FOREIGN EXCHANGE OPERATIONS APPLYING TECHNICAL ANALYSIS FOR MAXIMIZING EFFECTIVENESS by Sanjay Gupta

Project Title:

FOREIGN EXCHANGE OPERATIONS APPLYING TECHNICAL ANALYSIS FOR MAXIMIZING EFFECTIVENESS

Project Guide: MR.SREEKANTH I.V MANAGER FEDERAL BANK

Submitted by: ATHIRA U PISHARODY Post Graduate Diploma in Management (PGDM) SIES College of Management Studies Batch: 2008-10

Date of Submission: 9th July, 2009

ACKNOWLEDGEMENT I would like to articulate my appreciation and sincere gratitude to all those who have guided me in the development and successful completion of this project. First and foremost I would like to thank SIES COLLEGE OF MANAGEMENT STUDIES for providing this opportunity to get an exposure to gain a true corporate experience. I would like to thank Dr.A.K.Sengupta, Prof. C.R.RadhaKrishnan and Prof. A. R. Parasuraman for guiding me with this project. I would like to thank Mr. Jimmy P.K- General Manager (Treasury), Mr. Roy PaulDeputy General Manager (Treasury), and Mr. R. Rajan- Assistant General Manager (Treasury) for giving me this opportunity to do my summer internship in Federal Bank (Mumbai). My sincere gratitude to Mr. Sreekanth I.V, Manager-Equity (Treasury) Federal Bank, my company guide for having taken time from his busy schedule and for his invaluable suggestions. I am also very thankful to Mr. Bejoy Padamadan, Mr. Harikesh, and Miss. Swarna Latha for guiding me through this endeavor. I thank all the officials in Federal Bank who have been instrumental in the successful completion of the project work. Above all, I thank the ALMIGHTY for guiding me in the right direction.

Athira U Pisharody

Table of contents S.No 1

2 3

6 7 8 9 10 11

12 13 14

Particulars Executive Summary……………………………………............. 1.1 Objectives………………………………………….. 1.2 Type of research…………………………………… Organizational Study-Federal Bank………………………….. Treasury Management………………………………………... 3.1 Definition………………………………….............. 3.2 Importance of treasury……………………............. 3.3 Structure of integrated Treasury………………….. 3.4 Integrated treasury: cost centre and profit centre.... 3.5 Functions of integrated Treasury………………….. 3.6 Objectives of treasury…………………………….. 3.7 Integration…………………………………………. 3.8 Benefits of Integration…………………………….. 3.9 Arbitrage benefit to treasury………………………. 3.10Initiatives of integrated Treasury……………….... Organization Structure…………………………………………. 4.1 Organizational chart of treasury department……….. 4.2 Front office, Mid-Office, Back Office……………… Introduction to various markets………………………………… 5.1 Fixed Income Securities……………………………… 5.2 Money Market………………………………………… 5.3 Forex Market………………………………………….. Risk and control of Trading Operations………………………….. Introduction to Forex- Concepts and Terminologies……………. Developments in the Market……………………………………... History of Technical Analysis…………………………………… Basics of technical Analysis……………………………………... Technical Indicators……………………………………………. 11.1 Advantages/Disadvantages……………………… 11.2 The Different Types of Technical Indicators….. 11.3 RSI……………………………………………… 11.4 Fast Stochastic Oscillator……………………….. 11.5 Moving Averages………………………………… 11.6 MACD……………………………………………. 11.7 The Larry Williams % R………………………….. 11.8 Commodity Channel Index……………………….. 11.9 Average Directional Index………………………... 11.10 Volume Oscillator………………………………… 11.11 Bollinger Band…………………………………….

Page No 4 5 5 6 9 9 9 11 11 12 14 14 15 15 16 17 19 20 27 27 28 30 40 44 55 59 64 68 69 70 71 76 83 88 91 92 95 98 100

Study of currency charts, data analysis and observations………. 104 Treasury Terminologies………………………………………...... 121 Bibliography……………………………………………………… 125 3

1. Executive Summary This is a report of project work done at the treasury department of federal bank. The project has 3 parts-Functions of treasury department, integrated treasury management and technical indicators in detail. As the name suggests, treasury is basically concerned with managing the funds of banks as far as optimizing profits on deployment of surplus funds and finding cheapest sources of resources for funding deficits is concerned; while complying with the norms of RBI. Thus, the treasury branch is a profit centre. The Treasury department in Federal Bank has business presence in the following markets: 

Forex Market



Money market



Equity Markets



Fixed Income Securities Market

Treasury Department has the basic objective of maintaining the statutory reserves like CRR and SLR. The Department has the added responsibility of managing the funds in such a way that the profitability is maximized and the associated risk is optimized through prudent investments and trading. Since the magnitude of operations and the amount of funds involved in the operations of the Department are huge, utmost prudence is required of the personnel of the Department. The various desks are expected to adhere strictly to all the rules and regulations of the different markets they are associated with. The treasury has segregated its functions into dealing section (front office) and settlement (Back office) for the purpose of exercising internal control. Mid office has been established and some of the functions along with additional responsibilities of conduction research and analysis together with risk management system (RMS) are entrusted to this office.

1.1 Objectives of the study: The main objective of the project is:To study the technical indicators of various types like trend, momentum, volatility and volume and to convey its effective uses in the day to day trading of foreign exchange operations and observing the past data of currency movements and suggesting an effective method to trade.

1.2 Research Methodology Type of Research: This study is mainly exploratory in nature and makes use of primary data (Reuters-Information Platform) and secondary data. The main aim of this project is to study the various types of technical indicators and observe the past data relating to currencies EUR, GBP and JPY for five years starting from 2004 to 2009 to determine the usefulness and effectiveness of the indicators under study. The indicators are selected based on dealer feedback and requirements at the dealing desk. The research effort is towards finding out how to employ these indicators profitably in the forex activity.

2. Federal Bank Federal Bank is one of the leading private sector banks in India. Federal Bank has a banking history of around 70 years and its head office located at Alwaye near Kochi, Kerala. Federal bank has a wide network of more than 600 offices covering almost all major cities in the country with a major share in the state of Kerala. At present Federal Bank has network of over 200 plus ATMs all over India and is being expanded. Federal Bank has the largest number of ATMs in Kerala covering almost every town. The Federal Bank's ATM card also includes International Visa Debit Card enabling the bank's customers to use the card at any of the over 8, 40,000 networked ATMs round the world and pay for shopping at over 12 million retail establishments. Federal Bank has played a pioneer role in developing and deploying new technology assisted customer friendly products and services. A few of its early moves are cited below: 

First, among the traditional banks in the country to introduce Internet Banking Service through Fed Net.



First among the traditional banks to have all its branches automated.



First and only Bank among the traditional Banks in India to have all its branches inter-connected



First Electronic Telephone Bill Payment in the country was done through Federal Bank.



First and only bank among the older Banks to have an e-shopping payment gateway.



First traditional Bank to introduce Mobile Alerts and Mobile Banking service.



First Bank to implement an Express Remittance Facility from Abroad



First in India to provide RTGS facility in all its branches.

The Bank has also the distinction of being one of the first banks in the country to deploy most of these technology enabled services at the smaller branches including rural and semi-urban areas. The Bank has the full range of delivery channels including, Internet Banking, Mobile Banking and Alerts, Any Where (Branch) Banking, Interconnected Visa enabled ATM network, E-mail Alerts, Telephone Banking and a Centralized customer Call Centre with toll free number. Customers thus have the ability to avail 24 hour banking service from the channel of his choice, according to his convenience. Federal Bank already has the largest number of ATMs in Kerala, taking round-the-clock banking convenience to even many rural areas. The Bank's ATM card also doubles as a International Visa Debit Card enabling the Bank's customers to use the card at any of the over 8,40,000 networked ATMs round the world and pay for shopping at over 12 million retail establishments across the state. The Bank has launched its anywhere banking service, enabling customers to bank at any branch of his / her choice regardless of the place where the account is maintained. The Bank has now emerged into a financial supermarket giving the customers a range of products and services. Apart from the entire slew of Banking products and delivery channels we also provide the following facilities: 

Depository Services



Credit Cards



Life Insurance Products in association with ICICI Prudential



General Insurance Products in association with United India Insurance



Export Credit Insurance Products in association with ECGC



Express Remittance Facility from Abroad - FEDFAST 7



Cash -On- Line Express Cash Remittance



Lock Box Service for NRI's in the US



Cash Management Services



Merchant Banking Services



E-shopping Payment gateway



BSNL Bill Payment



Online LIC Insurance Payment



Easy Pay- On-line fee payment system



Online Railway Reservation System



Online Kiosks for customers

Goals for FY 2009 according to the business plan 2009 are as follows -: 

To achieve growth of 40% in Deposits & 36% in advances by 2009



To increase market share in deposits by 12 basis points



To increase market share in advances by 11 basis points



To increase CASA by at least 50% from the base



To maintain NIM over 3%



To increase non-interest income at least by 50%

3. Treasury Management 3.1 Definition The Treasury Management refers to the proper management of the banks funds optimally and profitably at an accepted risk level. Even though it sounds simple it includes a lot of functions. Treasury management involves an effective internal and external interface. It regulates the proper inflow and outflow of funds without shortage and surplus and by adding to the profitability of the organization. It is considered to be one of the most important functions of a bank. It is the investment tool of a bank and includes investments in the form of SLR and non-SLR investments. 3.2 Importance of Treasury The main source of income for banks till some years ago was Net Interest Margin (NIM), i.e. the difference between the interest on deposits paid and the interest on credit given by the banks. As the interest rates over the years have gone southwards due to various economic factors and increased competition, the NIM has narrowed, thus resulting in either wafer thin profits or enabling the banks to just break even. The Cost of Deposits (COD) is high whereas the corresponding income from interest on advances is not sufficient to cover the high cost. The banks have to adhere to various regulations put forward by the Reserve Bank of India (RBI). This includes maintenance of Cash Reserve Ratio and investments in Statutory Liquidity Ratio (SLR). Out of the total deposits received by the banks 5% has to be kept with the RBI as CRR. The daily shortage/excess of funds in relation to the requirement of CRR is managed out of money market operations. Since RBI does not pay interest for any excess amount maintained over and above the required level, the excess cash maintained with RBI shall be restricted to the minimum possible level, even though the excess over required CRR is reckoned for SLR. 9

Then the banks have to make investments to the tune of 24% of the total deposits in Statutory Liquidity Ratio (SLR), i.e. investment in government securities and bonds in the g-sec market. These financial instruments ensure a fixed income or return to the investor irrespective of any change in the market rate of interest. The interest /income on the securities are fixed at the time of issue. The maximum yield from these investments currently is around 7.59%, whereas the COD on this 25% deposits is only marginally less than that. Thus, though the bank has a positive spread the actual profits are wafer thin. The maintenance of CRR and SLR is mandatory as per the RBI guidelines and the banks can be penalized if the minimum requirement is not maintained. If banks maintain excess CRR it will lead to non utilization of the funds which could have been utilized in a more profitable manner. Thus maintaining the CRR and SLR are very important functions of the treasury. Out of the remaining deposits, i.e. the deposits left after providing for CRR and SLR, around 30-40% has to be given as credit to corporate. Lending to corporate houses that are ranked into various categories is essential, as this enables the bank to make its presence felt in the market. The lending rate to corporate is competitive in nature and is usually just a little northwards of the deposit rates. This means that inspite of a positive spread the profit is very less. Thus the remaining deposits (i.e. after providing for CRR, SLR and lending to corporate), have to be profitably invested by the banks in such a way that it will enable the banks to cover their COD and other costs as well as enable the company to earn profits. Certain avenues from which the banks earn profits are: Fee based income, i.e. income earned by charging commission on services such as demand draft transfer, pay order and by charging fees for services such as consultancy.

3.3 STRUCTURE OF INTEGRATED TREASURY The treasury is manned by the front office, mid office, back office and audit group. The dealers and traders constitute the front office. In the course of their buying and selling transactions, they are the first point of interface with other participants in the market (dealers of other banks, brokers and customers). They report to their department heads .They also interact among themselves to exploit arbitrage opportunities. A mid-office setup ,independent of the treasury unit ,acts as the unit responsible for risk monitoring, measurement and analysis and reports directly to the top management for control .This unit provides risk assessment to Asset Liability Committee (ALCO)and is responsible for daily tracking of risk exposures, individually as well as collectively. The back office undertakes accounting, settlement and reconciliation operation. The audit group independently inspects/audits daily operations in the treasury department to ensure adherence to internal/regulatory systems and procedures. 3.4 Integrated Treasury: Cost center and Profit center Integrated treasury is a holistic approach to funding the balance sheet and deployment of fund across the domestic as well as global money and forex markets. This approach enables the bank to optimize its asset -liability management and also capitalize on arbitrage opportunities. Traditionally, the forex dealing room of a bank managed the foreign exchange dealings mainly arising out of merchant transactions (forex buying from and selling to customers) and consequent cover operations in the interbank market. The domestic treasury / investment operations were independent of forex dealings of a bank. The treasury operations were treated as a cost center specifically devoted to reserve management (CRR and SLR) and consequent fund management. The treasury also undertook investment in government and non government securities. The need for integration of forex dealings and domestic treasury 11

operations has arisen on account of interest rate deregulations, liberalization of exchange control, development of forex market, introduction of derivative products and technological advancement in settlement systems and dealing environment. The integrated treasury performs not only the traditional roles of forex dealing room and treasury unit but also many other functions.

3.5 FUNCTIONS OF INTEGRATED TREASURY:

Reserve management and investment: It involves :-



Meeting CRR/SLR obligations



Having an approximate mix of investment portfolio to optimize yield and

duration. Duration analysis is used as a tool to monitor the price sensitivity of an investment instrument to interest changes. 

Liquidity and Funds Management which comprise of :



Analysis of major cash flows arising out of asset –liability transactions



Providing a balanced and well diversified liability base to fund the various

assets in the balance sheet of the bank 

Providing policy inputs to the strategic planning group of the bank on

funding mix (currency, tenor and cost) and yield expected in credit and investment. 

Transfer pricing: The treasury has to ensure that the funds of the bank are

deployed optimally, without sacrificing yield or liquidity. An integrated treasury unit has an idea of the bank’s funding needs as well as direct access to various markets .Hence ideally the treasury should provide benchmark rates after assuming market risk to various business groups and product categories about the correct business strategy to adopt.



Asset liability management: ALM calls for determining the optimal size

and growth rate of the balance sheet and also prices the assets and liabilities according to prescribed guidelines. 

Risk Management: Integrated treasury manages all market risks associated

with a bank’s liabilities and assets. The market risk of liabilities pertains to floating rate interest risks and asset and liability mismatches. Market risk for assets can arise from : 

Unfavorable change in interest rates



Increasing levels of disintermediation



Securitization of assets



Emergence of credit derivatives etc

While the credit risk assessment continues to be in the domain of Credit Department, the treasury would monitor the cash inflow impact from changes in asset prices due to interest rate changes by adhering to prudential exposure limits. 

