Forex and Real Estate

• Getting inside the forex market

• Understanding that speculating is the name of the game

• Trading currencies around the world

• Linking other financial markets to currencies

The foreign exchange market — most often called the forex market, or simply the FX market — is the most traded financial market in the world. We like to think of the forex market as the “Big Kahuna” of financial markets. The foreign exchange market is perhaps the most interesting of all markets, as it is one of the few markets where the sheer size of the market makes it almost impossible for any one person, institution or government to control.

The forex market is the crossroads for international capital, the intersection through which global commercial and investment flows have to move. International trade flows, such as when a Swiss electronics company purchases Japanese-made components, were the original basis for the development of the forex markets. Today, however, global financial and investment flows dominate trade as the primary non-speculative source of forex market volume. Whether it’s an Australian pension fund investing in U.S. Treasury bonds, or a British insurer allocating assets to the Japanese equity market, or a German conglomerate purchasing a Canadian manufacturing facility, each cross-border transaction passes through the forex market at some stage.

More than anything else, the forex market is a trader’s market. It’s a market that’s open around the clock six days a week, enabling traders to act on news and events as they happen. It’s a market where half-billion-dollar trades can be executed in a matter of seconds and may not even move prices noticeably. Try buying or selling a half billion of anything in another market and see how prices react.

Traditionally, currency trading has been a 'professionals only' market available exclusively to banks and large institutions, however, because of the rise of the new E-economy, online Forex trading firms are now able to offer trading accounts to 'retail' traders like you and I. Now almost anyone with a computer and an Internet connection can trade currencies just like the world's largest banks do. There are now over 6 million trading accounts worldwide up from 1.7million in 1997.

Getting Inside the Numbers

Average daily currency trading volumes exceed $2 trillion per day. That’s a mind-boggling number, isn’t it?
$2,000,000,000,000 — that’s a lot of zeros, no matter how you slice it. To give you some perspective on that size, it’s about 10 to 15 times the size of daily trading volume on all the world’s stock markets combined.

The Spot Market

The spot or cash market is the actual price of a currency at that moment in time - the price for immediate delivery. A trader will contact his broker or bank and ask for a price for the pair of currencies he wants to trade. A spot contract is a contract between two parties who exchange an agreed upon amount of two currencies at an agreed upon exchange rate. The normal delivery time for a forex contract is two days. With the exception of the Canadian dollar which is one day.

The reason for the two days for deliver was established long before modern technology and sufficient time was needed to verify all the details of the transaction. Nowadays, transactions are concluded in fractions of a second. Transactions are normally concluded via telephone or automated dealing desks. When using the telephone to transact a trade it is important to know the correct etiquette. This can differ dramatically from broker to broker or bank to bank. It is important that you first contact your broker or bank and ask for the correct procedure for placing orders.

Speculating in the currency market

While commercial and financial transactions in the currency markets represent huge nominal sums, they still pale in comparison to amounts based on speculation. By far the vast majority of currency trading volume is based on speculation — traders buying and selling for short-term gains based on minute-to-minute, hour-to-hour, and day-to-day price fluctuations. Estimates are that upwards of 90 percent of daily trading volume is derived from speculation (meaning, commercial or investment-based FX trades account for less than 10 percent of daily global volume).

The depth and breadth of the speculative market means that the liquidity of the overall forex market is unparalleled among global financial markets. The bulk of spot currency trading, about 75 percent by volume, takes place in the so-called “major currencies,” which represent the world’s largest and most developed economies. Additionally, activity in the forex market frequently functions on a regional “currency bloc” basis, where the bulk of trading takes place between the USD bloc, JPY bloc, and EUR bloc, representing the three largest global economic regions.

Getting liquid without getting soaked

Liquidity refers to the level of market interest — the level of buying and selling volume — available at any given moment for a particular asset or security. The higher the liquidity, or the deeper the market, the faster and easier it is to buy or sell a security. From a trading perspective, liquidity is a critical consideration because it determines how quickly prices move between trades and over time.

A highly liquid market like forex can see large trading volumes transacted with relatively minor price changes. An illiquid, or thin, market tends to see prices move more rapidly on relatively lower trading volumes. A market that only trades during certain hours (futures contracts, for example) also represents a less liquid, thinner market.

