babypips

Getting down and dirty with the exchange rate system
Exchange rate systems can be classified under the two broad categories of fixed and floating rates. In real life, exchange rate mechanisms are a mix of these, with some countries having abandoned exchange rates completely due to macro economic crisis. This phenomenon occurs when a nation loses faith in its own currency and adopts another currency as a medium of exchange. The usual choice for such currencies is the US dollar and the phenomenon is often termed as the Dollarization of the economy.

Fixed rate system
Broadly, there are three types of fixed rate systems in existence. The first is a currency board, which is a rigidly fixed system. The second is a traditional fixed rate system, which has some inbuilt flexibility. The third is a currency peg, which allows minor fluctuations in the currency value.

Currency board
The currency board is an arrangement by which, the value of a currency is fixed by the government and the nation undertakes to exchange the designated foreign currency for the local currency at the fixed rate. This implies that the quantum of domestic currency is based on the amount of designated foreign currency held by the nation. Intuitively, this also means that the nation does not issue its currency by fiat and thus does not follow an independent monetary policy. The currency board is well suited to nations that wish to instill confidence in their currency or may have been through a macroeconomic crisis. The Hong Kong dollar and the Argentinean Peso are prime examples of a currency board.

Fixed rate system or the currency peg
The currency peg traditionally is not as rigid as the currency board. Under this system, the government or the central bank undertakes to buy and sell foreign exchange at the fixed rate. The key difference between the currency board and the fixed rate system is that the latter allows periodic adjustments in the exchange rate.

The crawling peg
The crawling peg is another form of fixed exchange rate system that allows a narrow fluctuation of about 1% to 2% in the currency value. Under the crawling peg, the domestic currency can be pegged to a single foreign currency or a basket of foreign currencies. The narrow fluctuation band permitted under this system reduces the need for frequent interventions by the central bank to keep the value stubbornly fixed. The Bahamas and Marshall Islands have pegged their currencies to the U.S. dollar; Niger and Senegal to the French franc; and Bangladesh, Czech Republic and Thailand to a basket of several select currencies.

The currency peg systems allow some autonomy to central banks in following independent monetary policies. At the same time, the fixed rates also put a restrain on the central banks from following too loose a monetary policy.

The fixed exchange rate systems are attractive to foreign investors they cover their exchange rate risk. The system also helps keep inflation low, which in turn leads to low interest rates. This helps establish a virtuous cycle of investment and economic growth.

The floating exchange rate system
This kind of exchange rate system is a market friendly system, where the value of the currency is determined by market forces. Supply of the currency and demand for it help determine the value of the currency. Such systems are usually found in mature economies like the US, Europe and Japan. Under this system, it is usually unlikely for the central bank to intervene in the forex markets. The central banks intervene only if any wide and unexpected fluctuations occur in the currency value.

In theory the floating rate system is best equipped to correct any imbalances in an economy. Let’s understand this via a case study:

• Let’s assume that an economy has been hit by a slowdown.
• Slowdown implies reduction in employment and contraction of demand
• Contraction in demand will imply a lower demand for the local currency for buying goods and services
• This will lead to depreciation in the local currency
• Depreciation of the local currency will make imports more expensive
• This will stimulate demand for local goods and services and help generate employment in the local economy; (a self correction mechanism of imbalances in the case of floating rates)

Adoption of the floating exchange rate system requires great prudence in both the monetary and fiscal policies and such systems are best suited to mature economies.

Managed float
The managed float is a system, which allows the currency to float, but currency stability is managed by the central bank. Under this system the currency is allowed to move in response to macroeconomic parameters, but the central bank frequently uses open market operations to cushion sudden and wide fluctuations. Nations that have adopted a managed float are usually transitioning economies, which plan to achieve the full float as their economies mature further. Nations following a managed float, usually have sufficient autonomy to follow their own independent monetary policies. Prime examples include India, Taiwan and Venezuela.

Dollarization and the dual exchange rate system
Certain nations adopt the dollar as the medium of exchange officially or unofficially, once their own currencies become worthless. Zimbabwe is a nation, where the economy stands dollarized, and a majority of transactions are dollar denominated, with its own currency having lost its value due to hyperinflation. Inflation in Zimbabwe is running at over 350,000% and prices in the local currency double once every week or even faster rendering the local currency worthless.