Derivative products: The treasury can develop Interest Rate Swap (IRS) and

other rupee based /cross currency derivative products for hedging bank’s own exposures and also sell such products to customers/other banks. 

Capital adequacy: This function focuses on quality of assets, with Return

on Assets (ROA) being a key criterion for measuring the efficiency of deployed fund. 

Arbitrage: Treasury units of banks undertake arbitrage by simultaneous

buying and selling of the same type of assets in two different markets in order to make profit less risky. An integrated treasury is a major profit center .It has its own P and L measurement. It undertakes exposures through proprietary trading (deals done to make profits out of movements in market interest /exchange rates) that may not be required for general banking. 13

3.6 OBJECTIVES OF TREASURY

1) To take advantage of the attractive trading and arbitrage opportunities in the bond and forex market 2) To effectively manage the forex assets and liabilities of the bank 3) To manage and contain the treasury risks of the bank within the approved and prudential norms of the bank and regulatory authorities. 4) To maintain statutory reserves â&#x20AC;&#x201C;CRR and SLR as prescribed by RBI on current and forward planning basis 5) To offer comprehensive value added treasury and related services to the banks customers. 6) To assess advice and manage the financial risks associated with non treasury assets and liabilities. 7) To adopt best practices in dealing, clearing, settlement and risk management in treasury operations. 8) To act as a profit center for the bank

3.7 INTEGRATION: There is a geographical and infrastructural integration in the integrated treasury. The forex dealing rooms are merged and located in the same premises along with the domestic treasury unit. Under horizontal integration the dealing/trading rooms engaged in the same trading activity are bought under the same policies, hierarchy, technological and accounting platform. In vertical integration all existing and diverse trading and arbitrage activities are bought under one control with common pool of funding and contributions. The impact of transactions of all units on rupee funds is merged. There is computerized linking of transactions.

3.8 BENEFITS OF INTEGRATION The basic objective of integration is to improve portfolio profitability, riskinsulation and synergize banking assets with trading assets. Banking assets are held basically for client relationship / steady income/ statutory obligations and are generally held till maturity ,whereas trading assets are held primarily for generating profits on short term differences in prices /yields .The purpose is achieved through efficient utilization of funds, cost effective sourcing of liability ,proper transfer pricing, availing arbitrage opportunities ,online and offline exchange of information between the money and forex dealers, single window service to customers, effective MIS, improved internal control, minimization of risks and better regulatory compliance. An integrated treasury acts as a center of arbitrage and hedging activities. It seeks to maximize its currency portfolio and free transfer of funds from one currency to another in order to remain a proactive profit center. With phased liberalization on capital account convertibility, there will be scope for banks with integrated treasury to structure multi-currency balance sheets and take advantage of strategic positioning.

3.9 ARBITRAGE BENEFIT TO TREASURY The price differentials between different markets of the same asset category give rise to arbitrage opportunities. For example ,arbitrage benefit can be availed by borrowing in US dollar ,converting the same rupee ,taking forward cover to hedge exchange risk and investing in rupee .However efficient functioning of financial

markets

generates asset prices and exchange rates that preclude

arbitrage.

3.10 INITIATIVES OF INTEGRATED TREASURY Many banks in India have taken the initiative to set up their integrated treasury operations supported by infrastructural facilities like Reuters/Telerate/Bloomberg System, hotlines, Dealing Boards, Internet, etc, dedicated software for integrated treasury. Payment systems like Negotiated Dealing System(NDS),Clearing Corporation of India Limited(CCIL)and new initiatives like Real Time Gross Settlement System (RTGS) are already in place.

4. ORGANISATION STRUCTURE Organizational structure of a commercial bank treasury should facilitate handling of

all market operations

the

from dealing to settlement, custody and

accounting in both the domestic and foreign exchange markets .In view of the voluminous and complex nature of transactions handled by a treasury ,various functions are segregated as under-:  Front - Office : Dealing -Risk Taking  Mid-Office

: Risk Management and Management information

 Back-Office : Confirmations, Settlements, Accounting and Reconciliation The organization of treasury depends on the volume of activities handled. It is important that the above three functions are distinct and work in water tight compartments. The dealers are not supposed to handle settlement or accounts. The back office shouldn’t perform dealing but may perform accounting function and accounting section shouldn’t perform dealing but may perform back-office function. The corporate treasury is headed by an appropriate senior executive who directs, controls and coordinates the activities of treasury .He/she also coordinates the work between the chief dealer, the Head of Back office, Head of Research and is totally

responsible for management of funds ,investments and forex activity.

He/she will also be a member of Assets Liability Management Committee (ALCO) and help the committee in deciding on various policies on treasury management. Banks which have separate forex operations will have dealers for forex operations. Treasury will have a separate research division. Head of Research will be assisted by officers to carry out research activities /analysis in various types of securities. Research department may be common for money market, debt, equities and forex. Market analysis would be provided by the research department. 17

Appropriate Information Technology (process, package and infrastructure) is necessary for treasury management as the operations/transactions are distinct from branch banking and are also very critical. As software packages available in the market may not be adequate, banks may have to modify the software to suit its needs, changing circumstances and volatility. The fund manager looks into the liquidity position, fund flows and maintenance of reserve requirements. Risk managers should be posted in treasury for facilitating the evaluation of scenarios ,independent

review of line/limit excess, reviews of transactions to ensure

compliance with regulations ,monitor

risk factors 窶田redit risk, liquidity risk,

interest rate risk, operational risk in the transactions and give guidance to the frontline ,viz. dealers to remain in touch with product and market developments.

4.1 ORGANIZATIONAL CHART OF TREASURY DEPARTMENT BOARD OF DIRECTORS

MD & CEO

EXECUTIVE DIRECTOR

GM (TREASURY)

DGM (TREASURY)

FRONT OFFICE

BACK OFFICE

SLR

NSLR RETAIL

MID OFFICE FICEDIREC

SETTLEMENT ACCOUNTS ADMINISTRATION N

MERCHANT BO (COCHIN) RISK MITIGATION * RESEARCH PRODUCT DESIGN

MIS MONEY MARKET DERIVATIVE FOREX

*The officer reports directly to IRMD

EQUITY BALANCE SHEET MANAGEMENT 19

4.2 Front Office, Mid-Office and Back-Office ď ś Front office: The dealing room comprises the front office. This is the place where deals are struck. The dealers have access to information on prices and volumes of trade in securities worldwide through platforms like Reuters and Bloomberg. The dealers constantly monitor this information and strike the best possible deals for the purpose of complying with statutory requirements and optimizing profits. There are four sections in the front office: 1.

The G-secs Desk

The Money Market and Derivative Desk

The Equity Desk

The Forex desk ď&#x192;&#x2DC;The G-secs Desk

G-secs are a means of raising funds for the government through issue of bonds and notes.RBI is the manager of debt for the government. It comes out with a sixmonth auction calendar twice a year. This calendar mentions the amount the government will be borrowing and the term for which it will be borrowing. There is a separate desk in the dealing room for dealings in G-securities. The deals in Gsecurities are done for two purposes: 1.

To comply with SLR requirements(SLR is to be maintained at an amount not

less than 24% of Net Demand and Time Liabilities) 2.

For trading purpose.

Maintenance of SLR Utmost case shall be taken while arriving at the required SLR and maintaining the same, as defaulting will attract penal measures from Reserve Bank of India. SLR 20

as a percentage to NDTL arrived in Form A is to be maintained on a daily basis. As per the existing RBl instructions, the requirement of SLR during a particular fortnight is to be based on the NDTL of second preceding fortnight. NDS-OM (Negotiated dealing system-order matching) On this platform, the deals are directed through CCIL. The actual buyer and seller are not known. CCIL acts as the counter party for each transaction. Hence there is no default/credit risk. The minimum deal amount is 5 crores and the deals can be in multiples of 5 only. The window looks as shown below: Security

Maturity

Bid Amount

Offer Yield

Price

Trade Yield

Amount

LTP

LTY

LTA

Only certain securities are active. Two way quotes are given for each. If dealer is interested, he may strike the deal by clicking on it and wait for the counterparty’s approval. The dealer may also place his offer of buy or sale along with the details. If the dealer buys or sells, the SGL account of federal bank with RBI is adjusted accordingly. Money Market and Derivative Desk Money Market takes care of CRR requirements. At present, the CRR requirement, as specified by RBI, is 5% of NDTL. CRR is monitored on a daily basis. The RBI has given flexibility to banks to maintain the stipulated CRR on a product (average) basis in a reporting fortnight, subject to the daily balance being at least 70% of the required CRR. RBI pays no interest on the cash balances in the form of CRR. Thus any reserve in excess of minimum requirements is an opportunity loss for the bank. Thus, the dealer should ensure that optimum funds are maintained in CRR through short term borrowings and lending’s in the money market. The daily 21

shortage/excess of funds in relation to the requirement of CRR is managed out of money market operations through various types of money market instruments as follow: 

Call Money, Notice Money



Term money



Bill Rediscounting Scheme



Commercial Paper



Certificate of Deposit



Interbank Participation Certificate



Money Market Mutual Funds



Liquidity adjustment facility (from RBI)



CBLO (from CCIL)



Market Repo Equity Desk

Dealing in Capital Market means purchase/sales of Equity Shares and Units of Equity linked Mutual funds. Capital Market Dealer is permitted to deal in shares approved by the Investment Committee only. Since the risk associated with capital market operation is much higher when compared to Fixed Income Securities, utmost care shall be observed while investing in Capital market. For fresh additions to the approved list, a detailed note shall be put up to the Investment Committee incorporating the present standing and future prospects of the company whose shares are proposed to be added to the approved list.

The broker confirmation of the deals transacted should be obtained and verified before the end of business day. The deal confirmations should be promptly verified and confirmed using STPGate, which is interface between fund houses, custodians and brokers. Any deviations from the actual transaction should be rectified. Also the settlement instructions to the custodian should be sent before the time deadline set by the custodian. Prior to initiating a sale transaction, the saleable stock holding report from the custodian shall be verified to avoid short selling. Forex Desk The foreign exchange dealing desk has the following responsibilities: 

Trade in the Rupee (USD INR) market to generate profit



Trade in the Cross Currency (currency pairs other than those involving

Rupee) for profit 

Cover the forex merchant operations in the branches



Do swap transactions for management of funds in each maturity bucket

Forex market is a highly volatile market and the dealers should be extremely vigilant while trading. The limits as approved by the Board should be strictly adhered to and any deviation should immediately be reported and got ratified. The forex dealer should deal within the guidelines of RBI and FEDAI. The forex dealer should report on a daily basis the following:



Profits/Losses on spot transactions in INR and crosses, swaps, arbitrage.



Reasons for exceeding any limits set by the management



Reasons for huge losses if any.

Merchant Rates and Cover Operations Exchange Rates quoted to the customers by the Authorised Dealers are known as merchant rates. Bank can prepare the merchant rates by loading sufficient exchange margin for small transactions .However for large value transactions, banks can quote competitive depending on the amount of transaction, commission and other incidental charges on the forex transaction and the value of the customer. Merchant rates are of 4 types-: 

T.T Buying Rate



Bill Buying Rate



T.T Selling Rate



Bill Selling Rate

The T.T and Bill Rates are applied for the following transactions: T.T. Rates: 

All outward remittances in foreign currencies.



All clean inward remittances for which funds have been received.



Conversion of proceeds of instruments sent for collection.



Cancellation of forward contracts

Bill Rates: 

Purchase and Discount of Bills.



Payment of imports Bills. 24

T.T Rates are applied to clean transactions, which do not involve handling of documents. Bill Rates are applied for transactions, which involve handling of documents. Hence, exchange margin on Bill Rates is higher than those for T.T Rates. The Merchant transactions can be grouped under 2 heads: 

Ready transactions, and



Forward transactions.

Ready Transactions are transactions where the Rupee and the foreign currency are exchanged between the Merchant and the Bank on the day of transaction itself. Forward Transactions are transactions, which are booked for settlement at a future date, at a rate which, is agreed upon on the day of transaction itself.

CALCULATION OF MERCHANT RATES READY TRANSACTIONS The first step in the calculation of Merchant rates is fixing of Base Buying and Base Selling Rates. Base Rate is derived from on-going Inter-Bank rate. The next step after fixing the base rate is to load the exchange margins on these base rates and arrive at merchant rates. For example, if the Bank takes the Base Buying Rate as 43.57 and loads an Exchange Margin of 3 paise, then the Merchant T.T. Buying Rate would be 43.54.  MID-OFFICE Mid-office is responsible for onsite risk measurement, monitoring and management reporting. The other functions of Mid –Office are-:  Limit setting and monitoring exposures in relation to limits

 Assessing

likely market movements based on internal assessments and

external/internal research  Evolving hedging strategies for assets and liabilities  Interacting with the bank’s Risk Management Department on liquidity and market risk.  Monitoring open currency positions  Calculating and reporting VAR  Stress testing and back testing of investment and trading portfolios  Risk- return analysis  Marking open positions to market to assess unrealized gain and losses.  BACK - OFFICE FUNCTIONS The key functions of back-office are:  Deal slip verification  Generation and dispatch of interbank confirmations  Monitoring receipt of confirmations from counterparty banks  Monitoring receipt of confirmations of forward contracts  Effecting/receiving payments  Settlement through CCIL or direct through nostro as applicable  Monitoring receipt of forex funds in interbank contracts  Statutory reports to RBI  Management of nostro funds to advise latest fund position to enable the F/O to take the decision for the surplus /short fall of funds  Reconciliation of nostro/other accounts  Monitoring approved exposure and position limits  Accounting

5. Introduction to various markets 5.1 FIXED INCOME SECURITIES:Fixed Income Securities are instruments wherein the total return to the investor is fixed for the tenor of the instrument. These are tradable securities which usually carry a fixed interest rate payable periodically, called the “Coupon” and the amount payable on maturity called the “Redemption Amount” is also fixed. Thus the total cash flows to be received by an investor in such a security are fixed at the time of the issue of the security. Hence the name Fixed Income Security. However it should be noted that during the life of the security the return may fluctuate in case the investor wishes to sell the security before its redemption or if the investor values the security at the market price at any point in time. Fixed income instruments also cover “zero-coupon” securities which carry a zero coupon. In such securities the redemption amount is greater than the original issue price and the return to the investor arises from this difference. There also exists a class of securities whose coupon is linked to a benchmark which is reset periodically during the tenor of the security. Such securities are known as “Floating Rate securities” returns from these securities are obviously variable during the tenor of the security. Types of Bonds Bonds can be classified based on various parameters. One can classify them as floating rate or fixed rate bonds depending on their coupon type. Here the classification is based on the type of issuer which is as follows: i)

Government Securities or SLR Securities

ii)

Non-SLR Securities

SLR Securities can be further classified as: i)

Government of India Securities

ii)

State Development Loans

iii)

Other approved securities

Non-SLR securities can be classified as i)

PSU Bonds

ii)

