points.
7.3.3.2 Divergences
Buy and sell signals can also be generated by looking for positive and
negative divergences between the RSI and the underlying stock. For
example, consider a falling stock whose RSI rises from a low point of (for
example) 15 back up to say, 55. Because of how the RSI is constructed,
the underlying stock will often reverse its direction soon after such a
divergence. As in that example, divergences that occur after an
overbought or oversold reading usually provide more reliable signals.
7.3.3.3 Centerline Crossover
The centerline for RSI is 50. Readings above and below can give the
indicator a bullish or bearish tilt. On the whole, a reading above 50
indicates that average gains are higher than average losses and a reading
below 50 indicates that losses are winning the battle. Some traders look
for a move above 50 to confirm bullish signals or a move below 50 to
confirm bearish signals.
7.3.4 Stochastic Oscillator
Developed by George C. Lane in the late 1950s, the stochastic Oscillator
is a momentum indicator that shows the location of the current close
relative to the high/low range over a set number of periods. Closing levels
that are consistently near the top of the range indicate accumulation
(buying pressure) and those near the bottom of the range indicate
distribution (selling pressure).
Chapter 7 Technical Analysis
46
Readings below 20 are considered oversold and readings above 80 are
considered overbought. However, Lane did not believe that a reading
above 80 was necessarily bearish or a reading below 20 bullish. A security
can continue to rise after the stochastic Oscillator has reached 80 and
continue to fall after the stochastic Oscillator has reached 20. Lane
believed that some of the best signals occurred when the oscillator moved
from overbought territory back below 80 and from oversold territory back
above 20.
Buy and sell signals can also be given when %K crosses above or below
%D. However, crossover signals are quite frequent and can result in a lot
of whipsaws.
One of the most reliable signals is to wait for a divergence to develop
from overbought or oversold levels. Once the oscillator reaches
overbought levels, wait for a negative divergence to develop and then a
cross below 80. This usually requires a double dip below 80 and the
second dip results in the sell signal. For a buy signal, wait for a positive
divergence to develop after the indicator moves below 20. This will
usually require a trader to disregard the first break above 20. After the
EXHIBIT 7.4 Stochastic Oscillator
Chapter 7 Technical Analysis
47
positive divergence forms, the second break above 20 confirms the
divergence and a buy signal is given.
Now in the technical analysis some patterns of chars also used for very
short term forecast of the prices. We have used the candle stick chart
patterns for forecasting the prices base on the spot price of currencies
against the Rupee. Here we have used The Doji, Cup Formation, and
Fibonacci etc in our analysis.
First of all we understand the candlestick charts, how should we read the
candles, what indicates the different types of candles etc. so let‘s learn
about the basics of the candle stick chart.
7.4 The Candle Stick Chart
For a candlestick chart, the open, high, low and close are all required. A
daily candlestick is based on the open price, the intraday high and low,
and the close. A weekly candlestick is based on Monday's open, the
weekly high-low range and Friday's close.
Many investors believe that candlestick charts are easy to read because of
the relationship between the open and the close. White (clear)
candlesticks form when the close is higher than the open and black (solid)
candlesticks form when the close is lower than the open. The white and
black portion formed from the open and close is called the body (white
body or black body). The lines above and below are called shadows and
represent the high and low.
Chapter 7 Technical Analysis
48
Candlestick charts are the most popular charts among chartists. It gives
valuable insight into the trading patterns and can help in capturing the
signals more accurately and timely. There are various patterns within the
formation of candlestick charts itself which are very useful if understood
properly.
Different Kinds of Formation of Candlesticks
7.4.1 Long Candlesticks
Long candlesticks denote a high volatility during trading session and
whether the buyers or sellers were controlling the trading during the
session. Long white candles indicate that buyers controlled the period
initially and drew prices up to close at a higher price at during the trading
session. While long black candlesticks indicate that sellers dominated the
trading period and pushed the prices down resulting in a lower close.
7.4.2 Long Wicks
Long wicks indicate a trading period where there was a lot of action
during the trading period but the prices close relatively closer to the
opening price of the trading period. The 1
st
(left) long wick is a candle
stick which indicates that the sellers were initially in control of the trading
Chapter 7 Technical Analysis
49
period which resulted in a steep low during the trading session but the
buyers bounced back to close the stock closer to the opening level.
The 2
nd
(right) long wick candlestick chart indicates that the buyers
controlled the period initially and later the sellers took control of the
period and brought down the prices to close at levels lower than what
would have actually been.
7.4.3 Doji Candlestick Pattern
The difference between Doji and Spinning top is that doji
indicates a trading period where the closing price was
very close or exactly equal to the opening price. Doji is
considered a stronger signal than the spinning top. Doji
candlesticks if formed during a range bound market
represent a lot of indecision in the market. However, if a
doji candlestick forms during a trend then it gives a strong signal about a
possible reversal. But as said earlier all technical analysis should be done
with use of other indicators to avoid whipsaws.
7.5 Fibonacci Retracement
Fibonacci retracement is a very popular tool among technical traders and
is based on the key numbers identified by mathematician Leonardo
Fibonacci in the thirteenth century. However, Fibonacci's sequence of
numbers is not as important as the mathematical relationships, expressed
as ratios, between the numbers in the series. In technical
analysis, Fibonacci retracement is created by taking two extreme points
(usually a major peak and trough) on a stock chart and dividing the
vertical distance by the key Fibonacci ratios of 23.6%, 38.2%, 50%,
61.8% and 100%. Once these levels are identified, horizontal lines are
drawn and used to identify possible support and resistance levels. Before
we can understand why these ratios were chosen, we need to have a
better understanding of the Fibonacci number series.
The Fibonacci sequence of numbers is as follows: 0, 1, 1, 2, 3, 5, 8, 13,
21, 34, 55, 89, 144, etc. Each term in this sequence is simply the sum
Chapter 7 Technical Analysis
50
of the two preceding terms and sequence continues infinitely. One of the
remarkable characteristics of this numerical sequence is that each number
is approximately 1.618 times greater than the preceding number. This
common relationship between every number in the series is the
foundation of the common ratios used in retracement studies.