While, the Zimbabwe government chose to maintain an official exchange rate pegged to the dollar, in reality, the black market determines the true value of the local currency and this is usually the reference rate for business transactions. This implies that there exists a dual exchange rate system, the official exchange rate and the unofficial exchange rate. This in itself leads to further black market activities due to the arbitrage opportunity presented by the two exchange rates and leads to further erosion of faith in the local currency.

by Forex Gump - babypips.com

Has The Dollar Hit Its Trough?

That’s a billion dollar question. Let’s analyze the signals and economic environment in a comparative global context to see if the dollar trough is here or if there is room for it to depreciate further. Amongst other factors, the value of a currency is determined by the demand for the currency. Following are some of the key underlying factors which impact the demand and value of the dollar. A close review of these factors can provide some insight into the future value of the dollar.

* The US housing bust
* Interest rates
* Foreign investments into US treasuries
* US current account deficit
* Dollar as a world reserve currency

The housing bust
The US housing bust seems to have triggered the current recessionary state of the US economy. Though the direct exposure of the GDP to housing may be limited to 5%, this time around the risk seems to have been spread much wider. The risk had actually been spread with the objective of de-risking; however, it seems to have wreaked much havoc with the economy.

The exotic loans that were offered, allowed buyers to pay minimal amounts in the initial years and the payments were to move up after this initial period in accordance with the prevailing interest rates. We all know that interest rates shot up and prices collapsed. Home owners found themselves in a position termed as ‘upside down’, where the outstanding loans were greater than the re-sale value of the home. At the same time, recessionary tendencies are leading to rising unemployment and inflation is leaving less disposable income in the hands of the consumers. This can lead to a situation of mass foreclosures and leave lenders with a stock of homes, which are lower in value than the outstanding loans. Estimates by experts suggest that the bundling of home-mortgage loans into other instruments has increased the exposure of this sector close to 40% of the economy. Thus, mass foreclosures could have grave repercussions on the US economy and a large number of players in the financial sector could be forced into bankruptcy. Such a collapse could immediately push the US economy into deep recession, forcing the Fed to cut interest rates further. We all know that the dollar could be hit further if such a scenario were to unfold.

Interest rates, US treasuries and the current account deficit
The US current-account deficit has reached a staggering $1 trillion a year. A huge current account deficit implies that the demand for imports is greater than the exports. This means that the demand for foreign currency is greater than the domestic currency, which should lead to depreciation in the dollar. However, the US has run huge current account deficits for the past several years and maintained a strong dollar at the same time. The US has managed to do this by attracting nearly $60 to 70 billion monthly capital inflows via investments in to US treasuries. Nations such as Japan, Middle Eastern countries, and China traditionally have ploughed back their earnings from exports to the US and elsewhere into US government treasuries. This had set up a virtuous cycle, where the huge US current account deficit was financed by capital inflows and had become sustainable. However, now with the US having cut interest rates sharply, investments in US treasuries may not be attractive enough for these other nations. If these nations were to stop investing in US treasuries, the demand for the US dollar may decline considerably and lead to a further depreciation in the dollar.

Dollar as a world reserve currency
The American dollar has for long enjoyed the position of the world’s reserve currency. A majority of the world’s central banks hold vast dollar reserves to provide a backing to their currencies. Rough estimates put other central bank dollar holdings at about 70%, with the balance being held in Euros or other currencies. At the same time a majority of international trade has been dollar denominated. This includes pricing in dollar terms for commodities, oil, metals and a majority of other goods and services. The recent rapid depreciation in the dollar implies that the value of reserves held by central banks has dwindled. At the same time a weaker dollar means that returns on exports are on the fall. Earlier, there was no concrete alternative to the dollar as a reserve currency. But with the advent of the Euro, which is backed by an economy nearly as large as the US economy, the dollar has faced considerable challenge. A rapidly falling dollar could trigger greater usage of the Euro as a reserve currency. If central banks were to reduce their US dollar holding by a mere 5%, a massive sale of dollars could lead to a further depreciation in the currency.