Corporate Debentures

5.2 MONEY MARKET The money market is defined as a market for instruments/transactions with an initial maturity period of up to one year. It involves the various arrangements that are related with issuance, trading and redemption of low risk, short term marketable obligations. The important feature of money market is that it is liquid and can be turned over quickly at low cost and it provides an avenue for equilibrating the short term surplus funds of lenders and the requirements of borrowers .But currently bank treasuries buy and sell securities with maturity of more than one year from the market . The need for the market is to provide efficient facilities for adjustment of liquidity positions of commercial banks, non bank financial institutions, business firms and other investors. Obligations are bought from dealers who offer to sell at lowest prices (highest yields) and are sold to dealers who bid to buy at the highest prices(lowest yields).The notable feature of money market is that trading in various obligations take place entirely in over the counter markets rather than recognized exchanges. Screen based trading is also available, but not to every participants. Reserve bank of India through the Liquidity Adjustment Facility (LAF) and Open Market Operations (OMOâ&#x20AC;&#x2122;s) in Treasury bills and government securities manages 28

the money supply and liquidity in the economy. The rates of interest are deregulated .The market rates of supply are exclusively determined by forces of demand and supply. The Participants in this market includes the central government which issues Tbills and Government of India securities (G-secs),state government which issues State Development Loans ,public sector undertakings issuing ,tax free as well as taxable bonds ,scheduled commercial banks ,private sector companies, general insurance companies ,mutual funds ,NBFC’s ,primary dealers ,PFs etc. Money market instruments traded in treasury include:The daily shortage/excess of funds in relation to the requirement of CRR is managed out of money market operations through various types of money market instruments as follow: 

Call Money, Notice Money



Term money



Bill Rediscounting Scheme



Commercial Paper



Certificate of Deposit



Interbank Participation Certificate



Money Market Mutual Funds

Liquidity adjustment facility (from RBI) safe deployment coupled with maximizing the return. Most of the money market operations are in the form of unsecured instruments. Therefore utmost care shall be taken while choosing the counter party with whom money market deals are concluded

The requirement of funds is to be ascertained accurately before starting the dayâ&#x20AC;&#x2122;s operations. Since RBI does not pay interest for any excess amount maintained over and above the required level, the excess cash maintained with RBI shall be restricted to the minimum possible level, even though the excess over required CRR is reckoned for SLR. 5.3 FOREX MARKET Overview The Foreign Exchange market, also referred to as the "Forex" or "FX" market is the largest financial market in the world, with a daily average turnover of US$1.9 trillion â&#x20AC;&#x201D; 30 times larger than the combined volume of all U.S. equity markets. "Foreign Exchange" is the simultaneous buying of one currency and selling of another. Currencies are traded in pairs, for example Euro/US Dollar (EUR/USD) or US Dollar/Japanese Yen (USD/JPY). There are two reasons to buy and sell currencies. About 5% of daily turnover is from companies and governments that buy or sell products and services in a foreign country or must convert profits made in foreign currencies into their domestic currency. The other 95% is trading for profit, or speculation. For speculators, the best trading opportunities are with the most commonly traded (and therefore most liquid) currencies, called "the Majors." Today, more than 85% of all daily transactions involve trading of the Majors, which include the US Dollar, Japanese Yen, Euro, British Pound, Swiss Franc, Canadian Dollar and Australian Dollar. A true 24-hour market, Forex trading begins each day in Sydney, and moves around the globe as the business day begins in each financial center, first to Tokyo, London, and New York. Unlike any other financial market, investors can respond

to currency fluctuations caused by economic, social and political events at the time they occur - day or night. The FX market is considered an Over the Counter (OTC) or 'interbank' market, due to the fact that transactions are conducted between two counterparts over the telephone or via an electronic network. Trading is not centralized on an exchange, as with the stock and futures markets.

Functions of Foreign Exchange Market The foreign exchange market is a market in which foreign exchange transactions take place. In other words, it is a market in which national currencies are bought and sold against one another. A foreign exchange market performs three important functions: ď&#x192;&#x17E;

Transfer of Purchasing Power: The primary function of a foreign exchange market is the transfer of

purchasing power from one country to another and from one currency to another. The international clearing function performed by foreign exchange markets plays a very important role in facilitating international trade and capital movements. ď&#x192;&#x17E;

Provision of Credit: The credit function performed by foreign exchange markets also plays a very

important role in the growth of foreign trade, for international trade depends to a great extent on credit facilities. Exporters may get pre-shipment and post-shipment credit. Credit facilities are available also for importers. The Euro-dollar market has emerged as a major international credit market.



Provision of Hedging Facilities: The other important function of the foreign exchange market is to provide

hedging facilities. Hedging refers to covering of export risks, and it provides a mechanism to exporters and importers to guard themselves against losses arising from fluctuations in exchange rates.

Main Participants in Foreign Exchange Markets There are four levels of participants in the foreign exchange market. At the first level, are tourists, importers, exporters, investors, and so on. These are the immediate users and suppliers of foreign currencies. At the second level, are the commercial banks, which act as clearing houses between users and earners of foreign exchange. At the third level, are foreign exchange brokers through whom the nation’s commercial banks even out their foreign exchange inflows and outflows among themselves. Finally at the fourth and the highest level is the nation’s central bank, which acts as the lender or buyer of last resort when the nation’s total foreign exchange earnings and expenditure are unequal. The central then either draws down its foreign reserves or adds to them. CUSTOMERS The customers who are engaged in foreign trade participate in foreign exchange markets by availing of the services of banks. Exporters require converting the dollars into rupee and importers require converting rupee into the dollars as they have to pay in dollars for the goods / services they have imported. Similar types of services may be required for setting any international obligation i.e., payment of technical know-how fees or repayment of foreign debt, etc.

COMMERCIAL BANKS They are most active players in the forex market. Commercial banks dealing with international transactions offer services for conversation of one currency into another. These banks are specialised in international trade and other transactions. They have wide network of branches. Generally, commercial banks act as intermediary between exporter and importer who are situated in different countries. Typically banks buy foreign exchange from exporters and sells foreign exchange to the importers of the goods. Similarly, the banks for executing the orders of other customers, who are engaged in international transaction, not necessarily on the account of trade alone, buy and sell foreign exchange. As every time the foreign exchange bought and sold may not be equal banks are left with the overbought or oversold position. If a bank buys more foreign exchange than what it sells, it is said to be in ‘overbought/plus/long position’. In case bank sells more foreign exchange than what it buys, it is said to be in ‘oversold/minus/short position’. The bank, with open position, in order to avoid risk on account of exchange rate movement, covers its position in the market. If the bank is having oversold position it will buy from the market and if it has overbought position it will sell in the market. This action of bank may trigger a spate of buying and selling of foreign exchange in the market. Commercial banks have following objectives for being active in the foreign exchange market: 

They render better service by offering competitive rates to their customers

engaged in international trade. 

They are in a better position to manage risks arising out of exchange rate

fluctuations. 

Foreign exchange business is a profitable activity and thus such banks are in

a position to generate more profits for themselves. 

They can manage their integrated treasury in a more efficient manner. 33

CENTRAL BANKS In most of the countries central banks have been charged with the responsibility of maintaining the external value of the domestic currency. If the country is following a fixed exchange rate system, the central bank has to take necessary steps to maintain the parity, i.e., the rate so fixed. Even under floating exchange rate system, the central bank has to ensure orderliness in the movement of exchange rates. Generally this is achieved by the intervention of the bank. Sometimes this becomes a concerted effort of central banks of more than one country. Apart from this central banks deal in the foreign exchange market for the following purposes: 

Exchange rate management: Though sometimes this is achieved through intervention, yet where a central

bank is required to maintain external rate of domestic currency at a level or in a band so fixed, they deal in the market to achieve the desired objective 

Reserve management: Central bank of the country is mainly concerned with the investment of the

country’s foreign exchange reserve in a stable proportion in range of currencies and in a range of assets in each currency. These proportions are, inter alias, influenced by the structure of official external assets/liabilities. For this bank has involved certain amount of switching between currencies. 

Intervention by Central Bank It is truly said that foreign exchange is as good as any other commodity. If a

country is following floating rate system and there are no controls on capital transfers, then the exchange rate will be influenced by the economic law of 34

demand and supply. If supply of foreign exchange is more than demand during a particular period then the foreign exchange will become cheaper. On the contrary, if the supply is less than the demand during the particular period then the foreign exchange will become costlier. The exporters of goods and services mainly supply foreign exchange to the market. During a particular period if demand for foreign exchange increases than the supply, it will raise the price of foreign exchange, in terms of domestic currency, to an unrealistic level. This will no doubt make the imports costlier and thus protect the domestic industry but this also gives boost to the exports. However, in the short run it can disturb the equilibrium and orderliness of the foreign exchange markets. The central bank will then step forward to supply foreign exchange to meet the demand for the same. This will smoothen the market. The central bank achieves this by selling the foreign exchange and buying or absorbing domestic currency. Thus demand for domestic currency which, coupled with supply of foreign exchange, will maintain the price of foreign currency at desired level. This is called ‘intervention by central bank’.

Fundamentals in Exchange Rate Typically, rupee (INR) a legal lender in India as exporter needs Indian rupees for payments for procuring various things for production like land, labour, raw material and capital goods. But the foreign importer can pay in his home currency like, an importer in New York, would pay in US dollars (USD). Thus it becomes necessary to convert one currency into another currency and the rate at which this conversion is done, is called ‘Exchange Rate’. Exchange rate is a rate at which one currency can be exchange in to another currency, say USD 1 = Rs. 42. This is the rate of conversion of US dollar in to Indian rupee and vice versa. 35

METHODS OF QUOTING EXCHANGE RATES There are two methods of quoting exchange rates. 

Direct method: For change in exchange rate, if foreign currency is kept constant and home

currency is kept variable, then the rates are stated be expressed in ‘Direct Method’ E.g. US $1 = Rs. 49.3400. 

Indirect method: For change in exchange rate, if home currency is kept constant and foreign

currency is kept variable, then the rates are stated be expressed in ‘Indirect Method’. E.g. Rs. 100 = US $ 2.0268 In India, with the effect from August 2, 1993, all the exchange rates are quoted in direct method, i.e. US $1 = Rs. 49.3400

GBP1 = Rs. 69.8700

It is customary in foreign exchange market to always quote two rates means one rate for buying and another for selling. This helps in eliminating the risk of being given bad rates i.e. if a party comes to know what the other party intends to do i.e., buy or sell, the former can take the latter for a ride. There are two parties in an exchange deal of currencies. To initiate the deal one party asks for quote from another party and the other party quotes a rate. The party asking for a quote is known as ‘Asking party’ and the party giving quote is known as ‘Quoting party’

Major factors affecting foreign exchange rates INFLATION Increase in prices of the commodity in the domestic markets makes export prices higher. In turn exports of the country become less competitive. Once export reduces, the demand for the currency also reduces. It may be noted that the difference in the rates of inflation in two countries causes changes in their exchange rate. FLOW OF CAPITAL Speculative capital movements between countries also play a role in the movement of the currency rates. Capital will be attracted towards currencies yielding higher rate of interest. MONETARY AND FISCAL POLICY The objectives of monetary policy of any economy would be to maintain the money supply in the economy at an ideal level, which would ensure price stability while giving enough scope for economic growth and full employment. An increase in money supply in the country relative to its demand will lead to large scale spending on foreign goods and purchase of foreign investments. Thus, the supply of the currency in the International market increases and value of the currency decreases. The trend in growth in money supply and the monetary policy would give a hint on the future course of movement in the interest rate of the currency and in turn, its exchange rate. Instruments of fiscal policy like deficit financing, taxation, etc. also have a considerable influence on exchange rates.

NATIONAL INCOME AND RESOURCE DISCOVERIES An increase in national income reflects in an increase in the income of the residents of the country. Demand for goods and services will increase. Unutilized resources will be utilized and production will increase. When the country is able to discover any key natural resources its currency gains in value. A good example is the impact of discovery of oil reserves on the exchange rate. PURCHASING POWER PARITY The rate of exchange between two currencies depends on their relative purchasing power in the countries concerned. For example, if a bag of wheat in USA costs USD 10 and in India Rs.435/- the rate of exchange is 1$ = Rs.43.50. If there is a change in price levels, say in India one bag of wheat costs Rs.450/-, it means the purchasing power of the Indian currency comes down and the currency will weaken. The other choice would be to establish a new parity of 1$ = 45.00 Rupees, in which case the price competitiveness of Indian wheat would be maintained. POLITICAL FACTORS Political stability of a country induces confidence in the investors and encourages capital inflow into the country and this has the effect of strengthening the currency of the country. Conversely, instability in political situation forces the investors to withdraw their investments. Factors creating an uncertainty like elections, change in the government, death of a statesman, war etc. generally tends to weaken the currency of the country. SPECULATION Sometimes, the exchange rates may move just on the basis of market sentiment. Buying or selling of large amounts by speculators with the expectation of fall or 38

rise of a currency which attracts other market participants to follow the same path and take the currency to a new high or low level. Arbitrage operations undertaken by the speculators to take advantage of differences in interest and exchange rates in two markets also cause movement of exchange rates in both the markets till a level rate is reached. ď&#x192;&#x2DC;PSYCHOLOGICAL FACTORS Movements in exchange rates need not always follow facts and figures. In the short run, the exchange rate is affected mostly by the views of the market participants about the likely changes in the exchange rates. Very often rates move much ahead of the release of facts and figures on the basis of market forecasts available in Reuters, Tele rate screens etc. When there is a discrepancy between the expectations and the actual outcome, the exchange rate will be affected. ď&#x192;&#x2DC;INTERVENTION The Central Bank of a country may intervene when they feel that the currency is unduly volatile. The central bank aims at ensuring international competitiveness of the currency guided by needs to reduce volatility and to maintain orderly conditions in the market

6. RISK & CONTROL OF TRADING OPERATIONS A Bank carries out foreign currency operations for customers and also for trading. Dealing in currencies, though very risky in nature, is a good source of profit. A dealer, during the course of dealing, places substantial money of the bank at stake which otherwise would have required approval from top management. However, the positive feature of trading operations is that they can be effectively kept within manageable limits by putting controls in the form of dealing limits, stop loss limits etc. The goal of the bank is to balance cost and risk within limits. Foreign exchange transactions can expose the bank to the following types of risk: Exchange rate risk Exchange rate risk is the risk of loss on open un-hedged positions, arising from adverse movements in the market price. An open un-hedged position arises when a bank buys or sells currency and does not square it up by undertaking an opposite transaction. An open un-hedged long position may give rise to exchange loss if the currency bought weakens and short position may result into loss if the currency sold appreciates. Exchange rate risk can be controlled by fixing the following limits: •

Daylight limit

•

Overnight limit

•

Stop-loss limit

a) Daylight limit: Daylight limit is the maximum total exchange exposure, currency wise, permitted during the day to the trading room. Daylight limit is fixed depending upon the risk perception of the management, size of merchant/trading volume, volatility of 40

exchange rates, liquidity and depth of the market etc. These limits are fixed currency wise/dealer wise. It becomes the responsibility of the individual trader to comply with the limits allotted to him. b) Overnight Limits: Positions kept open overnight are called overnight positions and limits fixed for carrying such overnight position is called overnight limits. Overnights limits are usually smaller in size compared to daylight limits. c) Stop-loss limit: Depending upon the risk appetite of the management, cut-off points in the quantum of loss on trading transactions is fixed. The stop-loss limits may be fixed either in terms of absolute amount or in percentage terms. Any loss over and above these limits has to be approved by the Top Management.