The key Fibonacci ratio of 61.8% - also referred to as "the golden
ratio" or "the golden mean" - is found by dividing one number in the
series by the number that follows it. For example: 8/13 = 0.6153, and
55/89 = 0.6179.
The 38.2% ratio is found by dividing one number in the series by the
number that is found two places to the right. For example: 55/144 =
0.3819.
The 23.6% ratio is found by dividing one number in the series by the
number that is three places to the right. For example: 8/34 = 0.2352.
For reasons that are unclear, these ratios seem to play an important role
in the stock market, just as they do in nature, and can be used to
determine critical points that cause an asset's price to reverse. The
direction of the prior trend is likely to continue once the price of the asset
has retraced to one of the ratios listed above. The following chart
illustrates how Fibonacci retracement can be used. Notice how the price
changes direction as it approaches the support/resistance levels.
Chapter 7 Technical Analysis
51
In addition to the ratios described above, many traders also like using the
50% and 78.6% levels. The 50% retracement level is not really a
Fibonacci ratio, but it is used because of the overwhelming tendency for
an asset to continue in a certain direction once it completes a 50%
retracement.
In the next section we will see the technical analysis of the USDINR,
EURINR and GBPINR pairs of currencies. We have used above concepts of
technical analysis to forecast future trend and the price levels between
three pairs of currencies mentioned above.
We have taken quarterly trends for each currency pair for our analysis
and then we will compare it with the yearly trend of the same.
EXHIBIT 7.5 Fibonacci Retracement
Chapter 7 Technical Analysis
52
7.6 Technical analysis of Currencies: quarterly periods
7.6.1 USD/INR Technical Analysis 2009-10
Bollinger Bands
Bollinger band in the above depicted chart has increased volatility. On
13
th
June, the Bollinger band has contrasted indicating that there will be
high volatility in the upcoming future. As the Dollar has touched to the
average there is right strategy to watch rather then taking any action.
Moving Average Convergence/Divergence (MACD)
When MACD (12, 26) crossed to the MACD (9) while moving upward, it
indicates that there will be increase in the price of the dollar. Similar trend
Exhibit 7.6 USD/INR technical indicators: April-June
Chapter 7 Technical Analysis
53
observed on the date 21
st
April. Similarly when there is reverse the
position, there will be downward trend in he price of the Dollar. If we
predict the future of the Dollar price by considering the MACD ,then we
can say that there will be downward trend of the Dollar price as the
MACD(26,12) intersects the MACD(9) and moves downward after that.
Relative strength index
Relative price index also gives the prediction with same accuracy as the
MACD but it gives result earlier than MACD. The increase in the dollar
price was reflected by MACD on 6
th
June, the same was indicated by the
RSI on 25
th
may.
Stochastic
The stochastic in the above chart ends at the point 30,it is indication of
not taking any action though there are high chances that there will be
upward trend but the right step here is to wait for formation of pattern.
Chapter 7 Technical Analysis
54
Bollinger Bands
On august 17
th
there was the huge buying pressure in the Forex market
hence the price of the dollar crossed the upper bound of the Bollinger
band. Further there will be increase in the price of the Dollar in the
upcoming future is required to move upwards as there is slowly
decreasing the selling pressure and there is more buying of the Dollar. On
August 2 the Price line fell below the lower band, it gives strong signal
that the price of dollar will raise in next session.
Exhibit 7.7 USD/INR technical indicators: July-September
Chapter 7 Technical Analysis
55
Moving Average Convergence/Divergence (MACD)
The MACD in the above depicted chart indicates the huge amount of the
volatility in the price of the Dollar. The MACD indicated the price of the
Dollar to go up right from the 17
th
July. Further showing upward trend
beginning from the 14
th
august.
Relative Strength Index
The RSI has shown fluctuations relatively more as there has not been
formation of any particular trend. Hence further the safe option is to wait
and watch rather than entering r exiting from the market.
Stochastic
The fast stochastic had gone par up the 80% limit on July 3 to July 13
that shows the buying pressure and indicates the prices to fell. This is the
time not to purchase more dollars because the prices will start falling
soon. Hence we should start selling the dollars to encash our profit.
Chapter 7 Technical Analysis
56
Bollinger bands
The Bollinger band in the above chart indicates that, the Bollinger band is
contrasting which means that there have been fewer fluctuations in the
price of the Dollar. Further there are high chances of moving the dollar
prices in the upcoming future to increase sharply in the either direction
with high chances of moving upward.
Exhibit 7.8 USD/INR technical indicators: October-December
Chapter 7 Technical Analysis
57
Moving Average Convergence/Divergence (MACD)
The MACD in the above chart shows that there have been fewer
fluctuations in the dollar prices. Further there are high chances of Dollar
to move upward in the shorter period of time. On October 22, the MACD
line crossed the EMA line upward, so the prices had to rise in future, and
the same thing happened in next few days. So our analysis proved right.
We may rely on this type of technical analysis to find the future trend of
the price.
Relative Strength Index
There has been high Buying pressure on the date till October 19
th
. Hence
it was clear that there will be increase in the price of the Dollar. Other
thing in RSI is not clear since it is in the middle of the upper and lower
limits in this period.
Stochastic
The fast stochastic had gone par up the 80% limit on October 27 to
November 3 that shows the buying pressure and indicates the prices to
fell. This is the time not to purchase more dollars because the prices will
start falling soon. Hence we should start selling the dollars to encash our
profit.
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58
Bollinger Bands
Bollinger band in the above mentioned chart indicates that the Dollar
price has touched to the lower Bollinger band and has shown upward
trend after that it means that there will be increase in the Dollar price.
Moving Average Convergence/Divergence (MACD)
The MACD (12, 26) crossed to MACD (9) on January 20
th
hence the price
of the Dollar increased from there. Further the price started to decrease
after February 15
th
. The Dollar price has touched to the lower bound of
the Bollinger Band hence there are high chances that there will be
increase in the Dollar price. Hence the right strategy is to long the future.
