Foreign exchange trading

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Foreign exchange trading is generally conducted in a decentralized manner, with the exceptions of currency futures and options. Foreign exchange has experienced spectacular growth in volume ever since currencies were allowed to float freely against each other. While the daily turnover in 1977 was U.S. $5 billion, it increased to U.S. $600 billion in 1987, reached the U.S. $1 trillion mark in September 1992, and stabilized at around $1,5 trillion by the year 2000.

Main factors influence on this spectacular growth in volume are indicated below.

For foreign exchange, currency volatility is a prime factor in the growth of volume. In fact, volatility is a sine qua non condition for trading. The only instruments that may be profitable under conditions of low volatility are currency options.

Interest Rate Volatility
Economic internationalization generated a significant impact on interest rates as well. Economics became much more interrelated and that exacerbated the need to change interest rates faster. Interest rates are generally changed in order to adjust the growth in the economy, and interest rate differentials have a substantial impact on exchange rates.

Business Internationalization
In recent decades the business world the competition has intensified, triggering a worldwide hunt for more markets and cheaper raw materials and labor. The pace of economic internationalization picked up even more in the 1990s, due to the fall of Communism in Europe and to up-and-down economic and financial development in both Southeast Asia and South America. These changes have been positive toward foreign exchange, since more transactional
layers were added.

Increasing of Corporate Interest
A successful performance of a product or service overseas may be pulled down from the profit point of view by adverse foreign exchange conditions and vice versa. An accurate handling of the foreign exchange may enhance the overall international performance of a product or service. Proper handling of foreign exchange generally adds substantially to the rate of return. Therefore, interest in foreign exchange has increased in the past decade. Many corporations are
using currencies not only for hedging, but also for capitalizing on opportunities that exist solely in the currency markets.

Increasing of Traders Sophistication
Advances in technology, computer software, and telecommunications and increased experience have increased the level of traders' sophistication. This enhanced traders' confidence in their ability to both generate profits and properly handle the exchange risks. Therefore, trading sophistication led toward volume increase.

Developments in Telecommunications
The introduction of automated dealing systems in the 1980s, of matching systems in the early 1990s, and of Internet trading in the late 1990s completely altered the way foreign exchange was conducted. The dealing systems are online computer systems that link banks on a one-to-one basis, while matching systems are electronic brokers. They are reliable and much faster, allowing traders to conduct more simultaneous trades. They are also safer, as traders are able to see the deals that they execute. The dealing systems had a major role in expanding the foreign exchange business due to their reliability, speed, and safety.

Computer and Programming development
Computers play a significant role at many stages of conducting foreign exchange. In addition to the dealing systems, matching systems simultaneously connect all traders around the world, electronically duplicating the brokers' market. The new office systems provide full accounting coverage, ticket writing, back office processing, and risk management implementation at a fraction of their previous cost. Advanced software makes it possible to generate all types of charts, augment them with sophisticated technical studies, and put them at traders' fingertips on a continuous basis at a rather limited cost.




A moving average is an average of a predetermined number of prices over a number of days, divided by the number of entries. The higher the number of days in the average, the smoother the line is. A moving average makes it easier to visualize currency activity without daily statistical noise. It is a common tool in technical analysis and is used either by itself or as an
oscillator.

As one can see from Figure , a moving average has a smoother line than the underlying currency. The daily closing price is commonly included in the moving averages. The average may also be based on the midrange level or on a daily average of the high, low, and closing prices.


Figure MA1. Examples of three simple moving averages—5-day (white), 20-day (red) and 60-day (green).


It is important to observe that the moving average is a follower rather than a leader. Its signals occur after the new movement has started, not before.

There are three types of moving averages:
1. The simple moving average or arithmetic mean.
2. The linearly weighted moving average.
3. The exponentially smoothed moving average.

As described, the simple moving average or arithmetic mean is the average of a predetermined number of prices over a number of days, divided by the number of entries.

Traders have the option of using a linearly weighted moving average (See Figure MA2). This type of average assigns more weight to the more recent closings. This is achieved by multiplying the last day's price by one, and each closer day by an increasing consecutive number. In our previous example, the fourth day's price is multiplied by 1, the third by 2, the second by 3, and the last one by 4; then the fourth day's price is deducted. The new sum is divided by 9, which is the sum of its multipliers.




Figure MA2. Example of a 20-day simple moving average (red) as compared to a 20-day
weighted moving average (white)

The most sophisticated moving average available is the exponentially smoothed moving average. (See Figure 5.37.) In addition to assigning different weights to the previous prices, the exponentially smoothed moving average also takes into account the previous price information of the underlying currency.

Figure MA3. Example of a 20-day simple moving average (red) as compared to a 20-day
exponential moving average (white)