Exchange Differential Risk: This is a risk associated with movement in forward differentials between two currencies and affects the swap position held by the dealers. Swap positions can be controlled by fixing limits for total swap exposure, with sub-limits for different currencies and different maturities. 1. Market Risk Investments, in particular fixed income securities are sensitive to interest rate movement. A fall in the price of a security on account of rising interest rates depreciates the value of the investment asset. Treasury should make use of various tools available to mitigate the market risks in terms of asset liability management policy laid down by the bank.

2. Liquidity risk In contrast to the Exchange risk, this risk is connected with funds. Due to mismatch positions, the bank will be left holding a huge dollar surplus or deficit, which may have to be covered at a cost. This risk can be controlled by a proper check on the mis-matches and a good co-ordination between the forex dealing desk and call money desk. 3. Credit risk Credit risk means exposure arising out of failure of the counterparty to honor its commitments on the due date. The Credit risk in respect of forex deals are of two types, settlement risk and forward risk. 4. Settlement risk: Settlement risk is associated with one bank honoring its commitments on the due date and the other bank failing to do so. 5. Forward risk: If the default is known in advance i.e., before settlement, the risk involved would be less because both the banks will not honour their commitments. The bank, which would have honored its commitments in the ordinary course, will have to cover at the ongoing market rate all such transactions which it had put through earlier with the defaulting bank. The Bank is exposed to adverse currency movements only. Credit risk can be controlled by fixing credit limits for dealing with counterparty banks. The counterparty limits are fixed depending upon the bank's capital and reserves. As far as foreign banks are concerned, care must be taken to trade only with first class banks. The credit rating of these banks should be monitored by means of market reports.

6. Country risk Country risks are associated with counterparty banks abroad which cannot fulfill the obligation entered into when business was concluded due to wars, revolutions, riot, officially announced moratorium etc. In addition, some countries may prohibit the payment of foreign exchange for economic reasons. These limits can be controlled by having ceiling for each country. The ceilings should be examined periodically through country rating, foreign exchange restrictions and new regulations, political turmoil etc. 7. Operational risk Operational risk is the potential for financial and reputation loss arising from failure in operational process or the system that supports them. In foreign exchange operations these risks relate to omission of a contract from the position sheets, late delivery of contracts, non-delivery of contracts, miscarriage of funds etc., and will result in payment of overdue interest, which could be sizeable.

7. Introduction to Forex - Concepts and Terminologies Here are some important concepts/terminologies of Forex: Trading operations may be divided into the following categories. 

Outright Deals



Swap Deals

Outright deals maybe further divided into the following categories. 

Cash Deals



Tom Deals



Spot Deals



Forward Deals Settlement date /

Definition

Value Date Value Cash

Trade Date

Same day as deal date

Value Tom (Tomorrow)

Trade Date + 1

1 business day after deal date

Spot

Trade Date + 2

2 business days after deal date*

Forward Outright

Trade Date + 3 or any

3 business days or more

later date

after deal date, always longer than Spot

* USDCAD is the exception and trades T+1

a) Spot rate A spot transaction is a straightforward (or outright) exchange of one currency for another. The spot rate is the current market price or 'cash' rate. Spot transactions do not require immediate settlement, or payment 'on the spot'. By convention, the settlement date, or value date, is the second business day after the deal date on which the transaction is made by the two parties. b) Base currency and counter currency Every foreign exchange transaction involves two currencies. It is important to keep straight which is the base currency and which is the counter currency. The counter currency is the numerator and the base currency is the denominator. When the counter currency increases, the base currency strengthens and becomes more expensive. When the counter currency decreases, the base currency weakens and becomes cheaper. In telephone trading communications, the base currency is always stated first. For example, a quotation for USDJPY means the US dollar is the base and the yen is the counter currency. In the case of GBPUSD (usually called 'cable') the British pound is the base and the US dollar is the counter currency. c) Quotes in terms of base currency Traders always think in terms of how much it costs to buy or sell the base currency. When a quote of 1.1750 / 53 is given that means that a trader can buy EUR against USD at 1.1753. If he is buying EUR/USD for 1'000'000 at that rate he would have USD 1,175,300 in exchange for his million Euros. Of course traders are not actually interested in exchanging large amounts of different currency, their main focus is to buy at a low rate and sell at higher one.

d) Basis points or 'pips' For most currencies, bid and offer quotes are carried down to the fourth decimal place. That represents one-hundredth of one percent, or 1/10,000th of the counter currency unit, usually called a 'pip'. However, for a few currency units that are relatively small in absolute value, such as the Japanese yen, quotes may be carried down to two decimal places and a 'pip' is 1/100th of the terms currency unit. In foreign exchange, a 'pip' is the smallest amount by which a price may fluctuate in that market. e) Exchange Rate: This is when value of one currency is expressed in terms of another. For instance, the EUR/USD has an exchange rate of 1.3200 and then 1 Euro is worth 1.3200 USD. f) Cross rates: When two exchange rates are given and we are asked to find out a third rate out of these two rates, it is called a cross rate. For example, if we are having the rate of USD/INR and EUR/USD, we can derive the rate for EUR/INR. Example: USD/INR

43.5900/25

EUR/USD

0.9580/82

To have the EUR/INR we have to proceed as follows.

Case 1: For every dollar we sell we get INR 43.5900 and selling of every EURO we get 0.9580 USD. So by selling one EURO we will acquire how many Rupees? Euro 1= 0.9580 USD USD 1=43.5900 INR So Euro 1= 43.5900 X 0.9580=41.75922(Rounding off to 41.76) So by selling one Euro we will get 41.7600 INR. Case 2: For every USD we buy we have to pay 43.5925 INR and to buy one Euro we have to pay 0.9582 USD. So to get USD 0.9582 how many INR we have to pay? USD 1 = 43.5925 USD 0.9582(Euro 1) =43.5925 X 0.9582=41.7703335(Rounding off to 41.7700) So Euro 1=41.7700 INR and we are ready to pay 41.77 Rupees for one Euro. Finally the quoting bank can quote EUR/INR as 41.7600-41.7700. g) Forward Outright: A foreign exchange forward is an exchange of two currencies at a predetermined rate for any date other than spot delivery. A forward outright is a single exchange of two currencies at a predetermined rate for future delivery. (Spot+ Forward points)

Calculation of Premium and Discounts: Depending upon whether the forward rate is costlier or cheaper as compared to the spot rate, the forward margin is said to be quoted at premium or discount. When the forward rate is costlier than the spot rate the forward margin is quoted as a premium. When the forward rate is cheaper than the spot rate the forward margin is quoted as discount. Premium and discounts is the interest rate differentials between two currencies.

Premium: There is premium when swap rate is positive (the forward rate exceeds a spot rate).This is when the interest rates of the base currency are lower than the second quoted currency-pair. Example of USD/ CAD: US Dollar 3 months interest rates: 1.25 pct Canadian Dollar 3 months Interest rates: 2.75 pct The swap USD/CAD 3 month is 54/58.

Discount: There is a discount when Swap rate is negative (the forward rate is lower than spot rate).This is when the interest rates of the base currency are higher than the second quoted currency-pair.

Example of EUR/USD Euro 3 months interest rates 2.65 pct US Dollar 3 months Interest rates 1.30 pct The Swap EUR/USD 3 month is -38.5 / -33. Calculation: Customer wants to sell Euro 3 Mio (Million) against USD 3 Months forward. Trade Date

11thFeb

EUR/USD

1.0710/14

USD 3 MONTH RATE

1.25/1.35%

EUR 3 MONTH RATE

2.60/2.70%

MATURITY

90 DAYS(3 MONTHs)

How to calculate the Bid price for EUR/USD 3 months forward. 1ST Method: Forward Points= Spot * (1+ (OCR rate*n/360)) (1+ (BCR rate * n/360)) OCR=Other Currency Rate BCR=Base Currency Rate Forward points= 1.0710*(1+ (0.0125*90/360)) (1+ (0.027 rate*90/360)) 49

- Spot

Swap= -0.00385 Forward rate=1.0710-0.00385=1.06715 Alternative Method: Borrow

Lend

EUR 3’000’000

SPOT 1.0710

USD 3213000

90 days @ 2.70%

90 days@1.25%

Interest=EUR 20250

Interest=USD 10040.625

Total: EUR 3020250

Total USD 3223040.625

Forward rate= 3223040.625

=1.06715

3020250 Customer sells EUR 3 Mio against USD@1.06715 AT 3 month (1.07100.00385)

Example2: Customer wants to buy EUR 3 Mio against USD 3 months forward? Trade Date

Feb 11th

EUR/USD

1.0710/14

USD 3 MONTH RATE

1.25/1.35%

EUR 3 MONTH RATE

2.60/2.70%

Maturity

90 Days

How to calculate the bid price for EUR/USD 3 months forward?

1st method: Forward Points= Spot * (1+ (OCR rate*n/360)) - Spot (1+ (BCR rate*n/360)) = 1.0714*(1+ (0.0135*90/360))

-1.0714

(1+ (0.026 rate*90/360)) Swap= -0.0033 Forward rate=1.0714-0.0033=1.0681 Alternative Method: Lend

Borrow

EUR 3’000’000

Spot 1.0714

USD 3’214’200

90 days@2.60%

90 days@1.35%

Interest=EUR 19500

Interest=10,847.925

Total=EUR 3’019’500

Total=USD 3’225’047.925

Forward Rate= 3225047.925

= 1.0681

3019500

Customer buys EUR 3 Mio against USD at 1.0681 at 3 month (1.0714-0.0033)

h) Swaps: A foreign exchange swap is a simultaneous purchase and sale, or vice versa, of identical amounts of one currency for another with two different value dates. The two currencies are initially exchanged at the Spot Rate and are exchanged back in the future at the Forward Rate. The Forward Rate is derived by adjusting the Spot rate for the interest rate differential of the two currencies for the period between the Spot and the Forward date. Forex Trading In forex, traders take advantage of this difference by trading currency pairs; they buy one currency, such as the USD while simultaneously selling another. As the value of currencies changes in response to news and other events throughout the day, traders attempt to trade currency pairs to take advantage of market movements. A currency pair is made up of the two currencies; you buy one and sell another. The first currency is the base currency, and the second currency is called quote or terms currency. Example: GBP/USD where GBP is the base currency and USD is the quote/terms currency. GBP/USD

GBP/USD

1.2937

1.2938

1.2939

1 Pip change

What is a Pip? In a currency pair quote such as GBP/USD 1.2938, the last number behind the decimal represents the Pip, the smallest unit that can change for the pair.

What is a spread? GBP/USD 1.29 Sell

BUY

The difference between the buy & sell prices: 1.2941-1.2938=0.0003 (3 pip spread)

Spreads & Bid/Ask When viewing quotes, you will notice that there are two prices for each currency pair. Similar to all financial products, FX quotes include a "bid' and "ask". The bid is the price at which a dealer is willing to buy and clients can sell the base currency in exchange for the counter currency. The ask is the price at which a dealer is willing to sell and a client can buy.

Bid = The Price at which the Trader (You) Can Sell Ask = The Price at which the Trader (You) Can Buy

For example, say the EUR/USD is trading at 1.3050 x 1.3053. In this case, the bid is 1.3050 and the ask is 1.3053. The difference between the bid and ask constitutes the spread. In the above example, the spread is 3 pips, or points. This differential reflects the cost of the trade. Essentially, the market would have to move 3 pips in your favor for you to break even, and 4 pips for you to be in your profit zone.

Choosing a Position: 1) A buy position or “to go long.” This means you enter the market in anticipation that the price of the base currency will rise compared to the quote currency. In other words, you would buy EUR/USD because you believe the price of the euro will rise over the U.S. dollar.

2) A sell position or “to go short.” This means you enter the market in anticipation that the price of the base currency will fall compared to the quote currency. In other words, you would sell EUR/USD because you believe the price of the euro will fall compared to the U.S. dollar

Major& Minor Currencies The most popular and most heavily traded currency pairs are called “the majors.” They are EUR/CHF, EUR/JPY, EUR/USD, GBP/EUR, GBP/USD, USD/AUD, USD/CAD, USD/CHF and USD/JPY. Minor currencies, such as those from emerging countries, tend to be a higher risk to trade.

8. Developments in the market:

Clearing Corporation of India Ltd (CCIL)

The CCIL was set up in April, 2001, for providing exclusive clearing and settlement for transactions in money, G-Secs and foreign exchange. The company commenced operations with the objective to improve the efficiency in the transaction settlement process, insulate the financial system from shocks emanating from operations related issues, and to undertake other related activities that would help to broaden and deepen the markets.

Negotiated Dealing System (NDS)

Negotiated Dealing System (NDS) is an electronic platform for facilitating dealing in Government Securities and Money Market Instruments. It facilitates electronic submission of bids/application by members for primary issuance of Government Securities by RBI through auction and floatation. NDS also provides interface to Securities Settlement System (SSS) of Public Debt Office, RBI, thereby facilitating settlement of transactions in Government Securities including treasury bills, both outright and repos. CCIL extends guaranteed settlement for trades done/reported on NDS in government securities including Treasury Bills.

NDS Call

NDS Call is a screen based negotiated quote â&#x20AC;&#x201C; driven system for all dealings in call/notice and term money markets. It provides an electronic dealing platform with features such as negotiation screen with display of amount, rate, tenor and settlement type of borrowing and lending quotes, preferred counterparty and exposure limit set up at the choice of participants, and monitoring of adherence to regulatory limits. 55

Collateralized Borrowing and Lending Obligation (CBLO)

CBLO is a money market instrument as approved by RBI, is a product developed by CCIL for the benefit of the entities who have either phased out from interbank call money market or have been restricted participation in terms of ceiling on call borrowing and lending transactions and who do not have access to the call money market .CBLO is a discounted instrument available in electronic book entry form for the maturity period ranging from one day to ninety days .In order to enable the market participants to borrow and lend funds ,CCIL provides the Dealing System through Indian Financial Network (INFINET) a closed user group to the members of the Negotiated Dealing System (NDS) who maintain current account with RBI and through internal gateway for other entities who do not maintain current account with RBI.

Real Time Gross Settlement (RTGS)

RTGS is a centralized payment system in which, inter-bank payment instructions are processed and settled, transaction by transaction (one by one) and continuously (online) throughout the day, as and when the instructions are received and finally accepted by the system. RTGS has been implemented and managed by RBI. Since the funds transfer instructions are processed and settled in real time, the credit and liquidity risks are eliminated. This will lead to a seamless movement of funds from one end to another using the IT platform and would reduce the systematic risks in the settlement system. As the funds are received instantly online, in the RTGS system, the collecting banks and their customers can use the funds immediately without exposing themselves to settlement risk. Under normal circumstances the beneficiary bankâ&#x20AC;&#x2122;s branch receives the funds in real time as soon as funds are transferred by the remitting bank. If the beneficiaryâ&#x20AC;&#x2DC;s bank is unable to credit the 56

amount of the remittance to the account of the beneficiary for any reason, the beneficiary’s bank has to return the money to the remitting bank within 2 hours. Once this amount is received back by the remitting bank, the amount is credited to the Remitter's account by the remitting bank branch.