Implications for the forex trader
Forex traders need to carefully evaluate the parameters like interest rates, the housing bubble and the status of the dollar as a reserve currency, before taking a position on the dollar. It appears that the dollar is fairly low in value at this time, but the worst may not be over as yet. The outcome of the Fed meeting scheduled for late April 2008 is also likely to announce one final rate cut. After this cut, it may be difficult for the Fed to cut rates further due to the inflationary tendency in the economy.

Dr. Pipslow - babypips

It's Not the Size of the Fish But... Oh, Wait
During my very early days of currency trading my mind was running wild with the ideas and dreams of what I was going to do with my soon-to-arrive riches. Sound familiar? But I wasn't dreaming of a dollar here or a dollar there, but some serious cash money. I knew that I only needed a few monster winning trades to help me realize my then fantasies, and then the world was for my taking! Muuu-haha, muu-haha, muu-haha (imagine Dr.Evil/Austin Powers laughing).

Big trades weren't going to be easy or commonplace, I knew this. If they were, then everybody and their mothers would be here trading right along side me. And they weren't. So, I'd have to wait and be patient, and watch for the right signals and listen for that one hot tip. And then BAM! I'd get in low, wait for price to skyrocket, and then get out just before the masses new what hit them. SO EASY...

But did it happen that way? No.

And does it usually happen that way. Well, for a few, yes. But for the rest us (and the more common), of course not.

But who doesn't dream of being in the right place at the right time? Who doesn't dream of that rare elephant-sized gain? Again, it's normal and wishful, but not always realistic. Sure, yearning for that winning opportunity will motivate a trader to build his skill in hopes of becoming a trading master. But it's not going to be that rare trade that he waits forever for that transforms him into a profitable trader. For the most part, a trader's success will be defined by the many smaller, almost "boring", winning trades that are made and hopefully become regular. Although small profits, they are just as significant as the larger and more thrilling trades.

It's often times never realized that the many smaller trades provide just as much if not more to a new trader than a big win that hits only once every third full moon. Many novice traders make the small trades one after another with no real gains to show.

One pip here, six pips there... and so on.

They feel they've hit a level of experience that just can't be surpassed by making these small moves. But no matter how petite the trade, each trade provides another examination of the market and another test of the strategy and trader's skill. These trades all provide a new insight that ultimately aids in gaining more market experience and adding to that bag of knowledge.

Whether it's finally learning to identity a particular candlestick pattern and then better forecasting a price move to being risk-conscious by always placing a stop, the small experiences we have and learn along the way matter a great deal.

We all know that currency trading can be difficult, requiring various levels of commitment, whether financial, physical or mental. Many novice traders give up earlier after being smacked in face (figuratively), but there are those who make it. The surviving traders are still there because they have their systems in place; they're cool, calm and collect when dealing with the market and its uncertainties. They stay focused on their plan or strategy and they stay away from the risky and unrealistic trades and profit goals. They understand the risks involved with each position they take, and that losses are inevitable, but they look for the high profitability trades with minimized risk. It's always a calculated move, not driven my emotion. Now, it may not be World Cup type action, but the small profits are there. In the end, the many smalls add up to a very big.

Don't get disheartened if you feel you aren't progressing as you should be. Stay focused on making profits, no matter how small they are. You want to keep the capital on the positive side and continue to be able to make trades. That's the important part. You add more to your bag of knowledge when you're actually acting, and making a real trade. In the beginning, profits may not exist or may be small, but remember that a single pip gain is still a gain. And not a loss!

babypips

4 Reasons Why Traders Lose
Why do certain traders win consistently lose? Here are four reasons:

1. Not having a proven trading methodology

Those who consistently lose don’t know key numbers. They have no understanding of support and resistance. Chart patterns are foreign to them. Their definition of risk management is getting margin called. With no proven trading method or strategy, you are doomed to fail. You will end up quitting the game after a string of losses. But there is hope. With the right education, a workable method, psychological balance and persistence, it can be done.

2. Not understanding how the market works, key indicators, key numbers, and ideal times to trade.

When you place a trade, you literally go toe-to-toe against some of the biggest nerds in the world. Many professional traders are not only super smart and Ivy League educated, they’re also rich. That doesn’t mean that you, the small guy or gal, can’t win.

It just means that you simply must educate yourself and be prepared to do battle. David can beat Goliath, but only if he’s prepared. Some people might think the cost of a trading education is too high. But the cost of ignorance is way more expensive.