Exhibit 7.9 USD/INR technical indicators: January-March
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59
Relative Strength Index
The RSI indicated the selling pressure on January 10
th
hence there was
sharp fall in the Dollar price. The future trend from the above indicators
can be predicted as that there will be increase in the price of the Dollar.
Stochastic
The fast stochastic in the above chart is indicating that the red line is
below 20 percentile hence there are chances that there will be upward
movement of the Dollar price. Further the red line is crossing to blue line
and after that showing upward trend hence it is also indicating that there
will be correction in the market.
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60
7.6.2 EUR/INR Technical Analysis 2009-10
Bollinger Bands
The Bollinger band in the above indicated chart shows that there has been
contraction and expansion of the Bollinger band. When the Euro price
touched to the upper bound of the Bollinger band, there was sharp
decrease in the Euro price within two days from more than 67 to almost
65. Hence there was clear indication of rise in the Euro price.
Further on June 25
th was
rise in the Euro price sharply it means that there
was over buying of the Euro which gave rise to over valuation of Euro.
Hence it made it clear that there was going to be decrease in the Euro
price gradually.
Exhibit 7.10 EUR/INR technical indicators: April-June
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61
Moving Average Convergence/Divergence (MACD)
The MACD showed downward trend till 27
th
April. After that there was
increase in the Euro price. The MACD showed the fluctuations of the Euro
prices.
Relative strength Index
RSI has never shown the buying or selling pressure hence it was difficult
to predict the movement of the Euro prices. At the end of the period also
the Euro remained near to the average price. Hence the best strategy
here is to wait for a few days to determine the trend of the Euro price and
after that take the decision.
Stochastic
The stochastic in the above chart is almost at 60 percentile. Hence there
are chances that there will be downward movement of the price.
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62
Bollinger Bands
The Bollinger band in the above chart shows that there was upward trend
of the Euro price but it touched to the lower bound of the Bollinger band.
It is indication of the future upper side movement of the Euro.
Moving Average Convergence/Divergence (MACD)
The MACD shows that there has been continuous and gradual upward
movement of the Euro over the span of two months. But the MACD in this
chart is providing the contradictory picture compare to Bollinger band.
MACD indicates that there will be downward trend in the Euro price.
Exhibit 7.11 EUR/INR technical indicators: July-September
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63
Relative Strength Index
RSI showed the upward movement on 24
th
august and 14
th
September
respectively. Hence it made clear the downward movement of the Euro in
the upcoming period.
But at the end of the period the price remained below average it means
that the price will come upwards.
Stochastic
Stochastic in the above chart shows that there will be downward
movement of the Euro as the red line is moving downward after touching
to the blue line.
Chapter 7 Technical Analysis
64
Bollinger Bands
The Bollinger band in the above chart shows that it contrasted on 1
st
December it means that there was going to be the one side movement of
Euro price. But to determine what will be the direction of the movement,
MACD or RSI is used. If MACD or RSI shows buying pressure then there
will be increase in the price and vice versa.
Moving Average Convergence/Divergence (MACD)
The MACD in the above chart shows that there has been continuous
downward movement of the Euro. But as the MACD (12, 26) has crossed
to MACD (9) there are high chances that there will be upward movement
of the Euro price.
Exhibit 7.12 EUR/INR technical indicators: October-December
Chapter 7 Technical Analysis
65
Relative Strength Index
This indicator is also indicating that there will be upward movement of the
Euro price but it gives result on December 20
th
which is far ahead than
the result provided by the MACD.
Stochastic
Stochastic in the above chart shows that there will be still downward
movement of the Euro price as the red line is below the blue line, it
makes it clear that there might be chances that the same downward trend
may continue in the upcoming future also.
Chapter 7 Technical Analysis
66
Bollinger Bands
In above chart there has been downward trend of the Euro rice. There has
been constant decrease in it. The Euro was not able to touch to even the
average price. But at the end of the period it came back to the average. It
shows that there are high chances of Euro to show upward movement in
the future.
Moving Average Convergence/Divergence (MACD)
The MACD is also showing that there are fair chances that there will be
increase in the Euro price. The Euro price remained downward moving
over three months.
Exhibit 7.13 EUR/INR technical indicators: January-March
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67
Relative Strength Index
It shows that every time after touching to resistance level, Euro price
tried to go up but once again it came downward. This chain was repeated
for so many times in the period of three months. But at last it increased
considerably to believe that it will go up in the forth coming future.
Stochastic
Here the fast stochastic goes above the 60 percentile level at last so we
may see the fall in price of EURINR in coming day. If such thing happens,
it means that our pervious analysis is correct and we are establishing
relationship between trend of rice and future forecast.
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68
7.6.3 GBP/INR technical analysis
Bollinger Bands
The above chart shows the upward trend in the first quarter of the
selected period i.e. April 2009 to June 2009. Looking toward the Bollinger
bands, in the mid April chart line touches the upper band, it means that
the exchange rate GBPINR may fall from Rs. 74.5/£. This prediction
seems to be true watching further rates in the same quarter which fell to
just above Rs. 72/£ level. It means price of GBP fell around 2.5 rupee in
few days. The same thing happened in early June. The price line went
above the upper band it means it is high time to start selling the GBP and
wait to fall the prices. The prices were going to fall sharply. On June 2
Exhibit 7.14 GBP/INR technical indicators: April-June
Chapter 7 Technical Analysis
69
price was Rs. 77.5/£ it fell to 75.2/£ on June 5. at end of the quarter the
price line is in middle around the average. So to predict we should look to
other indicator.
Moving Average Convergence/Divergence (MACD)
In MACD at the end of the quarter the red line crosses the blue line of
EMA from above. It shows that the prices of GBP will fall in coming period.
The effect of such indicator is shown in the same period and price begun
to fall.