National Electronic Funds Transfer (NEFT)

Under NEFT, funds are transferred to the credit account with the other participating Bank using RBI's NEFT service. RBI acts as the service provider and transfers the credit to the other bank's account. The funds will be sent to the RBI within three hours of the transaction. The actual time taken to credit the beneficiary depends on the time taken by the beneficiary bank to process the payment. If the money cannot be credited for any reason, the beneficiary’s bank has to return the money to the remitting bank. Once this amount is received back by the remitting bank, the amount is credited to the Remitter's account by the remitting bank branch.

FX-CLEAR

FX – Clear is a forex dealing system developed by CCIL with a view to reducing the cost of forex transactions in India and enhancing the market depth through wider participation of banks in the market. FX-CLEAR offers both Order Matching and Negotiation Modes for dealing. The order matching mode is a neutral, anonymous and truly order driven dealing platform. It works on the principle of ‘full price discovery’. In this mode, orders (Bid and Offer) with valid inputs are accepted for dealing and the system matches these with the counter-orders available in the order book, based on price and time

priority. The counter-partyâ&#x20AC;&#x2122;s identities are not disclosed to either party until the matching has resulted in a trade. In negotiation mode, a dealer is able to converse through exchange of messages electronically with dealers of all other members for the purpose of arriving at a negotiated deal in the forex market. The Deals negotiated are captured as confirmed trades once acknowledged by both the parties. This mode is available for other major currency pairs besides USD - INR.

9. History of technical analysis: Most consider the father of technical analysis to be Charles Dow, the founder of Dow Jones and Company which publishes the Wall Street Journal. Around 1900 he wrote a series of papers which looked at the way prices of the Dow Jones Industrial Average and the Dow Jones Transportation Index moved. After analyzing the Indexes he outlined his belief that markets tend to move in similar ways over time. These papers, which were expanded on by other traders in the years that followed, became known as “Dow Theory”. Dow Theory is broken down into 6 basic tenets: The first tenet of Dow Theory is that The Markets Have 3 Trends.

• Up Trends which are defined as a time when successive rallies in a security’s price close at levels higher than those achieved in previous rallies and when lows occur at levels higher than previous lows. • Down Trends which are defined as when the market makes successive lower lows and lower highs.

• Corrections which are defined as a move after the market makes a move sharply in one direction where the market recedes in the opposite direction before continuing in its original direction.

To help better understand each trend let’s look at an example of each:

A Price Chart Showing an Up Trend:

A Price Chart Showing a Down Trend:

A Price Chart Showing a Correction:

The second tenet of Dow Theory is that Trends Have 3 Phases:

• The accumulation phase which is when the “expert” traders are actively taking positions which are against the majority of people in the market. Price does not change much during this phase as the “experts” are in the minority so they are not a large enough group to move the market.

• The public participation phase which is when the public at large catches on to what the “experts” know and begin to trade in the same direction. Rapid price change can occur during this phase as everyone piles onto one side of a trade.

• The Excess Phase where rampant speculation occurs and the “smart money” starts to exit their positions.

One of the best examples which show these three phases occurring in an uptrend that most people are familiar with is the run-up up the NASDAQ into 2000:

Chart of the NASDAQ Showing the 3 Phases of a Trend

The third tenet of Dow Theory is that The Markets Discount All News, meaning that once news is released it is quickly reflected in the price of an asset. This concept that the markets discount all news is one that is sited in arguments in favor of using technical analysis as a tool to profit from the markets as if it is true that markets already discount all fundamental factors then the only way to beat the market would be through technical analysis. Tenet four of Dow Theory is that The Averages Must Confirm Each Other. Here Dow was referring to the Dow Jones Transportation Index and the Dow Jones Industrial Average. In Dowâ&#x20AC;&#x2122;s time the growth in the US was coming mainly from the Industrial sector. These two indexes were made up of manufacturing companies and the rail companies which were the primary method used to ship the 62

manufacturers goods to market. What Dow was basically saying here is that you could not have a true rally in one of the averages without a confirmation from the other because if manufacturerâ&#x20AC;&#x2122;s profits were rising they would have to ship more goods. This meant that the profits of the transportation companies and therefore the transportation average should rise too. Dow stated that when these two averages moved in opposite directions it was a sign that the market was going to change direction.

Tenet five is Trends Are Confirmed by Volume. What Dow was saying here was that there are many reasons why price may move on low volume, but when prices move on high volume there is a greater chance that the move is representative of the overall marketâ&#x20AC;&#x2122;s view. Dow believed that if many traders were participating in a particular price move and the price moves significantly in one direction, then this was an indication of a trend developing as this was the direction the market was anticipated to continue to move. Tenet six is that Trends Exist Until Definitive Signals Prove That They Have Ended. What Dow was saying here is that there will be market moves which are against the primary trend but this does not mean that the trend is over and the market will normally resume its prior trend.

10. BASICS OF TECHNICAL ANALYSIS Technical analysis is a method of evaluating securities and assets by analyzing the statistics generated by market activity, such as past prices and volume. Technical analysts do not attempt to measure a currencies value, but instead use charts and other tools to identify patterns that can suggest future activity. The field of technical analysis is based on three assumptions: 1.

The market discounts everything:

A major criticism of technical analysis is that it only considers price movement, ignoring the fundamental factors of the company. However, technical analysis assumes that, at any given time, a stock's price reflects everything that has or could affect the company - including fundamental factors. 2.

Price moves in trends:

In technical analysis, price movements are believed to follow trends. This means that after a trend has been established, the future price movement is more likely to be in the same direction as the trend than to be against it. Most technical trading strategies are based on this assumption. 3.

History tends to repeat itself:

Another important idea in technical analysis is that history tends to repeat itself, mainly in terms of price movement. The repetitive nature of price movements is attributed to market psychology; in other words, market participants tend to provide a consistent reaction to similar market stimuli over time. Technical analysis uses chart patterns to analyze market movements and understand trends.

Technical analysis can be used on any security with historical trading data. This includes stocks, futures and commodities, fixed-income securities, forex, etc. Fundamental V/s Technical Analysis

Fundamental analysis which seeks to determine the value of a financial instrument by analyzing all the things such as the balance sheet of a company when trading stocks, or interest rate expectations when trading currencies to try and estimate whether a particular financial instrument is over or under valued.

Technical analysis on the other hand focuses purely on historical price action of a particular instrument to determine whether the instrument is more likely to increase or decrease in value in the future, and therefore how it should be traded. Candlestick chart: Candlestick charts (which are also sometimes referred to as Japanese candlesticks because they originated in Japan) display the most detail for the price movement of a security of the three chart types (line charts, bar charts, and candlestick). A candlestick chart is similar to a bar chart with one significant difference â&#x20AC;&#x201C; in addition to displaying the open, high, low and close prices, candlestick charts use different colors to represent when the open is higher than the close and vice versa. In general when the open price for the time period selected is lower than the close, white or unshaded candle form and when the open is higher than the close a black or shaded candle forms. It is said generally with reference to the colors of the candles as sometimes instead of shaded and unshaded candles. Red candle is used for showing down days and green candle for showing up days. On a candlestick chart the thick or colored part of the data points is referred to as the body of the candle and the thin lines at the top and bottom (which represent the space between the open/close and the high/low for the time period selected are referred to as the wick. The following kinds of currency prices represented on charts are being distinguished on Forex: 65

Open- A price at the beginning of a trade period (year, month, day, week etc) Close-A price at the end of a trade period High-The highest from the prices observed during a trade period Low-The lowest from prices observed during a trade period Example of a Candlestick Chart and Candles:

You should have a good understanding of price charts and the main types of charts available to you as a trader. Support A term used in technical analysis indicating a specific price level at which a currency will have the inability to cross below. Recurring failure for the price to move below that point produces a pattern that can usually be shaped by a straight line. A support level penetrated becomes resistance. 66

Resistance A term used in technical analysis indicating a specific price level at which a currency will have the inability to cross above. Recurring failure for the price to move above that point produces a pattern that can be usually be shaped by a straight line. A resistance level penetrated becomes support. Chart Showing Support and Resistance in a Range Market

Chart Showing Support and Resistance in a Trending Market

11. Technical indicators: A technical indicator is applied to a chart and uses three pieces of information â&#x20AC;&#x201C; time, price and volume, to give you insight into where a pair is headed. Because the forex is a distributed market, there is very little volume information. That leaves just price and time. There are a lot of ways to analyze that information and the potential variables are endless. Understanding how to wade through the swamp is vital. Technical indicators can help. Technical indicators are elements that predict the future trends of currencies in a given set of market conditions. Sometimes used to predict short-term trends, a technical indicator often focuses on the upward or downward movement of price associated with a given currency. In other applications, a technical indicator may be analyzed in order to predict the next short term movement that will occur with a market in general. Technical indicators can be broken down into two main categories which are leading and lagging indicators. As their name suggests, leading indicators are created to try and predict future price movement. Because most leading indicators are trying to gauge price momentum from relatively recent price action, these indicators tend to generate frequent buy and sell signals and are therefore normally used in ranging markets. While some traders like the opportunity to enter more trades, it is important to keep in mind that the potential for false signals with leading indicators is high. Lagging indicators on the other hand are created to give a picture of where the market has been, and therefore where it is likely to continue to go. As this is the case these indicators are normally used by traders looking to trade with the trend, and offer little value in ranging markets. Secondly because these indicators are designed to catch and stay with the trend for as long as possible, they generate less trading signals than leading indicators. This is often seen as a positive from the 68

standpoint of generating less false trading signals and also a negative as this also means that they normally get you into a move later than a leading indicator. One of the biggest issues when deciding how and when to use a particular indicator is determining how sensitive to make the indicator to price movements. The more sensitive the indicator the earlier you will catch the move, however the more false signals that will be given. Conversely the less sensitive the indicator the less false signals but the later you will get into the move. Investors who choose to focus their trading activity on short term deals that involve a continual cycle of buying and selling in order to take advantage of market trends derive the most value from the use of a technical indicator. Because these types of indicators do focus on short term movement, they are ideally suited for a quick turnaround. Active traders of this type will consult any of the common technical indicators on a daily basis, if not several times a day. It is not unusual for investors looking for insight into the best short-term investment deals to consult two or more of these indicators regularly, even cross referencing the data found in each of the various indexes. This activity of cross referencing can help to identify potential trades that may be identified by some of the indexes but not in others. 11.1 Advantages/Disadvantages: Technical indicators have some great advantages and some big drawbacks. Their biggest advantage is that they simplify price movement and are very easy to build rules around. Most technical indicators have very clear breakout levels. The disadvantage with technical indicators is that they lag price movement. By the time a breakout is identified on the indicator, the price move has already been in play for a while. Despite that, there are a few ways to use technical indicators that can be really helpful. 69

11.2 The Different Types of Technical Indicators: 1. Trend indicators These indicators are used to indicate the direction of a trend. These are very useful because the basic rule is that you should always trade with a trend and not against it. Some examples of trend following indicators include Parabolic SAR, MACD and Moving Averages.

2. Momentum indicators Momentum or strength indicators are used to indicate the speed or strength of a move in price and are best used to determine a change in direction. They tend to be oscillating indicators showing overbought and oversold positions. Examples include CCI, RSI and Stochastic.

3. Volatility indicators These indicators, as the name suggests, show a change in volatility, which often leads to a change in price. Examples include ATR, Bollinger Bands and Envelopes. 4. Volume indicators Volume indicators are used to show the volume of trading in a particular currency. These are useful to confirm the direction of a trend or to signal a breakout. For example, if the pair trades in a narrow range and then breaks out on high volume, then this is a very bullish signal. Examples of volume indicators include Chaikin Money Flow, Demand Index and OBV, Volume Oscillator.

11.3Relative Strength Index (RSI) RSI was developed by J. Welles Wilder. The relative strength index (RSI) helps to signal overbought and oversold conditions in a security. RSI measures the momentum of price movements. It is also plotted on a scale ranging from 0 to 100. Traders will tend to look at RSI readings over 80 as an indicator of a market that is overbought or susceptible to a downturn, and readings under 20 as a market that is oversold or ready to turn higher. This logic therefore implies that prices cannot rise or fall forever and that by using an RSI study, one can determine with a reasonable degree of certainty when a reversal will come about. However, trading on RSI indicator alone is not sufficient. In many instances, an RSI can remain at very lofty or sunken levels for quite a while without prices reversing course. At these times, the RSI is simply telling you that a market is quite strong or quite weak and shows no signs of changing course. Also look for divergences between prices and the RSI. If your RSI turns up in a slumping market or turns down during a bull run, this could be a good indication that a reversal is just around the corner. Wait for confirmation before you act on divergent indications from your RSI studies. The most common uses of RSI are to: 1)

Indicate overbought and oversold conditions.

An overbought or oversold market is one where prices have risen or fallen too far and therefore likely to retrace. If the RSI is above 70 then the market is considered to be overbought, and an RSI value below 30 indicates that the market is oversold.80 and 20 are used to indicate overbought and oversold levels.

Example of RSI Indicator Showing Overbought and Oversold

A second way that traders look to use the RSI is to look for divergences

between the RSI and the financial instrument that they are analyzing, particularly when these divergences occur after overbought or oversold conditions in the market. These divergences can act as a sign that a move is losing momentum and often occur before reversals in the market. As such traders will watch for divergences as a potential opportunity to trade a reversal in the stock, futures or forex markets or to enter in the direction of a trend on a pullback.

The third way that traders look to use the RSI is to identify bullish and

bearish changes in the market by watching the RSI line for when it crosses above or below the center line. Although traders will not normally look to trade the crossover it can be used as confirmation for trades based on other methods. As you can see in the chart below, the RSI crossover was a great confirmation of the head and shoulders top, a pattern formed in the EUR/USD chart.

