FOREX online news, analysis, healines for forex trading ...: EURO zone

Monday, July 7, 2008

EURO zone

German industrial output May drops strongly, below consensus at -2.4% mom (consensus 0.4%, April -0.8%). Negative April and May IP numbers confirm our view that Q2 GDP will be very weak, probably in negative territory. Meanwhile, ECB President Trichet spoke at an economics conference in France over the weekend and stuck to his comments from last Thursday's ECB meeting. He delivered another passionate defence of the ECB's mandate and warned that price stability remains the ECB's current position. He also said that "a lot of positive remarks" had been received after Thursday's decision and the ECB has reason to be content with the general response. In injecting pragmatism into their tone, the ECB will be able ... more

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Currency

A currency is a unit of exchange, facilitating the transfer of goods and/or services. It is one form of money, where money is anything that serves as a medium of exchange, a store of value, and a standard of value. A currency is the dominant medium of exchange. To facilitate trade between currency zones, there are exchange rates, which are the prices at which currencies (and the goods and services of individual currency zones) can be exchanged against each other. Currencies can be classified as either floating currencies or fixed currencies based on their exchange rate regime. In common usage, currency sometimes refers to only paper money, as in coins and currency, but this is misleading. Coins and paper money are both forms of currency.
In most cases, each country has monopoly control over the supply and production of its own currency. Member countries of the European Union's Economic and Monetary Union are a notable exception to this rule, as they have ceded control of monetary policy to the European Central Bank.

Market participants

Unlike a stock market, where all participants have access to the same prices, the forex market is divided into levels of access. At the top is the inter-bank market, which is made up of the largest investment banking firms. Within the inter-bank market, spreads, which are the difference between the bid and ask prices, are razor sharp and usually unavailable, and not known to players outside the inner circle. As you descend the levels of access, the difference between the bid and ask prices widens (from 0-1 pip to 1-2 pips for some currencies such as the EUR). This is due to volume. If a trader can guarantee large numbers of transactions for large amounts, they can demand a smaller difference between the bid and ask price, which is referred to as a better spread. The levels of access that make up the forex market are determined by the size of the “line” (the amount of money with which they are trading). The top-tier inter-bank market accounts for 53% of all transactions. After that there are usually smaller investment banks, followed by large multi-national corporations (which need to hedge risk and pay employees in different countries), large hedge funds, and even some of the retail forex market makers. According to Galati and Melvin, “Pension funds, insurance companies, mutual funds, and other institutional investors have played an increasingly important role in financial markets in general, and in FX markets in particular, since the early 2000s.” (2004) In addition, he notes, “Hedge funds have grown markedly over the 2001–2004 period in terms of both number and overall size” Central banks also participate in the forex market to align currencies to their economic needs.

Banks
The interbank market caters for both the majority of commercial turnover and large amounts of speculative trading every day. A large bank may trade billions of dollars daily. Some of this trading is undertaken on behalf of customers, but much is conducted by proprietary desks, trading for the bank's own account.
Until recently, foreign exchange brokers did large amounts of business, facilitating interbank trading and matching anonymous counterparts for small fees. Today, however, much of this business has moved on to more efficient electronic systems. The broker squawk box lets traders listen in on ongoing interbank trading and is heard in most trading rooms, but turnover is noticeably smaller than just a few years ago.

Commercial companies
An important part of this market comes from the financial activities of companies seeking foreign exchange to pay for goods or services. Commercial companies often trade fairly small amounts compared to those of banks or speculators, and their trades often have little short term impact on market rates. Nevertheless, trade flows are an important factor in the long-term direction of a currency's exchange rate. Some multinational companies can have an unpredictable impact when very large positions are covered due to exposures that are not widely known by other market participants.

Hedge funds
Hedge funds have gained a reputation for aggressive currency speculation since 1996. They control billions of dollars of equity and may borrow billions more, and thus may overwhelm intervention by central banks to support almost any currency, if the economic fundamentals are in the hedge funds' favor

Retail forex brokers
There are two types of retail broker: brokers offering speculative trading. Retail forex brokers or market makers handle a minute fraction of the total volume of the foreign exchange market. According to CNN, one retail broker estimates retail volume at $25–50 billion daily, which is about 2% of the whole market. Retail traders (individuals) are a small fraction of this market and may only participate indirectly through brokers or banks, and might be subject to forex scams.

Forex analysis

Two analytical models
When the objective of the analysis is to determine what stock to buy and at what price, there are two basic methodologies.

Fundamental analysis maintains that markets may misprice a security in the short run but that the "correct" price will eventually be reached. Profits can be made by trading the mispriced security and then waiting for the market to recognize its "mistake" and reprice the security.

Technical analysis maintains that all information is reflected already in the stock price, so fundamental analysis is a waste of time. Trends 'are your friend' and sentiment changes predate and predict trend changes. Investors' emotional responses to price movements lead to recognizable price chart patterns. Technical analysis does not care what the 'value' of a stock is. Their price predictions are only extrapolations from historical price patterns.
Investors can use both these different but somewhat complementary methods for stock picking. Many fundamental investors use technicals for deciding entry and exit points. Many technical investors use fundamentals to limit their universe of possible stock to 'good' companies.
The choice of stock analysis is determined by the investor's belief in the different paradigms for "how the stock market works". See the discussions at efficient market hypothesis, random walk hypothesis, Capital Asset Pricing Model, Fed model Theory of Equity Valuation, Market-based valuation, and Behavioral finance.

Use by different portfolio styles

Investors may use fundamental analysis within different portfolio management styles.
Buy and hold investors believe that latching onto good businesses allows the investor's asset to grow with the business. Fundamental analysis lets them find 'good' companies, so they lower their risk and probability of wipe-out.
Managers may use fundamental analysis to correctly value 'good' and 'bad' companies. Even 'bad' companies' stock goes up and down, creating opportunities for profits.
Contrarian investors distinguish "in the short run, the market is a voting machine, not a weighing machine"[1]. Fundamental analysis allows you to make your own decision on value, and ignore the market.
Value investors restrict their attention to under-valued companies, believing that 'it's hard to fall out of a ditch'. The value comes from fundamental analysis.
Managers may use fundamental analysis to determine future growth rates for buying high priced growth stocks.

Top-down and Bottom-up
Investors can use either a top-down or bottom-up approach.
The top-down investor starts his analysis with global economics, including both international and national economic indicators, such as GDP growth rates, inflation, interest rates, exchange rates, productivity, and energy prices. He narrows his search down to regional/industry analysis of total sales, price levels, the effects of competing products, foreign competition, and entry or exit from the industry. Only then does he narrow his search to the best business in that area.
The bottom-up investor starts with specific businesses, regardless of their industry/region.
Managers may also include fundamental factors along with technical factors into computer models (quantitative analysis).

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