Australian Dollars

The Australian dollar is a commodity-based currency and is currently the sixth most traded currency in the world currency market (behind the US dollar, the euro, the yen, the British pound and the Swiss franc).

It accounts for approximately 5% of the total volume of foreign exchange transactions (approximately 1.9 trillion dollars a day). Its popularity is due to the fact that there is little government intervention in the currency and a general view that Australia has a stable economy and government.

For much of its history, the Australian dollar was pegged to the British pound however, that changed in 1946, when it was pegged to the US dollar under the Bretton Woods system. When this system broke down in 1971, the AUD moved from a fixed peg to a moving peg to the US dollar.

 Then in September 1974, it moved to a moving peg against a basket of currencies called the TWI (trade weighted index) because of concerns about the fluctuations in the US dollar. This continued until December 1983, when the then Labour government under Prime Minister Bob Hawke and Treasurer Paul Keating floated the Australian dollar.

The  Australian dollar is now governed by its economies terms of trade. Should Australians commodity exports (minerals and farms) increase then the dollar increases. Should mineral prices falls or when domestic spending is greater than exports, then the dollar falls.

The resulting volatility makes the Australian dollar an attractive vehicle for currency speculators and is the reason why it is one of the most traded currencies in the world despite the fact that Australia only comprises 2% of the global economic activity.

Over the last 23 years as a free floating currency, the Australian dollar has usually served as a proxy for gold due to the fact that Australia is the second largest producer of gold after South Africa. Fluctuations in the price of gold have seen corresponding rise and falls in the Australian dollar.

As well as its relationship with gold, like the Canadian and the New Zealand dollars, the Australian dollar is a commodity currency. Agriculture and Resources Economic, commodity sales are expected to total AUD billion or about 55% of Australias exports, hence any movements in commodity prices will effect the Australian dollar.

Expectation over the next few years is for a gradual easing of world economic growth, which should see the price of Australian commodities average lower and result in downward pressure on the Australian dollar especially in late 2006/2007.

It should however be noted, that there is considerable uncertainty in predicting Australian dollar movements since it can be significantly influenced by a change in market sentiment. Since the floating of the Australian dollar in 1983, the currency has fluctuated in an average range of 10 cents a year.

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Stock Exchange Markets Rates

Currencies are traded in pairs and exchanged one against the other when traded, the rate at which they are exchanged is called the exchange rate. The majority of the currencies are traded against the US dollar (USD).

The four next-most traded currencies are the Euro (EUR), the Japanese yen (JPY), the British pound sterling (GBP) and the Swiss franc (CHF). These five currencies make up the majority of the market and are called the major currencies or "the Majors". Some sources also include the Australian dollar (AUD) within the group of major currencies.

The first currency in the exchange pair is referred to as the base currency and the second currency as the counter term or quote currency. The counter term or quote currency is thus the numerator in the ratio, and the base currency is the denominator.

The value of the base currency (denominator) is always 1. Therefore, the exchange rate tells a buyer how much of the counter term or quote currency must be paid to obtain one unit of the base currency.

The exchange rate also tells a seller how much is received in the counter term or quote currency when selling one unit of the base currency. For example, an exchange rate for EUR/USD of 1.2083 specifies to the buyer of euros that 1.2083 USD must be paid to obtain 1 euro.

At any given point, time and place, if an investor buys any currency and immediately sells it - and no change in the exchange rate has occurred - the investor will lose money.

 The reason for this is that the bid price, which represents how much will be received in the counter or quote currency when selling one unit of the base currency, is always lower than the ask price, which represents how much must be paid in the counter or quote currency when buying one unit of the base currency.

For instance, the EUR/USD bid/ask currency rates at your bank may be 1.2015/1.3015, representing a spread of 1000 pips (also called points, one pip = 0.0001), which is very high in comparison to the bid/ask currency rates that online Forex investors commonly encounter, such as 1.2015/1.2020, with a spread of 5 pips.

In general, smaller spreads are better for Forex investors since even they require a smaller movement in exchange rates in order to profit from a trade.

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Forex Price Dynamics

In order to gain an understanding of what actually moves the prices, or exchange rates in the interbank market, we must first understand that for any transaction to take place, there must be a buyer and there must be a seller – there must be a counter party for every trade.