Example of the RSI Indicator Centerline Crossover

Calculation: Relative Strength Index (RSI) measures the strength of all upward movement against the strength of all downward movement in a specified time frame. For mathematical formula of RSI is as follow: ď&#x201A;ˇ

RSI = 100 - [100/(1+RS)]

ď&#x201A;ˇ

RS = average of n day's up closes / average of n day's down closes

The most common parameter for RSI is period 14, RSI can range from 0-100. In the formula, if RS = 1, which means the average n day's up closes equals to the average of n day's down closes, RSI = 50. In that case, the market is having an equal strength of upward and downward force. If RSI > 50, which means the upward force is stronger than the downward force. If RSI < 50, which means the downward force is stronger than the upward force. 74

Example: Euro Daily 14 period Data LastDates

Open

High

Low

Last

Open

10/1/2008

1.412199974

1.4174

1.39740002

1.4019

-0.0103

10/2/2008

1.402400017

1.4025

1.3743

1.3816

-0.0208

10/3/2008

1.381600022

1.3905

1.37020004

1.3769

-0.0047

10/6/2008

1.366299987

1.3674

1.3441

1.3488

-0.0175

10/9/2008

1.363000035

1.3784

1.35790002

1.3596

-0.0034

10/10/2008

1.358700037

1.365

1.32570004

1.3412

-0.0175

10/15/2008

1.361999989

1.3685

1.34529996

1.346

-0.016

10/17/2008

1.348099947

1.3516

1.33850002

1.3407

-0.0074

10/20/2008

1.34010005

1.353

1.32840002

1.3342

-0.0059

10/7/2008

1.348399997

1.3739

1.34790003

1.3617

0.0133

10/8/2008

1.362800002

1.3756

1.35420001

1.3629

0.0001

10/13/2008

1.355700016

1.3681

1.34560001

1.3591

0.0034

10/14/2008

1.359200001

1.3769

1.35839999

1.3622

0.003

10/16/2008

1.346500039

1.3537

1.33440006

1.3485

0.002

In this (Last-open Column) bear candles are those in negative and those in positive is bull candle. So, adding all positive last column values (1.3617+1.3629+1.3591+1.3622+1.3485) we get: 6.794400096. And adding all negative last column values (1.4019+1.3816+1.3769+1.3488+1.3596+1.3412+1.346+1.3407+1.3342) we get: 12.23089993. Therefore, RS= 6.794400096/5 รท 12.23089993/9, now calculate 100- 100/1+rs, you get RSI=49.99799729. 75

11.4Fast Stochastic Oscillator Developed by George C. Lane in the 1950's, the Stochastic Oscillator comes in 3 flavors: Fast, Slow, and Full. The Stochastic Oscillator is a momentum indicator designed to show the relation of the current close price relative to the high/low range over a given number of periods using a scale of 0-100. It is based on the assumption that in a rising market the price(s) will close near the high of the range and in a declining market the price(s) will close near the low of the range. The stochastic oscillator is one of the most recognized momentum indicators. The idea behind this indicator is that in an uptrend, the price should be closing near the highs of the trading range, signaling upward momentum in the security. In downtrends, the price should be closing near the lows of the trading range, signaling downward momentum.

The Stochastic Oscillators are typically plotted as 2 lines: %K and %D. %K is the main (fast) line and %D is the signal (slow) line.

The Fast Stochastic Oscillator is calculated by the formula:

Fast %K = ((Today's Close - Lowest Low in %K Periods) / (Highest High in %K Periods - Lowest Low in %K Periods)) * 100

%D = 3-period simple moving average of Fast %K i.e., %D = MA (%K, N), where: MA is the moving average which you has chosen its method (Exponential, Simple, Smoothed, or weighted). N is the smoothing period of calculation.

Calculation:

%k=

100 X

Date

Open

High

Low

1/3/2005

1.3545

1.358

1.3384

1.3461

1/4/2005

1.3464

1.3494

1.3247

1.327

1/5/2005

1.3279

1.3302

1.3212

1.3259

1/6/2005

1.3258

1.3282

1.3152

1.3167

1/7/2005

1.317

1.325

1.3023

1.3053

1/10/2005

1.306

1.3123

1.3048

1.3083

1/11/2005

1.3078

1.317

1.3064

1.3112

1/12/2005

1.3107

1.3292

1.308

1.3263

1/13/2005

1.3256

1.3266

1.3191

1.3217

1/14/2005

1.3216

1.3224

1.3054

1.3103

1/17/2005

1.3099

1.3127

1.3061

1.3062

1/18/2005

1.306

1.3075

1.2993

1.3026

1/19/2005

1.3023

1.3118

1.2962

1.3

1/20/2005

1.3007

1.3023

1.2919

1.2966

Recent close-lowest low (n) Highest High (n)-lowest low (n)

100 X

1.2966-1.2919

= 7.11%

1.358-1.2919

A 14-day %K (14-period Stochastic Oscillator) would use the most recent close, the highest high over the last 14 days and the lowest low over the last 14 days. %K tells us that the close (1.2966) was in the 7.11th percentile of the high/low range. Because %K is a percentage or ratio, it will fluctuate between 0 and 100. A 77

3-day simple moving average of %K is usually plotted alongside to act as a signal or trigger line, called %D.

%K: This is the main line and called the fast line, it displayed as solid line in above figure. %D: This line called the slow line, it displayed as dotted line in above figure

Interpretation Crossover Signals: ď&#x201A;ˇ

For a Sell, one looks for the %K line to cross below the %D line.

ď&#x201A;ˇ

For a Buy, one looks for the %K line to cross above the %D line.



Since crossovers of %K and %D are often unreliable, they should be verified

with other indicators. The Centerline The centerline lies at the 50% level in the indicator panel. It implies that there is a balance between bulls and bears. Situations when the stochastic indicator crosses the centerline can give an insight into whether the buyers or sellers will begin to control market conditions. Centerline Crossovers 

If the indicator is staying below the centerline (between 40%-50%) and

crosses up, then it is an indication that the bulls are taking control of the market. 

If the indicator is staying above the centerline (around 50%-60%) and then

crosses below the centerline, it can be an indication that the bears have taken control. Overbought and Oversold Level The main way to use Stochastic as signals is to look for overbought conditions at the 80% level and oversold conditions at the 20% level. The key is not to look just at when the %K or %D lines touch or cross overbought/oversold, but when they cross over and back through these levels. As with other momentum oscillators (such as RSI) the readings can stay inside the overbought and oversold levels for some time. When the lines cross back below or above the levels it is usually a good indication of an upcoming reversal. Note: Looking at different time frames when using overbought and oversold levels can also help to determine correct entry strategies. The main principle is to “trade with the trend.” It is prudent to check longer term stochastic readings as a short term graph may mislead a trader. 79

Divergence

Divergences can be considered one of the stronger signals when using the stochastic indicator. The anatomy of a divergence is presented through some examples: Example 1: British Pound v/s US Dollar (May 9th, 2006)

A Bullish Divergence in the GBP/USD is followed by a 130 pip rise in price. When prices are making new lows but the stochastic indicator is not dipping past its recent lows it is an indication that a bullish rally may be likely.

Example 2: The Euro v/s Japanese Yen (May 5th, 2006)

A Bearish Divergence in EUR/JPY is followed by a 125 pip drop in price. When price is making new highs but Stochastic is not matching its most recent highs there is an increased likelihood that a bearish divergence will follow. ď&#x192;&#x201E;

What is meant by overbought and oversold?

ď ś

Overbought: It is a technical condition where prices are considered to be too

high and likely to decline. ď ś

Oversold: It is a technical condition where prices are considered to be too

low and possibly ready for a rally. It is a tool used to determine if price trends move suddenly or distant than normal. The terms are used to describe a market condition that is quantified by certain technical indicators. These indicators are called oscillators with two popular examples being the Stochastic and RSI. An oscillator is a commonly used momentum indicator that measures the current currency price compared to its historical price over a given time period. It looks to gauge the strength and momentum of a currency pair's move by measuring the degree by which a currency is overbought or oversold. The scale for the both indicators is 0 to 100. 81

When Stochastic reaches a value of 80, the market is considered overbought and when Stochastic reaches a value of 20, the market is considered oversold. RSI uses the same scale of 0 to 100, but the value for overbought is 70, while the value for oversold is 30. The idea is when the market reaches either extreme, the chance for a reversal increases. However, a reversal is not imminent. Markets that are in a strong uptrend can remain overbought for long periods of time and markets that are in a strong downtrend can remain oversold for long periods of time. However, when the market is in a downtrend and the oscillator moves up to overbought, there is a much better chance of a reversal. On the flip side, when the market is in an uptrend and the oscillator moves down to oversold, there is also a good chance of a reversal. Here is an example using the daily chart of the EUR/USD with one year of activity.

Also plotted on the chart is a Slow Stochastic using values of 25, 5, 5. You can see that while the market is in an uptrend, the Stochastic will spend more time in an overbought condition and little time in the oversold condition. Also, when Stochastic moves down to an oversold condition, the market has a tendency to

reverse. But the key here is that the market is in an uptrend. If the market was in a downtrend, the opposite would be true.

11.5 Moving Averages Simple Moving Average A Moving averages simply measure the average price or exchange rate of a currency over a specific time frame. For example, 5 day Simple Moving Average is the sum of last 5 days closing/opening price divided by the number of time periods (5). Day

Price

5 Day SMA

6.8

Exponential Moving Average (EMA) While the simple moving average is a lagging indicator, we may find a way to reduce the lag. To do this, it is better to use another kind of Moving average which called Exponential Moving Averages. Exponential moving averages reduce the lag by applying more weight to most recent prices relative to older prices or in other words it is a weighted simple moving average putting more weight on the today's closing price. The weighting applied to the most recent price fully depends on the period of the moving average. That means if you apply a shorter period to exponential moving average then you actually placed more weight to the most recent price. So we should take this into consideration that an exponential moving average (EMA) react much quicker to most recent price movements. Also remember, a 10 day EMA is in fact more than 10 day moving average as it could include data from the entire life of a security. It can smooth the price changes and at the same time react to price changes very quickly. Therefore Exponential Moving Average often identified as the best kind of moving averages among short term traders in Forex and Futures market day traders. Weighted Moving Average (WMA) Weighted Moving Average is a kind of moving average that put more weight on most recent data and less weight on older data. A weighted moving average is calculated by multiplying each of the previous day's data by a weight. To calculate this kind of moving average we have to put a weight of 1 to oldest data and then 2 for next data and so on up to the current price. The applying weight is based on the sum of the number of days in the moving average. To calculate 5 day WMA calculates the weight of the first day as below:

Divide the number of each day by sum of the number of days (15) and multiply it by the value of the security (Price). For the last step, you should add all 5 weighted values together (sum). The sum of the number of days = 1 + 2 + 3 + 4 + 5 = 15 5 day weighted moving average (WMA) = 2.33 + 4 + 8 + 12 + 16.66 = 43 Day

Value of the security

Weighting Factor

1/15

2/15

3/15

4/15

5/15

Weighted Value

2.33

16.66

Moving averages can be used as a tool to: 1.

Identifying a trend

Identifying Support & Resistance levels

Identifying price breakouts

Measuring price momentum

Moving Average can be used easily as a tool to identify an uptrend market when 1.

The moving average is rising

The price line tend to be above the moving average

A shorter moving average crossed the longer moving average

Normally, a longer term map of the trend gives us much reliable perspective for the fact of what's going on with the market. In order to identify a trend you should take a look at a longer term chart like Weekly or Daily to see what the major direction of the price is. Remember that this is very important to make sure you are not on the wrong side of the market because a large number of big losers easily had too many trades against the major trend. To identify the longer term trend you can draw 200 SMA and 144 EMA onto the chart. Simply when the 144 EMA is above the 200 SMA and at the same time the price is above the 200 SMA while both moving averages are diverging.

How to identify range market by Moving Average: As it is already explained, a trend market would be confirmed when two moving averages diverge from each other. In other words, when a market is in an uptrend the shorter moving average tends to diverge quickly from the longer moving average and this makes the distance between two moving averages looks wider. This phenomenon indicates that the momentum of the price is rising. Otherwise, when two moving averages are converging after they diverged once earlier (Where we took the LONG trade), the price tends to pull back and this means the momentum of the market is slowing, so the LONG trade is about to be invalid and we must exit the market. Furthermore, two moving averages are on their way to cross over again but this time shorter moving average cross the longer moving average in opposite direction (Downward). The downward crossover of two moving averages gives us very valuable information in which the momentum has slowed into levels that the price cannot rely on it anymore. A very weak momentum would means that the market 87

is going to be lazy (Consolidation) so we must avoid this situation and wait till a new clear signal tell us what to do next.

11.6 MACD: This indicator is comprised of two exponential moving averages, which help to measure momentum in the security. The MACD is simply the difference between these two moving averages plotted against a centerline. The centerline is the point at which the two moving averages are equal. Along with the MACD and the centerline, an exponential moving average of the MACD itself is plotted on the chart. The idea behind this momentum indicator is to measure short-term momentum compared to longer term momentum to help signal the current direction of momentum. MACD= Longer term moving average â&#x20AC;&#x201C; Shorter term moving average 88

When the MACD is positive, it signals that the shorter term moving average is above the longer term moving average and suggests upward momentum. The opposite holds true when the MACD is negative - this signals that the shorter term is below the longer and suggest downward momentum. Moving average convergence divergence indicator combines the features of a moving average cross over system with the ability to determine overbought and oversold conditions. MACD utilizes 3 moving averages in its construction, although only 2 lines are shown in the chart. The first one (called the MACD line) is the differential between 2 exponentially smoothened moving average of the price (usually 12 and 26 periods). Of the two moving averages that make up MACD, the 12-day EMA is the faster and the 26-day EMA is the slower. Closing prices are used to form the moving averages. A moving average (usually 9 periods) is then used to smoothen the MACD line to form a second (signal) line. MACD HISTOGRAM: Another aspect to the MACD indicator that is often found on charts is the MACD histogram. The histogram is plotted on the centerline and represented by bars. Each bar is the difference between the MACD and the signal line or, in most cases, the nine-day exponential moving average. The moving average convergence divergence (MACD) is comprised of two exponential moving averages, which help to measure a security's momentum. The histogram plots the difference between the MACD line and Signal line. The vertical bars are used to show the difference. The histogram fluctuates above and below the zero line. When the histogram value is above the zero line, it means the price is in bullish territory (i.e., the MACD line is above the signal line).When the MACD line is below the signal line, the histogram value falls below its zero line. 89

The direction of the histogram tells us whether that bullish or bearish relationship is gaining or losing momentum. If the histogram is above the zero line but begins to drop towards the zero line, which tells the positive relationship between the MACD line and Signal line is beginning to weaken. Example of the Signal Line (Signal line-Blue, MACD line â&#x20AC;&#x201C;Black)

Example of the MACD Histogram

When the MACD histogram is above zero (the MACD line is above the signal line) this is an indication that positive momentum is increasing. Conversely when the MACD histogram is below zero this is an indication that negative momentum is increasing. The higher or lower the histograms goes above or below zero the greater the momentum of the trend is thought to be.

11.7The Larry Williams %R Williams % R is a momentum indicator that measures overbought and oversold levels. Williams % R was developed by Larry Williams. It is very similar to stochastic oscillator except that %R is plotted upside down and the stochastic has internal smoothing. To display %R it is usually plotted using negative values. (e.g. -20%).For the purpose of analysis and discussion simply ignore the negative symbols. Readings in the range of 80 to 100% indicate that the security is oversold while readings in the 0 to 20% range suggest that it is overbought. Calculation: The formula used to calculate Williamsâ&#x20AC;&#x2122; %R is similar to the stochastic oscillator.