Relative Strength Index
RSI indicates the volume of buying by market makers more than
expected or average. Here the RSI line touched the resistance line on 2
nd
June same as the Bollinger Bands. It shows the over bought situation in
market. Thus prices are going to fell. And that happened in few days.
Prices came back to 75.2 from 77.5.
Stochastic
In this quarter the stochastic line looks like zigzag, and there is more
price volatility than average movement. So forecasting prices from here is
very difficult. MACD shows that prices may fall in coming days. We should
consider that.
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70
Bollinger Bands
In this quarter the Bollinger band had contrasted. This shows that the
there will be more volatility in the prices of GBP against INR. The high
price was Rs.81.75 on August 5. After that the prices fell to 75.99 at the
end of quarter. Thus when Bollinger Bands contrasts we see more
volatility in the market. In the end the price line fell bellow the Bollinger
bands thus now it is time to rise in price of GBP. In next few days it is
sure that prices will rise.
Exhibit 7.15 GBP/INR technical indicators: July-September
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71
Moving Average Convergence/Divergence (MACD)
The MACD (12, 26) crossed EMA line from above in the latter period. On
September 18, both lines in intersects. It shows that this is time to sell
the GBP or we can short the GBP contract in the future, because it
indicates that prices would go down. On the September 30, price has
fallen to considerable level. Now we can start purchasing the GBP or long
the future. In future when price will raise we can square off our position
and have some gain out of it.
Relative Strength Index
Here the RSI is in the middle of the upper and lower level resistant in the
3 month period. But in the end it is bellow the 20 percentile level, it
means the prices should go up now in next periods. It shows the same
results as the MACD. Thus we can go long in future because it is seems
that price will rise.
Stochastic
In this quarter the stochastic line looks like zigzag, and there is more
price volatility than average movement. So forecasting prices from here is
very difficult. MACD shows that prices may fall in coming days. We should
consider that
Chapter 7 Technical Analysis
72
Bollinger Bands
Here the Bollinger bands are contrasting after November 16, 2009. The
contraction of bands shows that there will be more volatility in the
market. But the was no volatility as expected. Thus this time we may
prove wrong.
Moving Average Convergence/Divergence (MACD)
In the beginning of the period, the MACD shows the positive divergence.
Thus we may expect the bullish trend in the GBPINR market in coming
days. As per our expectation there were the positive signals in the
market.
Exhibit 7.16 GBP/INR technical indicators: October-December
Chapter 7 Technical Analysis
73
Relative Strength Index
In alien with the other two indicators, RSI also shows the bullish signal.
On October 10 the trend goes upward. RSI gives the signals before other
indicator as seen in the chart. RSI gives positive signal before the MACD.
Here in MACD we can see that the red line (MACD) coming closer to blue
line (EMA) it may cross blue line from up to down and it is sign of bearish
trend in the GBP market.
Exhibit 7.17 GBP/INR technical indicators: Jnuary-March
Chapter 7 Technical Analysis
74
In mid of January Fast Stochastic line crosses the 80% limit. Thus it is the
sign of the coming bearish trend in the market because the marker rate
has gone far up than the average and the price that should be in the
market.
Chapter 7 Technical Analysis
75
7.7 Yearly Trend Analysis of Currencies for last 3 years
7.7.1 USD/INR yearly analysis
Bollinger Bands
The Bollinger Bands in the above mentioned chart makes it clear that the
Dollar price in the financial year 2007-08 has plummet down for the first
quarter of the year but afterwards t remained fluctuating. In August, the
bands came very close to each other and so that we saw the volatility n
next period in the market.
Exhibit 7.18 USD/INR technical indicators: 2007-08
Chapter 7 Technical Analysis
76
Moving Average Convergence/Divergence (MACD)
The MACD chart is also making true to our assumption of downward
movement of the Dollar price. The red line which is MACD is crossing to
the EMA and afterwards moves downwards it shows that there will be
downward trend of the Dollar.
Relative Strength Index
RSI is also making the picture of downward trend clear but it is providing
the picture far before the MACD. It touched to the higher bound hence it
was clear that there will be downward trend. Hence the right strategy
here would be to sell the future at the higher price.
7.19 USD/INR Technical Analysis 2008-09
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77
Bollinger Bands
The Bollinger band in the above chart shows that Dollar is below the EMA
further the price is at the median hence it can be predicted that there will
be downward movement of the Dollar price the reason being it is below its
moving average.
Moving Average Convergence/Divergence (MACD)
MACD in the above chart is also showing that there will be downward
movement of the Dollar as the red line is moving below the blue line. But
this trend will continue for the short period of time as the red line is likely
to cross to the blue line.
Relative Strength Index
RSI at the end of the march shows that there will be downward trend
reason being it shows that the Dollar price has been above the upper limit
of the RSI hence there will be downward trend.
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78
Bollinger band
The Dollar price in the above chart has touched to the lower bound of the
Bollinger band. Hence it can be said that there will be upward correction
in the Dollar price. Over all over the period of one year there was
downward trend in the Dollar price.
Exhibit 7.20 USD/INR technical indicators: 2009-10
Chapter 7 Technical Analysis
79
Moving Average Convergence/Divergence (MACD)
MACD in the above chart also supports the prediction of upward
movement. As the MACD line is likely to cross the EMA line.
Relative Strength Index
RSI also shows that as it has touched to the lower bound of it it will show
upward trend in the upcoming year.
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80
7.7.2 EUR/INR yearly technical Analysis
Bollinger Bands
The Euro price in the above chart shows that the price of the Euro
remained stable till February but after that it showed upward trend by
leaps and bounds. As the Euro has touched to the EMA there can not be
any specific prediction about it as there are chances of movement of the
Euro in either direction.
Exhibit 7.16 EUR/INR technical indicators: 2007-08 Exhibit 7.21 EUR/INR technical indicators: 2007-08
Chapter 7 Technical Analysis
81
Moving Average Convergence/Divergence (MACD)
The above mentioned MACD chart shows that downward movement of the
Euro may continue in the upcoming future as the MACD that is the red
line is continuing to be below the blue line.