Trading Times

The forex market is open and active 24 hours a day from the start of business hours on Monday morning in the Asia-Pacific time zone straight through to the Friday close of business hours in New York. At any given moment, depending on the time zone, dozens of global financial centers — such as Sydney, Tokyo, or London — are open, and currency trading desks in those financial centers are active in the market. Currency trading doesn’t even stop for holidays when other financial markets, like stocks or futures exchanges, may be closed.

Even though it’s a holiday in Japan, for example, Sydney, Singapore, and Hong Kong may still be open. It might be the Fourth of July in the United States, but if it’s a business day, Tokyo, London, Toronto, and other financial centers will still be trading currencies. About the only holiday in common around the world is New Year’s Day, and even that depends on what day of the week it falls on.

The opening of the trading week

There is no officially designated starting time to the trading day or week, but for all intents the market action kicks off when Wellington, New Zealand, the first financial center west of the international dateline, opens on Monday morning local time. Depending on whether daylight saving time is in effect in your own time zone, it roughly corresponds to early Sunday afternoon in North America, Sunday evening in Europe, and very early Monday morning in Asia.

The Sunday open represents the starting point where currency markets resume trading after the Friday close of trading in North America (5 p.m. Eastern time). This is the first chance for the forex market to react to news and events that may have happened over the weekend. Prices may have closed New York trading at one level, but depending on the circumstances, they may start trading at different levels at the Sunday open.

Trading in the Asia-Pacific session

Currency trading volumes in the Asia-Pacific session account for about 21 percent of total daily global volume, according to a 2004 survey. The principal financial trading centers are Wellington, New Zealand; Sydney, Australia; Tokyo, Japan; Hong Kong; and Singapore. In terms of the most actively traded currency pairs, that means news and data reports from New Zealand, Australia, and Japan are going to be hitting the market during this session Because of the size of the Japanese market and the importance of Japanese data to the market, much of the action during the Asia-Pacific session is focused on the Japanese yen currency pairs (explained more in Chapter 2), such as USD/JPY – forexspeak for the U.S. dollar/Japanese yen -- and the JPY crosses, like EUR/JPY and AUD/JPY.

Of course, Japanese financial institutions are also most active during this session, so you can frequently get a sense of what the Japanese market is doing based on price movements. For individual traders, overall liquidity in the major currency pairs is more than sufficient, with generally orderly price movements. In some less liquid, non-regional currencies, like GBP/USD or USD/CAD, price movements may be more erratic or nonexistent, depending on the environment.

Trading in the European/London session

About midway through the Asian trading day, European financial centers begin to open up and the market gets into its full swing. European financial centers and London account for over 50 percent of total daily global trading volume, with London alone accounting for about one-third of total daily global volume, according to the 2004 survey. The European session overlaps with half of the Asian trading day and half of the North American trading session, which means that market interest and liquidity is at its absolute peak during this session.

News and data events from the Eurozone (and individual countries like Germany and France), Switzerland, and the United Kingdom are typically released in the early-morning hours of the European session. As a result, some of the biggest moves and most active trading takes place in the European currencies (EUR, GBP, and CHF) and the euro crosscurrency pairs (EUR/CHF and EUR/GBP). Asian trading centers begin to wind down in the late-morning hours of the European session, and North American financial centers come in a few hours later, around 7 a.m. ET.

Trading in the North American session

Because of the overlap between North American and European trading sessions, the trading volumes are muchmore significant. Some of the biggest and most meaningful directional price movements take place during this crossover period. On its own, however, the North American trading session accounts for roughly the same share of global trading volume as the Asia-Pacific market, or about 22 percent of global daily trading volume. The North American morning is when key U.S. economic data is released and the forex market makes many of its most significant decisions on the value of the U.S. dollar. Most U.S. data reports are released at 8:30 a.m. ET, with others coming out later (between 9 and 10 a.m. ET).

Canadian data reports are also released in the morning, usually between 7 and 9 a.m. ET. There are also a few U.S. economic reports that variously come out at noon or 2 p.m. ET, livening up the New York afternoon market. London and the European financial centers begin to wind down their daily trading operations around noon eastern time (ET) each day. The London, or European close, as it’s known, can frequently generate volatile flurries of activity. On most days, market liquidity and interest fall off significantly in the New York afternoon, which can make for challenging trading conditions.