Highest high in n periods-todayâ&#x20AC;&#x2122;s close Highest high in n periods-lowest low in n periods

The following is the chart of Williams %R:

X -100

11.8Commodity Channel Index (CCI) The Commodity Channel Index (also known as CCI) is a momentum indicator that was first introduced by Donald Lambert in 1980. It can be used either as an oscillator showing overbought and oversold levels, or as a trend indicator showing the beginning and end of trends. The CCI is calculated using the price, a simple moving average of the price, and a standard deviation around the price. The CCI displays the difference between the price and the simple moving average as a momentum line oscillating around a 0 (zero) line. A scaling factor is also used (0.015 by default), so that most of the values are between 100 and -100. A buying signal is generated when the price exceeds the upper (+100) line, and a selling signal occurs when the price dips under the lower (-100) line. CCI can be used to identify overbought and oversold levels. A security would be deemed oversold when the CCI dips below -100 and overbought when it exceeds +100. From oversold levels, a buy signal might be given when the CCI moves

back above -100. From overbought levels, a sell signal might be given when the CCI moved back below +100. Ranging Market ď&#x201A;ˇ

Go long if the CCI turns up from below -100.

ď&#x201A;ˇ

Go short if the CCI turns down from above 100.

Calculation: There are 4 steps involved in the calculation of the CCI: 1.

Calculate today's Typical Price (TP) = (H+L+C)/3 where H = high; L = low,

and C = close. 2.

Calculate today's 20-day Simple Moving Average of the Typical Price

(SMATP). 3.

Calculate today's Mean Deviation. First, calculate the absolute value of the

difference between today's SMATP and the typical price for each of the past 20 days. Add all of these absolute values together and divide by 20 to find the Mean Deviation. 4.

The final step is to apply the Typical Price (TP), the Simple Moving Average

of the Typical Price (SMATP), the Mean Deviation and a Constant (.015) to the following

formula:

For scaling purposes, Lambert set the constant at .015 to ensure that

approximately 70 to 80 percent of CCI values would fall between -100 and +100. The CCI fluctuates above and below zero. The percentage of CCI values that fall 93

between +100 and -100 will depend on the number of periods used. A shorter CCI will be more volatile with a smaller percentage of values between +100 and -100. Conversely, the more periods used to calculate the CCI, the higher the percentage of values between +100 and -100. 6.

The CCI uses the difference between the market price of a security and a

moving average of that security to measure the strength of a trend. 7.

Buy signals are generated when the +100 line is crossed and sell signals are

generated when the -100 line is crossed.

How to trade using CCI indicator: The main usage of the CCI indicator is to indicate the overbought and oversold market. So, the best trade is the reversal trend trade. When the CCI go above +100 line it means itâ&#x20AC;&#x2122;s an overbought mood and the trader have to wait the reversal of the trend and the CCI must went to below +100 line in order to take short. 94

When the CCI go below -100 line it means itâ&#x20AC;&#x2122;s an oversold mood and the trader have to wait the reversal of the trend and the CCI must went to above -100 line in order to take long.

11.9 Average Directional Index (ADX): J. Welles Wilder developed the Average Directional Index (ADX) to evaluate the strength of a current trend, be it up or down. It's important to determine whether the market is trending or trading (moving sideways), because certain indicators give more useful results depending on the market doing one or the other. The ADX is an oscillator that fluctuates between 0 and 100. Even though the scale is from 0 to 100, readings above 60 are relatively rare. Low readings, below 20, indicate a weak trend and high readings, above 40, indicate a strong trend. The indicator does not grade the trend as bullish or bearish, but merely assesses the strength of the current trend. A reading above 40 can indicate a strong downtrend as well as a strong uptrend. ADX can also be used to identify potential changes in a market from trending to non-trending. When ADX begins to strengthen from below 20 and moves above 20, it is a sign that the trading range is ending and a trend is developing. The ADX indicator does not give buy or sell signals. Thus, ADX measures the strength of a prevailing trend, rising when the direction is strong and falling when the prior confirmed trend or direction is weakening.ADX is not a directional indicator. +DI and â&#x20AC;&#x201C;DI show direction. When DI+ rises above DI-, upward direction is confirmed. When DI- rises above DI+, downward direction is confirmed. When the move is strong, ADX is rising and DI+ and DI- remain apart.

When ADX begins to weaken from above 40 and moves below 40, it is a sign that the current trend is losing strength and a trading range could develop.

Positive and Negative Directional Indicators: (See the above diagram) The ADX is derived from two other indicators, also developed by Wilder, called the Positive Directional Indicator (sometimes written +DI) and the Negative Directional Indicator (-DI). When the ADX Indicator is selected, Sharp Charts plots the Positive Directional Indicator (+DI), Negative Directional Indicator (-DI) and Average Directional Index (ADX). With the Red, White and Green color scheme on Sharp Charts, ADX is the thick black line with less fluctuation, +DI is green and -DI is red. +DI measures the force of the up moves and -DI measures the force of the down moves over a set period. The default setting is 14 periods, but users are encouraged to modify these settings according to their personal preferences.

In its most basic form, buy and sell signals can be generated by +DI/-DI crosses. A buy signal occurs when +DI moves above -DI and a sell signal when -DI moves above the +DI. Be careful, though; when a security is in a trading range, this system may produce many whipsaws. As with most technical indicators, +DI/-DI crosses should be used in conjunction with other aspects of technical analysis. The ADX combines +DI with -DI, and then smoothes the data with a moving average to provide a measurement of trend strength. Because it uses both +DI and -DI, ADX does not offer any indication of trend direction, just strength. Generally, readings above 40 indicate a strong trend and readings below 20 a weak trend. Conversely, an ADX decline from above 40 might signal that the current trend is weakening and a trading range is developing.

11.10 Volume Oscillator A volume oscillator measures volume by measuring the relationship between two moving averages. The volume oscillator indicator calculates a fast and slow volume moving average. The difference between the two (fast volume moving average minus slow volume moving average) is then plotted as a histogram. The histogram, like an oscillator, fluctuates above and below a zero line. Volume can provide insight into the strength or weakness of a price trend. This indicator plots positive values above the zero line and negative values below the line. A positive value suggests there is enough market support to continue driving price activity in the direction of the current trend. A negative value suggests there is a lack of support that prices may begin to become stagnant or reverse.

The Volume Oscillator formula uses two volume moving averages (VMAs):

Volume Oscillator = [Fast VMA] / [Slow VMA] Fast VMA is shorter-term VMA Slow VMA is longer-term VMA

For instance Volume Oscillator (5,25) means that the period of the Fast Volume Moving Average is set to 5 bars (shorter period) and the period of Slow Volume Moving Average is set to 25 bars (longer period). 

If the fast MA (5 days) is above the slow MA (10 days) the oscillator will be

positive. 

If the fast MA is below the slow MA then the oscillator will be negative.



The Volume Oscillator will be zero when the two MA's cross.

Trading Signals: 

Rising volume (positive VO) signals a strong trend.



Falling volume (negative VO) indicates trend weakness.

Rising volume in addition to rising prices is bullish, as is falling price and falling volume. On the other hand, increases in volume with falling prices, or volume decreases when prices rise signify a bearish market. The reason for this belief is that rising prices and increased volume implies more buyers, but falling prices and increased volume means more sellers.

The breakout above the resistance line is then confirmed by a sharp rise in volume.

11.11 Bollinger Band: A band plotted two standard deviations away from a simple moving average, developed by famous technical trader John Bollinger.

100

In this example of Bollinger bands, the price of the stock is banded by an upper and lower band along with a 21-day simple moving average.

Because standard deviation is a measure of volatility, Bollinger bands adjust themselves to the market conditions. When the markets become more volatile, the bands widen (move further away from the average), and during less volatile periods, the bands contract (move closer to the average). The tightening of the bands is often used by technical traders as an early indication that the volatility is about to increase sharply.

This is one of the most popular technical analysis techniques. The closer the prices move to the upper band, the more overbought the market, and the closer the prices move to the lower band, the more oversold the market. The following chart shows Bollinger Bands on Exxonâ&#x20AC;&#x2122;s prices.

101

The Bands were calculated using a 20-day exponential moving average and are spaced two deviations apart. The bands were at their widest when prices were volatile during April. They narrowed when prices entered a consolidation period later in the year. The narrowing of the bands increases the probability of a sharp breakout in prices. The longer prices remain within the narrow bands the more likely a price breakout. Calculation It consists of 3 bands: â&#x20AC;˘ The middle band known as the Simple Moving Average (measures the intermediate-trend)

â&#x20AC;˘ An upper-band (usually 2 standard deviation above the middle band) â&#x20AC;˘ A lower-band (2 standard deviation below the middle band) The default setting for is 20 for period and 2 for deviation. It provides you with an insight that price are high at the upper band and low at the lower band. This system of trading is famous among traders. They give an indication of when to buy or sell a particular currency. You may want to buy when price touches the lower bands and exit when price retraces back to the middle band. Same rule applies for selling that is, sell when price touches the upper band and exit when it reaches the middle band. To make it simpler, they may be used as support and resistance levels. As a side note, the formula used in the calculation of Bollinger bands is as follows: Upper Band = MA (TP, n) + m * SD [TP, n] Lower Band = MA (TP, n) - m * SD [TP, n] 102

SD = Standard Deviation over Last n Periods Typical Price (TP) = (HI + LO + CL) / 3 n = Smoothing Period m = Number of Standard Deviations (SD) The following are the characteristics: 1) Sharp Prices changes tend to occur after the bands tighten and as volatility lessens. 2) When prices move outside the bands, a continuation of the current trend is implied. 3) Bottoms and tops made outside the bands followed by bottoms and tops made inside the bands calls for reversals in the trend.

103

12. Study of currency charts, data analysis and observations: 1) RSI Indicator Daily charts of currency pairs EUR/USD, GBP/USD, USD/JPY were taken and RSI Data was calculated and compared to the corresponding price movements of the pairs. Various time periods were tried for RSI and the period of 14 days was found to be more correlated and effective. To find if high RSI values and low RSI values resulted into subsequent price decline or rise, instances of RSI being in higher range and lower ranges were located and subsequent price reaction was examined. The observations made for each of the currency pairs for five years starting from 2004 to 2009 are listed as below:a) Currency: EUR/USD Out of 1418 RSI data points, the following observations have been noted.

Above

Below

70(Overbought)

30(Oversold)

50(Reversal)

230

141

662

This means 16.22% of the whole RSI data 1418; it has been in the overbought position, while 9.94% times it has been in the oversold position. And 46.68% times, it has been in the downtrend, i.e. below 50% RSI. b) Currency: GBP/USD Out of 1493 data year 2003 to 2009, the following observations have been noted.

104

Above 70(Overbought)

Below 30(Oversold)

Below 50(Reversal)

123

688

This indicates that out of 1493 RSI data, 8.23% is in the overbought position while out of the above 1493, 4.35% is in the below 30 category which indicates the oversold position. 46.08% is below 50 categories which indicates major reversals had taken place. c) Currency: USD/JPY Out of 1413 days, following observations have been noted. Above

Below

70(Overbought)

30(Oversold)

50(Reversal)

693

Thus, it is observed that 4.31% (61 out of 1413) have been the price charts in the overbought position while majorly it has been showing a downtrend, with 49% being below 50 categories. And oversold position being 4.74%.

Out of all the instances where RSI ventured into overbought zone, approximately 10% stretched into higher values above 80 and nearer to 90 levels. However, it was found that higher RSI values invariably resulted into a price correction by approximately 10-20% of the immediately preceding price rise or fall. The same percentage correlation was observed for RSI at lower ranges also. Note: The lows and highs of the RSI will be below 30 and above 70, so when the RSI reaches this level and stays there, you can be sure that when it changes direction and heads closer to 50 then you will see a trend or market reversal.

105

To trade the RSI is to use the number 50 as a center line or deviation line. This means that when the RSI crosses the center line and continues to climb steadily, this could be an indication to buy. Conversely, if the RSI crosses the center line and continues to decline steadily, this could be a good indication to sell. Readings above 70 indicate the prices are overbought and are likely to start falling. Readings below 30 indicate that prices are oversold and a reversal to the bullish side may occur. Additionally, the value of 50, can serve the same purpose as the zero line in other oscillators. The slowing down of a current trend or a trend reversal may be signaled by crossing above or below 50.

Fast Stochastic

Daily charts of currency pairs EUR/USD, GBP/USD, USD/JPY were taken and stochastic data was calculated and compared to the corresponding price movements of the pair for the past 5 years starting from 2004 to 2009. Various time periods were tried for Stochastic and the period of 14 days was found to be more correlated and effective. a)

Currency GBP/USD:

Out of 1411 data, the following observations have been noted. Overbought/Oversold:

%K>80

%K<20

%D>80

%D<20

384

315

294

270

106

In 5 years, the GBP/USD has reached overbought positions 384 times and oversold positions 315 times.

Currency USD/JPY:

Out of 1414 data for 5 years (2004 to 2009), the following observations have been noted. Overbought/Oversold:

%K>80

%K<20

%D>80

%D<20

399

298

388

254

In 5 years, the USD/JPY has reached overbought positions 399 times and oversold positions 298 times. c)

Currency EUR/USD:

Out of 1416 daily data for 5 years (2004 to 2009), following observations have been noted. Overbought/Oversold

%K>80

%K<20

%D>80

%D<20

381

302

368

273

In 5 years, EUR/USD has reached overbought positions 381 times and oversold positions 302 times. It was found that stochastic was highly effective as a momentum indicator and the inter relation between %K and %D line signify loss of momentum or impending correction.

107

It was observed that stochastic oscillator made cyclical highs and lows regardless of the currency being in a bullish or bearish trend or in a consolidation phase. Stochastic oscillator peaks corresponds exactly with the highs registered by the currency price and the same holds true for the stochastic lows. It was observed that nearly half the time the stochastic oscillator was either in overbought or oversold zone. This suggested that in currency market periodic price swings were likely in an interval of approximately two days and traders could prepare themselves for a turn in the immediately preceding trend. But a higher or lower stochastic value should not be interpreted as a signal for complete turnaround in the trend. For example, it was found that in a uptrend the percentage K line which was in the highly overbought zone, many times corrects lower but takes support from the %D level and again moves up. Considerable price appreciation happens during this phase. So, stochastic oscillator is taken as a turnaround signal only in cases where %K line cuts %D line convincingly and proceeds towards the centerline.

3) MACD: Daily charts of EUR/USD, GBP/USD and USD/JPY were taken and MACD data was calculated and compared to the corresponding price movements of the pairs. Various time periods were tried for MACD, and the time periods 26 days and 12 days were found to be more correlated and effective. And for the signal line 9 periods was found to be effective. a) Currency: EUR/USD Out of 1417 data, following observations have been noted. (Year 2004to2009)

108

Positive MACD

Negative MACD

Histogram>0

Histogram<0

784

634

368

b) Currency: GBP/USD Out of 1413 data, following observations have been noted.

Positive MACD

Negative MACD

Histogram>0

Histogram<0

678

736

713

701

c) Currency: JPY/USD Out of 1416 data, following observations have been noted.