Relative Strength Index
The RSI in the above chart shows that it crossed to the upper bound in
starting of the December. Hence it was sure that there will be downward
movement of the Euro in the future. Similarly in the march also it
surpassed to the upper bound hence it can be said that there might be
correction in the market and Euro might fall down.
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82
Bollinger Bands
The chart depicted above shows that there has been huge amount of
fluctuations during the financial year. The Euro fluctuated from 68 to 60.
Hence it can be said that there was huge amount of the fluctuations. If we
consider the future prediction of the Euro price it is likely to come down.
Hence the right step to be taken here should be to sell the future of the
Euro.
Exhibit 7.22 EUR/INR technical indicators: 2008-09
Chapter 7 Technical Analysis
83
Moving Average Convergence/Divergence (MACD)
MACD crossed the upper bound four times in the year and touched to
lower bound twice the year. Hence there were huge fluctuations in the
Euro. Further if we consider that what should be the future trend then it
can be said that as the MACD line is crossing to EMA line and afterwards
moving down hence it can be said that there will be downward trend.
Relative Strength Index
If we consider the RSI then at the end of the march it touched almost to
the upper bound. That shows that there has been huge amount of long
contracts in the Euro market. Hence the better option here is to sell the
future.
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84
Bollinger Bands
The Bollinger band in the above chart shows that there has been creation
of two trends over the span of two years. Firstly there has been upward
movement of the Euro and afterwards there is downward trend. If we
consider what will be the future trend of the Euro then it can be said that
there will be upward movement of the Euro the reason being it has
started to recover from the support further it has crossed to the EMA that
shows that there will be correction in the market in the forthcoming
future.
Exhibit 7.23 EUR/INR technical indicators: 2009-10
Chapter 7 Technical Analysis
85
Moving Average Convergence/Divergence (MACD)
The MACD in the above chart is also giving the positive signals for the
Euro in the future. The MACD has shown the huge amount of fluctuations
in the financial year. But at the end the MACD crosses to the EMA hence
there will be upward trend in the Euro price.
Relative Strength Index
The RSI is also indicating that there will be correction in the Euro market
as it touched to the lower bound and recovered from the same
successfully hence there are bright chances of the Euro to reach back to
the level which it attained in the September.
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86
7.7.3 GBP/INR yearly analysis
Bollinger Bands
The Bollinger band in the above chart shows that there have been
fluctuations in the pound prices over the span of the year. But at the end
of the year there has been reduction in the pound price. If we consider
the Bollinger band and try to predict the future status of the pound price
then it can be said that there will be upward movement of the pound. The
reason for the same can be regarded that the pound has touched to the
lower bound and further it has recovered from the same point. Hence the
best strategy here is to long the future at the lower price so that while
Exhibit 7.24 GBP/INR technical indicators: 2007-08
Chapter 7 Technical Analysis
87
price has moved upwards the position can be squared off and the fruits of
the profit can be taken.
Moving Average Convergence/Divergence (MACD)
The MACD in the above chart also shows that there has been mixed
trends in the pound prices. If we take into consideration the MACD to
predict the future then it can be said that the MACD is moving below the
EMA but there are high chances that MACD will cross to EMA and will
move above it hence there will be correction in the pound price.
Relative Strength Index
RSI shows that there has been continuous downward trend of the pound,
there has been touching of the RSI to downward bound and further
upward movement but there is no strong upward support hence there was
no scope for entering into the market but at last there has been
considerable support to increase the price.
Chapter 7 Technical Analysis
88
Bollinger Bands
Taking into consideration the Bollinger band and EMA it can be said that
there has been considerable amount of downward trend in the price of
pound. But after 15
th
January there has been stable in the price of the
pound and after that there has been buying signals and there has been
signal of upward trend. The pound has touched to the EMA and after that
it has moved upwards hence there will be upward trend. The right step
here would be to buy the future.
Exhibit 7.25 GBP/INR technical indicators: 2008-09
Chapter 7 Technical Analysis
89
Moving Average Convergence/Divergence (MACD)
The MACD and EMA are moving and crossing each other. From that it can
be said that there will be huge amount of ups and downs in the upcoming
year. But if we consider the long term future then it can be said that there
will be upward movement.
Relative Strength Index
RSI in the above chart indicates that it touched to the central line and
after that it moved upwards hence pound is more likely to move upwards
rather downwards.
Exhibit 7.26 GBP/INR technical indicators: 2009-10
Chapter 7 Technical Analysis
90
Bollinger Bands
The above chart shows that there has been huge amount of volatility in
the pound. It fluctuated from RS.82/£ to RS.68.7/£. Hence there has
been huge price range. But if we consider the prediction of future then it
can be said that as pound has moved upwards after touching to the
resistance, it can be concluded that there will be strong upward
movement of the pound.
Moving Average Convergence/Divergence (MACD)
The red line indicating the MACD shows that it is about to touch and to
cross the blue line that is EMA; hence in the upcoming year there will be
upward movement of the pound.
Relative Strength Index
The RSI moved downward in the beginning of the march and remained
there till 15
th
of the march. But after that there was correction in the
market and RSI moved upwards and touched to the lower bound means
broke the support hence there is new support for the pound and there are
chances that it will go up.
The right step here would be to long the future to gain from increase in
the pound price.
This was the trend analysis of the prices of currencies. Now let‘s see some
patter of charts that we have mentioned earlier in the chapter. We will
see how we can use candle stick chart patterns to forecast the future
trend of the market prices.
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91
7.8 Pattern indicators in Candlestick chart
In above section we have seen the trend indicators, which are useful to
forecast price trend in future. We can use some patterns of graphs to
forecast price trend as well as to know the level of prices up to what price
could move in future bases of averages and open, high, low, close of the
previous period‘s prices.
Here we have used The Doji, hammers, hangingman fibonacci
retracement to forecast prices trend and targets.
The Doji is the indication of reversal trend in the technical charts. If we
consider the above chart then it can be seen that whether Doji is bullish
or bearish is immaterial. In the above chart the bearish Doji has occurred.