Open interest in the forex can be loosely defined as the combination of all resting (limit) orders. Many market participants set such orders either above (sell limit) or below the current price (buy limit). These orders are to be filled only when price reaches the set level. For example, say we are trading EUR/USD and the current bid price is at 1.2500.

We set a sell limit order at 1.2501. When will our order get triggered? Once all the sell orders at 1.2500 have found buyers, the bid price will move up to the next available level, which is 1.2501. Once buyers enter the market at that price (they would actually be paying the ask price, and the broker would collect the difference), they become the counter party to our trade and our order is filled.

 One way to look at it is that there are essentially 2 types of orders: limit orders and market orders. There are other types, but they can always be classified as sub-types of these two. Limit orders are set to execute if and only if a set price level is reached, while market orders are set to execute at the current market price. Alternately, limit orders can be described as providing open interest, while market orders can be described as consuming open interest. This is a very important distinction because it is the backbone of price dynamics.

It should be noted that the only relationship between bid and ask prices is that the ask price, by its definition, should never be lower than the bid price. In every other aspect, the two are unrelated, so the spread between the two varies according to where the open interest lies.

During times of low liquidity there may be no one interested in buying above 1.2450 and no one interested in selling below 1.2550, making the spread 100+ pips. This is not necessarily the product of shady dealer practices (though at the retail level it may be), but is more likely caused my normal market mechanics – all open interest was either consumed by market orders, or withdrawn (limit orders can be cancelled before they are executed).

This type of situation normally happens when important, unexpected information enters the market, such as an NFP reading that is way off the mark. In that case, open interest in one direction will be consumed by a barrage of market orders, and open interest in the other direction will be withdrawn by market participants cancelling their orders.

This is equivalent to saying that liquidity is “drying up”, and that the bid price will gap down until it finds a buy limit order, and likewise, the ask price will jump up until it reaches a sell limit order. Note that no one has come in and “set” the spread.

The spread is not a parameter that can be set, but is rather the result of market mechanics at their most basic level. It also should not be a surprise that, although today’s technology is lightning fast, there are delays between market order entry and execution, during which time the open interest at the desired level can be consumed, particularly in fast moving markets.

In such circumstances, there is no longer a counterparty to take the market order at the desired level, and it can either be filled at a worse price (slippage), or it can be re-quoted. Again, this is not necessarily indicative of any malpractice by your broker, but is more often than not a natural result of market mechanics and the delays inherent in communication media.

It should be noted however, that once prices have moved through several tiers and they reach the retail level, they may or may not have been “massaged” by someone along the way (a practice known as price shading). This is the reason many quote for their preference in trading through an ECN rather than a traditional retail broker. In reality, there are advantages and disadvantages to both. You can explore exactly how and why this is true in our follow-up article How Forex Brokers Work.

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How to Choose a Forex Broker

Choosing a good forex broker is one of the most important decisions you need to make at the beginning (or at any point) of your forex trading career. Do not take this decision lightly, but at the same time don’t stress over it – the process does not need to be complicated – just like in your trading decisions, once you do your homework, things tend to fall into place.

Chance favors the prepared trader and everything you need to make an informed decision is listed right here. All you have to do is follow the advice given and you will find yourself a broker that suits your needs.

Regulation

The first thing you need to do is check whether the broker is regulated. The fact that the forex market itself is not regulated opens the door to a lot of possibilities for a scheming mind.

There are shifty brokers out there, ranging from outright scams to just badly run businesses which are not accountable to any regulatory body. The brokers who are regulated choose to be so, in order to add a layer of legitimacy to their reputation. Please do NOT fund any accounts with an unregulated forex broker.

There are not many good reason to do so, and plenty of reasons not to. It just makes sense.

Most forex brokers, even if they are not based in the United States, are members of the NFA and registered Futures Commission Merchants (FCMs) with the CFTC.

The UK based Financial Services Authority (FSA) is also a well respected regulating body, as is CySEC (Cyprus), ARIF (Switzerland), ASIC (Australia) and SFC (Hong Kong) among others.

Just because a firm writes on their website that they are regulated however, does not make it so. Always check the websites of the regulating bodies themselves – they all offer a searchable database that allows visitors to find regulated members by name

NFA/CFTC:http://www.nfa.futures.org/basicnet/

FSA:http://www.fsa.gov.uk/register/home.do

ARIF:http://www.arif.ch/en/membres.htm

CySEC:http://www.cysec.gov.cy/licence_members_1_en.aspx

ASIC:http://www.search.asic.gov.au/gns001.html

SFC:http://www.sfc.hk/sfcprd/eng/pr/html/PR002.jsp?charset=ISO8859_1

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Structure of forex brokers in the markets..!!!