Positive MACD

Negative MACD

Histogram>0

Histogram<0

712

705

735

682

phase when MACD crossovers occurred into positive zone and vice versa. The indicator serves as excellent signal for entry and exit point determination. In this case of RSI and Stochastic, extreme values suggest impending correction but not a change in underlying medium or longer term trend. But a MACD crossover helps in identifying trend changes unlike the oscillators and can be reliably consulted before exiting a position. Also when MACD is plotted as a histogram it is easy to observe momentum changes as well as trend changes. 4)

ADX

Daily charts of currency pairs EUR/USD, GBP/USD and USD/JPY were taken and ADX was calculated and compared to the corresponding price movements of the pair. Time period of 14 days was found effective. a) Currency: EUR /USD (Year 2004 to 2009) Out of 1420 data, the following observations have been noted. ADX > 40

ADX < 20

163

494

Low readings, below 20, indicate a weak trend and high readings, above 40, indicate a strong trend. The indicator does not grade the trend as bullish or bearish, but merely assesses the strength of the current trend. A reading above 40 can indicate a strong downtrend as well as a strong uptrend. b) Currency: GBP/USD ADX>40

ADX<20

488

110

In this case, ADX above 40 indicates strong trend, while ADX below 20 indicates weak trend. c) Currency: USD/JPY Out of 1418, the following observations have been noted. ADX > 40

ADX < 20

158

451

+DI and -DI In its most basic form, buy and sell signals can be generated by +DI/-DI crosses. A buy signal occurs when +DI moves above -DI and a sell signal when -DI moves above the +DI. Out of 1421 data, following findings have been noted Currency: EUR/USD (14 periods) [mm/dd/yy] (1/1/2004 to 6/5/2009) O u

Buy Signals ( +DI > -DI)

Sell Signals ( +DI < -DI)

786

635

t .

Currency: GBP/USD Out of 1416 data, the following observations have been noted.

111

Buy Signals ( +DI > -DI)

Sell Signals ( +DI < -DI)

711

705

Currency: USD/JPY Out of 1419 data, the following observations have been noted. Buy Signals ( +DI > -DI)

Sell Signals ( +DI < -DI)

672

747

From the observations made on the three currency pairs, it was found that ADX returned higher values whenever a strong trend in market emerged. ADX moving above 40 could be reliably viewed as emergence of a trend and the price pattern will tell us if a bullish trend or a bearish trend is in place. So whenever ADX moves up above 40 one can safely presume that the bullish or bearish trend which is already in place is likely to strengthen further and the trader can position themselves accordingly. The importance of ADX comes in the fact that for almost 80 percent of the trading sessions markets remain range bound only and the remaining 20 percent of the time moves very fast exhibiting an understandable trend. To utilize the trending up or down moves ADX readings be consulted along with chart patterns studies and other indicators discussed so far. Also, the relationship between +DI and â&#x20AC;&#x201C;DI give buy or sell signals just like MACD crossover and can substitute MACD studies while analyzing the market.

112

Bollinger Bands:

Daily charts of currency pairs EUR/USD, GBP/USD and USD/JPY were taken and Bollinger band was calculated and compared to the corresponding price movements of the pair. Time period of 20 days was found effective.

The closer the prices move to the upper band, the more overbought the market, and the closer the prices move to the lower band, the more oversold the market. Currency: EUR/USD Out of 1416 data, the following observations have been noted.

High Price >= BB upper Low Price>=BB lower band Higher Volatility band 120

(BB up-BB low)>0.05 1338

668

The above table tells the number of times in 5 years, the prices have reached the Bollinger Bands Upper band and the number of times the prices have reached lower band. So it is evident that 120 times, the market is in the overbought and 1338 times it is in the oversold. And the volatility has been high 668 times. Currency: GBP/USD Out of 1411 data, the following observations have been noted.

High Price >= BB upper band

Low Price>=BB lower band

Higher Volatility (BBup-BB low)>0.05

1319

113

1039

The above table tells the number of times in 5 years, the prices have reached the Bollinger Bands Upper band and the number of times the prices have reached lower band. So it is evident that 81 times, the market is in the overbought and 1319 times it is in the oversold. And the volatility has been high 1039 times.

Currency: USD/JPY [mm/dd/yy] (1/2/2004 to 6/1/2009) Out of 1414 data, the following observations have been noted. 92 times the market is in the overbought position and 1307 times in the oversold position. And the volatility has been greater than 5.00, 92 times.

High Price >= BB upper Low Price>=BB lower Higher Volatility band

band

(BB up-BB low)>5.00

1307

Bollinger band study using 20 day period for the Simple moving average and + & two standard deviations for determining upper and lower bands were applied for the currency pairs under study. It was observed that prices tend to remain within the two standard deviation bands created from the moving average. But at the same time whenever the bands contracted it led to a period of large one sided movement on either side. A contracting Bollinger band could therefore be used as a signal of a large movement of prices in offing. Also prices tend to move further in the direction that it has already taken in a narrow band between the SMA and the outer band concerned. This observation can help in locating entry points in a live up or down move.

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Moving Averages

Daily charts of EUR/USD, GBP/USD and JPY/USD were taken and Moving Average data was calculated and compared to the corresponding price movements of the pairs. Various time periods were tried for moving averages and the period 50 for EMA, 100 for SMA and 14 days for WMA was found to be correlated and effective. Currency: EUR/USD Out of 1416 data, the following observations have been noted.

50 EMA > 100 SMA

50 EMA<100 SMA

Last Price>wma

886

535

745

When 50 EMA crosses above 100 SMA, then it shows uptrend, and when it crosses below then it shows downtrend. When prices close above WMA, and when WMA acts as a support line then it shows that it is an uptrend. So 886 times it has been in the upward direction and 535 times it has been in the downward direction. And 745 times, wma has acted as a support line to the price which shows an uptrend. When moving averages were applied, it was observed that the inter relation between a longer term moving average and a shorter term moving average gave a strong clue about the market direction. The 50 day EMA when cut the 100 day SMA towards the upward direction resulted in good upside movements and vice versa. Also, in cases where all three moving averages were aligned parallel and moving in a single direction it resulted in unilateral lasting trends. A cluster of moving averages of varying periods can effectively be used for gauging the strength of upward move or downward. Currency: GBP/USD 115

Out of 1411 data, the following observations have been noted.

50 EMA > 100 SMA

50 EMA<100 SMA

Price>wma

770

625

709

So 770 times it has been in the upward direction and 625 times it has been in the downward direction. And 709 times, wma has acted as a support line to the price which shows an uptrend. Currency: USD/JPY

50 EMA > 100 SMA

50 EMA<100 SMA

Price>wma

762

653

760

So 762 times it has been in the upward direction and 653 times it has been in the downward direction. And 760 times, wma has acted as a support line to the price which shows an uptrend. 7)

Commodity Channel Index (CCI):

Daily charts of EUR/USD, GBP/USD, and USD/JPY were taken and CCI data was calculated and compared to the corresponding price movements of the pairs. The standard time period of 14 days was used for computing the CCI values. Currency: EUR/USD Out of 1420 data, the following observations have been noted. CCI > +100

CCI > -100

371

253

Currency: GBP/USD

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Daily charts of currency pairs EUR/USD, GBP/USD, USD/JPY were taken and CCI data was calculated and compared to the corresponding price movements of the pairs. Out of 1416 data, the following observations have been noted. CCI > +100

CCI > -100

299

271

Currency: USD/JPY Out of 1419 data, the following observations have been noted. CCI > +100

CCI > -100

346

289

A buying signal is generated when the price exceeds the upper (+100) line, and a selling signal occurs when the price dips under the lower (-100) line. A comparison with the corresponding price movement reveals that CCI can be used as a good signal for identifying emergence of bullishness and bearishness in the market. CCI can be used to identify overbought and oversold levels. A security would be deemed oversold when the CCI dips below -100 and overbought when it exceeds +100. But the usefulness of the security comes in identifying bullish & bearish trend and reversal of those trends. 8)

Williams %R

Daily chart of EUR/USD, GBP/USD and USD/JPY were taken and Williams %R was calculated and compared to the corresponding price movements of the pairs. Various time periods were taken and the period 14 days was found to be correlated and effective.

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Currency: EUR/USD Out of 1420 data [mm/dd/yy] (1/2/2004 to 6/8/2009), the following observations have been noted. %R > 80 (Oversold)

%R < 20 (Overbought)

328

388

Currency: GBP/USD Out of 1416 data [mm/dd/yy] (1/2/2004 to 6/8/2009), the following observations have been noted. %R > 80 (Oversold)

%R < 20 (Overbought)

328

388

Currency: USD/JPY Out of 1419 data [mm/dd/yy] (1/2/2004 to 6/8/2009), following observations have been noted. %R > 80 (Oversold)

%R < 20 (Overbought)

289

385

Readings in the range of 80 to 100% indicate that the security is oversold while readings in the 0 to 20% range suggest that it is overbought. The Williams % R was observed to be a highly sensitive indicator showing overbought and oversold conditions. A comparison between RSI and Williams % R reveals that Williams R returns considerably higher number of overbought and oversold positions than the RSI for the same set of data. In first sight though this 118

highly sensitive behavior of the indicator may seem a welcome characteristic. But in practice the high sensitivity makes it very misleading in accurately gauging the overbought and oversold situations. The indicator can well be used for confirming if the reaction movement from the over bought/sold region has started as it captures the movement very early and gives definite signals. The indicator be looked into in cases where RSI is seen stuck in ranges in the overbought/sold levels. This may give vital clues as to if market is going to correct as Williams R being very sensitive to the conditions easily catches the move. 9)

Volume oscillator

When the fast volume MA is higher than the slow volume MA then the Volume Oscillator will be positive, and when the Volume Oscillator is negative the slow volume MA is higher than the fast volume MA. Therefore a positive Volume Oscillator (VO) signals a strong trend while a negative VO signals a weak trend. Currency: EUR/USD Out of 745 data [mm/dd/yy] (8/7/2006 to 6/8/2009), the following observations have been noted. Volume Oscillator > 0

Volume oscillator < 0

414

331

Currency: GBP/USD Out of 741 data [mm/dd/yy] (8/7/2006 to 6/8/2009) the following observations have been noted.

119

Volume oscillator > 0

Volume oscillator < 0

429

312

Currency: USD/JPY Out of 744 data, [mm/dd/yy] (8/7/2006 to 6/8/2009) the following observations have been noted. Volume oscillator > 0

Volume oscillator < 0

405

339

Note: The VO will provide a bullish signal when prices and the VO are rising or, VO and prices are falling. VO will provide a bearish signal when the VO is rising and prices are falling or when the VO is falling and prices are rising. From the observation of currency prices along with the plots of VO it was found that the indicator provides excellent insights into the strength of the market trend that is in place. Observing the indicator along with other indicators serves in judging the exit points in market to very high accuracy. Conclusion: The Bank can include the above mentioned indicators study while analyzing the currency charts for trading as well as cover activities. Instead of relying on chart pattern studies alone, the Bank may use the indicators to ponder deeper into the expected movement in market, its direction, time period and likely exit conditions by considering the indicators as well. The ADX may be used to determine the phase of market ie if the market has a firm trend or if it is in a range the RSI, Williams %R and stochastic may be used to time the market in entry as well as exit points, CCI may be used to track the strength of the existing trend and moving averages and Bollinger Bands can be employed to determine support and resistance levels. Converging chart pattern studies along with indicators analysis makes technical analysis highly effective. 120

Treasury Terminologies Arbitrage It is the process of buying and selling the same securities, more or less simultaneously to profit from a price disparity .In the forex market, arbitrage trades capitalize on forward exchange rates being out of line with the interest differential. Bank rate The bank rate is fixed by RBI for refinance facilities to banks and also the rates of interest paid on cash balances maintained by banks for their CRR obligations. Bid(s) The price at which market makers/buyers want to buy securities or foreign exchange from the market. Cash Reserve Ratio CRR is the percentage of Net Demand and Time Liabilities (NDTL) that scheduled commercial banks must maintain with RBI as cash. Clearing The process of exchanging securities and funds through a clearing house after a trade /deal is concluded. Clearing House An institution /entity which collects securities from sellers and funds from buyer and passes on to the respective counterparties.

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Derivatives Financial instruments or contracts based on an underlying cash instrument. The price of a derivative is a function of price of the underlying instrument or product in the cash market and other variables such as interest rates, time to maturity of the derivative and volatility of prices in the cash market. FEDAI Short for Foreign Exchange Dealersâ&#x20AC;&#x2122; Association of India, a body comprising representatives of the foreign exchange departments of banks and entrusted with the formulation of norms for interbank and merchant forex transactions and self regulation of forex markets. Forward Premium A currency is at a premium in the forward market when fewer amounts can be bought for a forward maturity than spot. Forward Discount Refers to the value of a currency in the forward market, i.e., for future delivery. When a currency is at a discount compared to the spot rate, it is worth less or, in other words, is cheaper to buy in the forward market than for spot settlement. FCNR â&#x20AC;&#x201C;FOREIGN CURRENCY NON RESIDENT ACOUNT -: These are foreign currency deposits maintained by non resident Indians (NRI) and overseas corporate bodies with authorized dealers. FIMMDA Fixed Income Money Market and Derivatives Association of India, a body comprising representatives of the treasury departments of banks and entrusted with

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the responsibility of self regulation of money markets and fixed income and derivative markets. Forward Contracts Forex deals between two currencies to be settled on a future date specified at the time of the deal. Hedging Insulating interest rate exposures from market fluctuations, using derivative instruments like swaps and futures. Liquidity Adjustment Facility (LAF) A facility designed by the RBI to mop up excess liquidity or supply liquidity to the banking system on a daily basis through repo or reverse repo auctions. Net Interest Income (NII) The impact of volatility on the short term profit is measured by Net Interest Income. Net Interest Income= Interest Income- Interest Expense Net Interest Margin (NIM) Net Interest Margin is defined as net interest income divided by average total assets. The net income of banks comes mostly from the spreads maintained between total interest income and total interest expense. The higher the spread the more will be the NIM. Nostro accounts Nostro accounts are foreign currency accounts maintained with correspondent banks to facilitate forex transactions of the bank. 123

Repo/Reverse repo Repo is short for repurchase agreement .A repurchase agreement is a contract to buy securities today and sell them back on a future date at a price fixed today. The transaction is termed as repo for the seller of securities and reverse repo for the buyer of securities. RTGS (Real Time Gross Settlement) The system of clearing trades in securities immediately on completion of a deal Statutory Liquidity Ratio (SLR) The statutory liquidity is the mandatory minimum percentage of Net Demand and Time Liabilities which scheduled commercial banks must invest in notified securities (also called SLR securities) Subsidiary General Ledger A record of ownership of Gsecs/t-bills /state government securities maintained by RBI. This is now in electronic form. SWIFT Society for World Wide Interbank Financial Telecommunication is a co-operative society created under Belgian law and having its corporate office at Brussels. It is a computer guided communication system to rationalize international payment transfers. Vostro Accounts Vostro accounts are rupee accounts maintained by banks outside India with a bank in India to clear and settle their rupee transactions.

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 Bibliography: Websites: o www.Informedtrades.com o www.fxstreet.com o www.investopedia.com o www.rbi.org.in o www.federalbank.co.in o www.fxfriend.com Books: o Treasury and Risk Management in Banks-IIBF o Foreign Exchange Simplified –Srinivasan B o E-BOOKS on Trading Strategies in Forex Market

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