But it causes the trend to move upward. Further the cup formed here
from Doji to end of the period makes it clear that there will be downturn
in the market for the upcoming future.
Exhibit 7.27 EUR/INR candlestick-The Doji
Chapter 7 Technical Analysis
92
In the above Chart the Euro price has plummet down after occurrence of
Doji. There has been huge amount of decrease in the Euro price. It has
plummet down to almost RS.66.6880/ Euro from RS. 70.0000. There was
upward trend in the Euro price after reaching to the level of RS.68.0000
but there was no proper formation of the cup means price touched to
RS.70 but could not touch to the previous resistance level. Hence there
was not completion of cup therefore Euro couldn‘t touch to the new levels.
If we consider the future trend of the Euro market then it can be said that
as the Euro has broken three resistances, there are high chances that
there will be further decrease in the Euro price. Hence better strategy
here will be to sell the future at the higher price.
Exhibit 7.28 EUR/INR candlestick-The Doji 2
Chapter 7 Technical Analysis
93
There has been continuous downward trend in the Euro price. On
February 9
th
, there was record increase in the Euro price, but such
positive trend couldn‘t resist the decrease in Euro prices. On February 8,
there is long wick in the chart. It shows the high price fluctuation during
the day, but at end of the day it closed near to the previous one only.
There was little high close but long wick indicates that the trend will
continue in spite of little higher close on particular day.
Exhibit 7.29 EUR/INR candlestick-Long Wicks
Chapter 7 Technical Analysis
94
The above chart shows that there was occurrence of the Doji which
resulted into the indication of reversal trend. Further there was complete
formation of the cup which started from September 1
st
and completed on
September 17
th
hence it was reverse cup formation. It is indication of the
bearish trend and hence there was sharp decrease in the Pound price. As
there are no signals of market to move upward, the better strategy here
is to wait for the market to show any signals and then enter into it.
Exhibit 7.30 GBP/INR candlestick-The Doji
Chapter 7 Technical Analysis
95
The above chart shows that as there was complete formation of the cup
during the first month of the year, there was sharp increase in the Pound
price. Further at the end of the quarter also there was formation of the
chart and hence if the Pound price moves down and breaks the resistance
level of RS. 69.5, then there are high chances of downward movement of
the Pound price therefore the right strategy at that time will be to short
the future.
Exhibit 7.31 GBP/INR candlestick-Cup formation
Chapter 7 Technical Analysis
96
The above chart shows that there were two incidents where there was
occurrence of the Doji were there. At the end of the quarter there was
occurrence of the Doji hence it is indicating that there will be upward
movement in the Dollar price. Hence the right strategy here would be to
long the future of the Dollar.
We have used above indicators to take decision about short term future
trends. Now by using Fibonacci we can set the target prices in future for
given currency. In the following section we have tried to give target prices
for next period using Fibonacci Retracement.
Exhibit 7.32 EUR/INR candlestick-The Doji
Chapter 7 Technical Analysis
97
7.9 Use of Fibonacci Retracement
The above chart shows that the next target price for the Dollar will be at
the resistance level RS. 48.1469, if such resistance level is broken
effectively then it can reach to further to the next target price at
RS.48.6305 and the last target will be RS.49.1142. the stop loss limit
price here would be the support level that is the level of RS.46.5813 and
if such level is broken then there can be high downward movement in the
Dollar price. When the dollar prices cross the first target of Rs. 49.1142
we should not wait and we should sell dollars if we are having, because it
shows that, now prices will fall further.
Exhibit 7.33 USD/INR candlestick-Fibonacci Retracement April-June
Chapter 7 Technical Analysis
98
The target price for the Dollar price at the end of the March can be said
that it will be RS.45.8378, and the second target can be at the resistance
level RS.46.3402, and further the third target would be at 46.7463 and
above. The stop loss limit price can be established at the current support
level RS.45.0257.
Exhibit 7.34 USD/INR candlestick-Fibonacci Retracement: January-March
Chapter 7 Technical Analysis
99
The above chart shows that as Euro is already at the high level the first
target for the Euro is at RS.67.5334, and the second target will be the
resistance level at RS.68.5691, further there would be stop loss level at
Rs.65. 5691. We can see that when EUR prices crossed the first two
target prices, it went above it up to Rs. 68.5691 level. Thus it is proved
that we can use this as the best indicator of price in future.
Exhibit 7.35 EUR/INR candlestick-Fibonacci Retracement: April-June
Chapter 7 Technical Analysis
100
The above chart makes it clear that there are high chances for the Euro to
come down from the level established at the end of the period, the reason
being there has been complete formation of the cup and further Euro has
broken two resistance levels sharply. The first target for the Euro is at
Rs.70.2511 and second target will be at Rs.71.2511, but as there are high
chances for decline in Euro the better option is to short the future.
Exhibit 7.36 EUR/INR candlestick-Fibonacci Retracement: July-September
Chapter 7 Technical Analysis
101
From the above chart it can be predicted that the first target price for the
Pound will be at Rs. 78.6968, and second target will be at 80.4086 and
above, further the stop loss limit price will be at Rs.77.3529. At the end of
this quarter there are equal opportunities for up as well as downward
movement.
Exhibit 7.37 GBP/INR candlestick-Fibonacci Retracement: April-June
Chapter 7 Technical Analysis
102
The above chart shows that there has been correction in the market and
hence there are high chances of further upward movement of the Pound
price. If we consider the target price then it can be said that the first
target will be at 77.9379, the second target will be 76.8693 and the third
target will be at 79.2600 and above. Further the stop loss limit will be
72.3416 as at this level there will be completion of the cup formation at
the downward trend, there will be further decrease in the Pound if such
level is achieved.