The forex is unique among financial markets in a number of ways. One of these is that it was not traditionally used as an investment vehicle. It had, and still maintains to some extent, a somewhat more utilitarian purpose.

In today’s globalized economy, most businesses have some international exposure, creating the need to exchange one currency for another in order to complete transactions.

For example, Honda builds its cars in Japan and exports them to the United States, where an eager American buyer exchanges his dollars for a brand new Honda. Some of this money has to make its way back to Japan to pay the factory workers that built the car, but first those dollars have to be exchanged for Japanese yen, since that is the currency the Japanese factory workers are paid in.

Transactions such as this are facilitated by international banks and are done through a mechanism known as the foreign exchange market, or forex. Since banks are used to facilitate these cross-border transactions, they naturally want to be paid for their services.

 This payment comes in the form of a bid/ask spread – offering to buy the desired currency at a slightly lower price than they are willing to sell it at, and pocketing the difference. Considering the fact that more than $3bn moves through the forex market daily, these seemingly small fees can add up to a significant sum.

Since the 1970’s most of the world’s major currencies have been on a (mostly) free-floating exchange mechanism, allowing for exchange rates to be determined by market forces, that is, supply and demand. I say “mostly” because there have been times when major central banks have intervened in the market to manipulate exchange rates by either buying or selling large amounts of their currency, but normally this only takes place in extreme situations.

There are also other central banks that choose to manage their currencies much more strictly, but these are a minority in the developed world. So in most cases, this free-floating exchange rate mechanism allowed currencies to fluctuate against one another much more, and this in turn opened the door to speculation on the future movement of exchange rates.

The banks’ intimate knowledge of the forex market, and their high level of capitalization allowed them to be the first to speculate in the forex market, and to significantly increase their profits by doing so. An unfortunate consequence of this speculation however was that liquidity at certain times became scarce, and some necessary transactions could not be completed. In order to solve this problem, banks turned to expanding the number of participants in the market to include non-banks, thereby generating sufficient order flow (liquidity distribution) to complete clients’ transactions, and also to profit from these newer and less knowledgeable market participants.

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How forex brokers work

Like any other business in the history of business, your broker’s raison d’etre, is to make as big a profit as possible. There are about as many ways to go about this as there are brokers.

 For those who are in it for the long haul, however, it is generally best to adopt a set of practices which are deemed fair by their clients: certain boundaries are set, and operating beyond them can cost a brokerage its reputation, and along with it its clients. Straying outside these boundaries, therefore, is not considered as being in line with the long term goals of the business.

How strictly these boundaries are enforced, especially when there is little chance of clients ever even becoming aware of any transgression, again varies from business to business. For the sake of simplicity, in this article we assume that everyone in the business is squeaky clean, as if every client could peek into the broker’s back office at any time and dissect every trade. This is obviously not the case, and many brokers do take advantage of this opaqueness, but the details of that are best left for another discussion.

So without further ado, let’s get into the details of how forex brokers function. Somewhat removed from the top-tier interbank market, retail forex brokers are there to provide a service that would otherwise not be available, that is, giving an investor with a $10,000 bankroll the chance to speculate in the up-until-recently very exclusive forex market. There are generally considered to be 2 types of brokers providing access at the retail level: Electronic Communications Networks (ECNs) and Market Makers.

ECNs are generally somewhat more exclusive, requiring larger deposits to get started, but are seen as providing more direct access to the interbank market. As we will see, there are certainly advantages to this, but some disadvantages as well.

Market makers, on the other hand are more often than not, the counter party to their clients’ trades, creating somewhat of a conflict of interest, whereas ECNs profit from commission fees charged directly to the clients, regardless of the result of any trade, they are seen as being completely impartial – an ECN has no incentive for a client to lose money.

In fact, one could argue that an ECN stands to profit more if a client is successful, meaning that s/he will stay around longer and they will be able to collect more commission fees from them. A market maker, on the other hand, being the counterparty to a client’s trade, makes money if the client loses money, providing an incentive for some shady practices.

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