On quiet days, the generally lower market interest typically leads to stagnating price action. On more active days, where prices may have moved more significantly, the lower liquidity can spark additional outsized price movements, as fewer traders scramble to get similarly fewer prices and liquidity. Just as with the London close, there’s never a set way in which a New York afternoon market move plays out, so traders just need to be aware that lower liquidity conditions tend to prevail, and adapt accordingly.

Currencies and Other Financial Markets

As much as we like to think of the forex market as the be all and end all of financial trading markets, it doesn’t exist in a vacuum. You may even have heard of some these other markets: gold, oil, stocks, and bonds. There’s a fair amount of noise and misinformation about the supposed interrelationship among these markets and currencies or individual currency pairs. To be sure, you can always find a correlation between two different markets over some period of time, even if it’s only zero (meaning, the two markets aren’t correlated at all).

Always keep in mind that all the various financial markets are markets in their own right and function according to their own internal dynamics based on data, news, positioning, and sentiment. Will markets occasionally overlap and display varying degrees of correlation? Of course, and it’s always important to be aware of what’s going on in other financial markets. But it’s also essential to view each market in its own perspective and to trade each market individually. Let’s look at some of the other key financial markets and see what conclusions we can draw for currency trading.

Gold

Gold is commonly viewed as a hedge against inflation, an alternative to the U.S. dollar, and as a store of value in times of economic or political uncertainty. Over the long term, the relationship is mostly inverse, with a weaker USD generally accompanying a higher gold price, and a stronger USD coming with a lower gold price. However, in the short run, each market has its own dynamics and liquidity, which makes short-term trading relationships generally tenuous. Overall, the gold market is significantly smaller than the forex market, so if we were gold traders, we’d sooner keep an eye on what’s happening to the dollar, rather than the other way around. With that noted, extreme movements in gold prices tend to attract currency traders’ attention and usually influence the dollar in a mostly inverse fashion.

Oil

A lot of misinformation exists on the Internet about the supposed relationship between oil and the USD or other currencies, such as CAD or JPY. The idea is that, because some countries are oil producers, their currencies are positively (or negatively) affected by increases (or decreases) in the price of oil. If the country is an importer of oil (and which countries aren’t today?), the theory goes, its currency will be hurt (or helped) by higher (or lower) oil prices. Correlation studies show no appreciable relationships to that effect, especially in the short run, which is where most currency trading is focused.

When there is a long-term relationship, it’s as evident against the USD as much as, or more than, any individual currency, whether an importer or exporter of black gold. The best way to look at oil is as an inflation input and as a limiting factor on overall economic growth. The higher the price of oil, the higher inflation is likely to be and the slower an economy is likely to grow. The lower the price of oil, the lower inflationary pressures are likely (but not necessarily) to be. We like to factor changes in the price of oil into our inflation and growth expectations, and then draw conclusions about the course of the USD from them. Above all, oil is just one input among many.

Stocks

Stocks are microeconomic securities, rising and falling in response to individual corporate results and prospects, while currencies are essentially macroeconomic securities, fluctuating in response to wider-ranging economic and political developments. As such, there is little intuitive reason that stock markets should be related to currencies. Long-term correlation studies bear this out, with correlation coefficients of essentially zero between the major USD pairs and U.S. equity markets over the last five years.

The two markets occasionally intersect, though this is usually only at the extremes and for very short periods. For example, when equity market volatility reaches extraordinary levels (say, the Standard & Poor’s loses 2+ percent in a day), the USD may experience more pressure than it otherwise would — but there’s no guarantee of that. The U.S. stock market may have dropped on an unexpected hike in U.S. interest rates, while the USD may rally on the surprise move.

Bonds

Fixed-income or bond markets have a more intuitive connection to the forex market because they’re both heavily influenced by interest rate expectations. However, short-term market dynamics of supply and demand interrupt most attempts to establish a viable link between the two markets on a short-term basis. Sometimes the forex market reacts first and fastest depending on shifts in interest rate expectations. At other times, the bond market more accurately reflects changes in interest rate expectations, with the forex market later playing catch-up.

Overall, as currency traders, you definitely need to keep an eye on the yields of the benchmark government bonds of the major-currency countries to better monitor the expectations of the interest rate market. Changes in relative interest rates (interest rate differentials) exert a major influence on forex markets.