Exhibit 7.38 GBP/INR candlestick-Fibonacci Retracement: July-September
Chapter 7 Technical Analysis
103
The above chart gives the first target at 70.5715, the second target at
71.5567 and finally the third target at 72.5479 and above. Further the
sop loss limit would be at 67.3820. but if the pound reaches to 67.3820
then there will be high chances of downward trend in the Pound. Now in
next days if the price the GBP against INR crosses 70.5715 then we
should hold the GBP and wait till it cross next level and then we should
start selling it. Let‘s see what happens in the next days of the month.
Exhibit 7.39 GBP/INR candlestick-Fibonacci Retracement: January-March
Chapter 7 Technical Analysis
104
Summery
In above short term analysis we found that the Bollinger Bands is the
strong indicator of the coming volatility in the market. Each time when two
bands comes near to each other we have found that the prices moved in the
either direction sharply. To know in which direction price will move we can
use other indicator like MACD.
MACD can be used to know to direction of the price movement. Whenever
MACD line crossed the EMA line we have seen the reversal trend in the
market prices for each currency.
RSI gives signals about the over bough and over sold of particular currency.
Whenever RSI line went over 80 percentile level or bellow 20 percentile level
we have seen reversal trend. RSI gives earlier signal then other indicator
about the coming trend in the market
We can use Stochastic indicator for the taking buying or selling decision at
particular level of price. It can be used similar to RSI. But it gives more clear.
result in short term.
After formation of The Doji the prices move in reverse direction every time,
so when we see the doji in the candle stick chart we should consider as signal
of reverse trend in the future.
From above analysis we can say that we can use Fibonacci Retracement to
wet the target prices at the various levels. When price crosses two level in
either direction then it goes further in the same direction. It strong indicator
of the future price.
We also concluded that the cup formation can help to find out the further
Upward or down word trend in the market. We can use only candle stick chart
for forecast of the future prices in the market.
105
Chapter 8 Fundamental Analysis
Fundamental analysis
The fundamental analysis is based on the various macro economic factors
of the two countries of the pair of currency as we have mentioned in
Chapter 6. Here we have used the same fundamental indicators like
economic events and the Interest rate parity relations of the two
countries to forecast the future rates.
For economic events, let‘s first discuss about the widely used tool- The
Economic calendar. The economic calendar is the list of events happening
in the countries, on the bases of these events we can judge where the
prices should go in future because of particular event.
8.1 Economic Calendar
Impact factor — suggests how much influence current economic data is
expected to bring along.
It is important to know the time of High impact data release if you trade
affected currency pair.
During actual news release market becomes volatile. The strength of the
volatility depends on the "factor of surprise" brought in the news. "Factor
of surprise" can be defined as a level of unexpectedness, where traders
compare Forecast data to actually released data.
Medium impact economic data should also be kept in mind in case the
factor of surprise turns to be high. Low impact data most of the time do
not shift Forex market significantly.
Column Previous in Forex Calendar — provides data from last release.
Column Forecast indicates numbers that economists are predicting and
expecting for the upcoming release today.
Chapter 8 Fundamental Analysis
106
Column Actual is updated only after the data is out. At the very second
when data becomes available it is instantly compared against Forecast
values, and depending on overall positiveness or negativeness of the
news for the currency plus taking into consideration the factor of surprise,
price dips or rises in a matter of seconds.
Economic News impact — increased market volatility — usually lasts for
1-3 minutes (highest volatility); next 5-10 minutes market experiences
corrective/adaptive volatility, where price settles in summarizing new
market shift.
8.2 Interest rate Parity
It is a theory that the interest rate differential between two countries is
equal to the differential between the forward exchange rate and the spot
exchange rate. Interest rate parity plays an essential role in foreign
exchange markets, connecting interest rates, spot exchange rates and
foreign exchange rates.
The relationship can be seen when you follow the two methods an
investor may take to convert foreign currency into U.S. dollars. Option A
would be to invest the foreign currency locally at the foreign risk-free rate
for a specific time period. The investor would then simultaneously enter
into a forward rate agreement to convert the proceeds from the
investment into U.S. dollars, using a forward exchange rate, at the end of
the investing period. Option B would be to convert the foreign currency to
U.S. dollars at the spot exchange rate, then invest the dollars for the
same amount of time as in option A, at the local (U.S.) risk-free rate.
When no arbitrage opportunities exist, the cash flows from both options
are equal.
To find forward rate we can use this formula:
Fundamental analysis on the bases of the Economic Calendar; Here we
have consider few events and its effect on the foreign exchange rate.
Chapter 8 Fundamental Analysis
107
8.3 Event and impact on exchange rate
8.3.1 Manufacturing PMI in Europe
Here the Manufacturing PMI turn out less than the forecasted one, thus
there should be negative impact on the EUR prices. But it is not necessary
that each event has the expected impact on the prices.
8.4.2 Interest Rate Decision of European Central Bank
The interest rates has great impact on the exchange rate. When the
government hikes the interest rate, the money supply in the market
decreases and the price of perticular currency increases.
Chapter 8 Fundamental Analysis
108
8.3.3 Unemployment in USA
On December 4 2009, unemployment rate turned lower than expected,
this is a good sign for USA economy. It means, it is the sign that USD will
be stronger in world markets. Prices of USD may rise in coming days. And
as our expectation USDINR went up from Rs. 46.0448/USD on December
3 to 46.52/USD on December 7, 2009.
8.3.4 USA Budget Balance
USA government‘s budget balance came positive then the expected on
December 10 2009. Thus we may consider it as positive sign for the USD.
After that day, USD shown the upward movement against INR.
Chapter 8 Fundamental Analysis
109
8.3.5 M4 Money supply in UK
In UK M4 money supply remain as per the expectation of the people and
government of UK. Thus there will be neutral effect on the prices of GBP
in market. We have to see towards other indicators to forecast the price.
8.4 Interest Rates and Foreign Exchange Forecast
We can use the prevailing interest tares in the both countries to forecast
the exchange rates. If the interest rates parities do not hold between two
countries then there will be an arbitrage opportunity for the investors.
Suppose the prevailing future price in the market for the particular date is
higher than the price that we get by calculating the interest rate parity
relations, it means the actual spot price on that day will be lower than the
today‘s Future price. In this situation we can sell future contract today
and on expiry date we could settle our position at the lower price.
Here we have calculated the expected theoretical future price, on the
bases of that we can forecast the future rate.
To calculate future prices we have used MIBOR Mumbai Inter Bank Offer
Rate for Rupee and LIBOR for USD, GBP and EUR.
Following table shows the expected future price on the March 28, 2010 on
day of settlement of contract on NSE and MCX-SX.
Chapter 8 Fundamental Analysis
110
We have calculated the expected prices by using this formula:
Here we can see that on March 19, 2010; the expected future price is Rs.
45.5225/USD in the market for March 28. But according to our calculation
it should be Rs. 45.5136/USD on March 28. Thus we can sell future
contract at higher price available in the market, and if our expectation
would turns right, we might be able to settle our position at lower price.
The same situation exists in EURINR market. The EUR has been selling at
lower future price that it should be. Thus we can use the same strategy as
mentioned for USD.
On March 19, in INRGBP market the situation is different. GBP has been
selling at higher in future market than our expected price in the Futures.
Thus we should short the Future contract. By doing the same we will be
selling GBP at higher and we could settle the position at the lower price.
USD
Date
Future
Price
Spot
Price MIBOR LIBOR
Theoretical Expected
Future Price
19-Mar-10 45.5225 45.4800 3.5741 0.8756 45.5136
2-Mar-10 46.0500 46.0200 3.3455 0.8394 46.1160
1-Jan-10 46.8800 46.6500 3.3292 0.9938 46.9217
EUR
Date
Future
Price
Spot
Price MIBOR LIBOR
Theoretical Expected
Future Price
19-Mar-10 62.1800 61.8900 3.5741 1.19500 61.9303
2-Mar-10 62.4200 62.3100 3.3455 1.19750 61.8662
GBP
Date
Future
Price
Spot
Price MIBOR LIBOR
Theoretical Expected
Future Price
19-Mar-10 69.3600 69.0925 3.5741 1.3156 69.1352
2-Mar-10 68.7400 68.7217 3.3455 1.2975 68.8388
Exhibit 8.1 Calculation of Future Rates
111
Conclusion
Technical Analysis can prove to be a very powerful tool for knowing the
direction or near term behavior of any underlying instrument. If a person
has the proper knowledge of the nature of moving averages, price chart
patterns and other technical indicators then he/she can effectively use
technical analysis to benefit from it.
Technical analysis though has proved to be effective in most of the cases;
it still can lead to many whipsaws if any person jumps the gun without
confirming a current move he/she is analyzing.
we find it very effective to predict the price with the help of ,candlestick
reversal pattern, RSI, MACD ,stochastic ,support resistance & crossover
with EMA20, pivot level Fibonacci retrenchment levels our accuracy for
predicting the price is about 70-75% in all cases I had not included the
charts which are failed as per the prediction but in general view we Would
say it‘s a very useful tool for investing in stock market Limitation which I
find is that finding varies from person to person , it is because of
dependence on visual identification of pattern so we need good practice of
it and sometimes bias view can come for making some pattern which our
mind want to see or mind want to create.
Bollinger band
Bollinger band in the technical analysis can be used as the support and
resistance for the scrip or the currency, the upper side of the Bollinger
band serves the resistance level above which there is indication of
overbought and which makes it clear that there are high chances that
there will be fall in the underlying asset.
In majority of the part of the analysis it can be seen that whenever and
wherever there has been contraction in the Bollinger band there has been
wide fluctuations in the price. Further the down limit of the Bollinger band
Conclusion
112
serves as the resistance below which there will be high probability for the
asset to increase in price.
Moving Average Convergence/Divergence (MACD)
MACD in all the above charts of the report has served as an important
tool whenever it has intersected to EMA and moved upward upward after
that then there is positive movement in the currency. Similarly when it
turns downward after intersecting to the EMA then there has been
occurrence of downward trend.
Relative Strength Index
RSI is also the most important technical indicator for determining the
movement of the currency prices. It has given the result quickly then the
MACD all the times.
Stochastic
Stochastic in the all the charts have given the prediction for very next
trading session; hence it is used generally for the short term compare to
long term.
Patterns
In technical patterns, it can be seen that the most accurate pattern was
cup formation. It gave the accurate result al the times.
Further the Doji is also useful for interpretation of the future trend of the
currency.
Hammer and hangman are hard to see in the currency market.
The morning and Evening star are also important measures. But they are
also difficult to see in the currency market as it is 24X7 markets.
Conclusion
113
Fibonacci Retracement
Fibonacci is useful for determining the target prices and stop loss prices of
the currency. It proves accurate enough to determine these prices. The
investor can take decision when to enter in the contract and when to exit
from the standing position.
Correlation among three currencies
If we consider the correlation among the three dominant currencies then
it can be observed from the charts and patterns that there is positive
correlation between the Euro and Pound price. Whereas there is no
significant correlation between Dollar and pound or Dollar and Euro price.
Fundamental analysis
Fundamental Analysis includes the various economic indicators and the
events happening in the countries. Fundamental factors have been a
great impact on the prices of the particular currency. The trader should
consider these factors as a determinant of the trends of prices.
In India we have managed float system, because of government‘s
interference, many times, in spite of having strong signals for change in
prices of currency from economic indicators; we may not see that
changes.
Still Traders can use all these indicators to take decision about hedging
and arbitrage opportunity.
114
Recommendation
? Before a person starts using technical analysis he/she should be
aware of the entire gamut of technical indicators and its drawbacks.
? The person should know which indicator suits which pattern and
gives what kind of signals.
? The best use is to club Technical Analysis with Fundamental
Analysis. Both together help in gauging a better picture of price
chart movements. · Multiple indicators should be used for analysis
to avoid whipsaws. · Each person should make his/her moves as per
his/her risk appetite and based on his/her own discretion.
? The best strategy is to trade with the primary trend and not against
it.
115
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