3. Risking too much per trade.

The wannabe trader risks 10% or more of her trading account on a single trade. Real deal traders understand risk and manage it FIRST before thinking about profit. They don’t take trades if it forces them to risk too much. Pros keep their risk below 2% of their account balance. This gives them the staying power to survive multiple losing trades in a row without turning into a worry wart.

4. Not being mentally prepared.

Psychology is a huge part of trading and most people are not mentally prepared. When money is on the line, fear, greed, and other emotions make trading very hard. Make sure you understand the emotional aspects of trading and be prepared to deal with them before you put your money on the line.

babypips

You can't handle the truth!

For novice Forex traders there always exists the desire to be right. What better to help justify their progress as traders than their decisions being correct, resulting in a successful trade? Yet this yearning to be right can get them into trouble.

To keep from having to deal with the consequences of bad trading decisions (or indecision), some traders will put off placing the trade all together. Others will go as far as holding a losing position, hoping the market will turn in their favor to prove their judgments right.

In these events, the need to be right is smothering any chances of success and doing nothing to help the trader grow. When there's hesitation at that critical moment of a trade, fear takes over, and the trader can't make a move. And when a trader is scared, he stays clear of making trades at all. You have to trade and trade and trade to learn the markets and sharpen your skills. Accepting criticism is an important trait that may help you get over those fears of trading by providing insight about your trading shortcomings.

Why do we have such a hard time accepting criticism? For one, criticism has negative connotations, usually associated with poor performance, doing something wrong, or not being sufficient enough in the task at hand. Most people, traders included, don't take well with negative feedback or comments. Some of the psychological aspects of the way we now deal with criticism are deeply rooted in our past, from experiences with our parents and school teachers. They were in the position to correct us and tell us when we were wrong, and some were more extreme than we liked with their criticism. They definitely had a psychological impact on us was there, with many of us now transferring those experiences to our trading.

Here is where we can make a change. Don't let criticism take an emotional toll on you. Don't take it as a personal attack, but as an opportunity to possibly make some changes. View criticism only as information you can use to better your skills. Removing the emotional ties to your performance is vital to using criticism constructively.

We also have a tough time accepting criticism because, deep down, we all want to be perfect. This position has been ingrained in us since our early days in school. You are taught to be. And if you're always right, you'll undoubtedly be successful. You usually didn't get a second chance at correctly answering a question or fixing your mistakes on a test you bombed. You weren't allowed the option of trying again and sharpening your skills.

Many traders take this position with their Forex trading. But this is where trading is different. You have the power to (demo) trade over and over again. Start with a small trade, learn from your errors, and try again. It's that simple. This process will give you experience with the Forex market and allow you to sharpen your trading skills, all while managing you risk effectively.

Don't be afraid of criticism... look for it! Keep an open mind and don't take everything so personal. Learn to view criticism as only information, and take it as free advice and training. It's not enough just making a trade and living with the outcome. To be a successful trader, you want to understand why you lost or won, and sometimes the best way of determining this is from someone else (through their experiences, views and comments). The better you get at staring criticism in the face AND learning from it, the more you help to develop your own trading skills. TRADE ON!

babypips

Oooh Look At That Stagflation!
by Forex Gump

The US economy seems to have reached a critical point where recession may be accompanied by inflation, a situation that is extremely difficult for the Fed to manage. Such a condition is termed as stagflation. And just what the hell is stagflation - Is it some special kind of stag released by the economy? It is actually a term coined by economists and is loosely defined as a period of slow economic growth and relatively high unemployment accompanied by a rise in prices, or inflation.

The signs for such a recipe seem to be in the making for the US economy. The US Labor Department recently announced that consumer prices in the nation had jumped 0.4% in January, which was nearly 4.3% higher than the prices a year ago. Unemployment has also started to raise its ugly head and latest numbers indicate that it has risen to about 4.9%.

Any central banker faces a dilemma under these conditions. Under ordinary circumstances, a central bank could lower interest rates to spur the economy and fight unemployment. Alternatively, the central bank has the option to raise interest rates to fight inflation and rising prices. Oops! Right now the Fed may need to fight both together – sounds like a dilemma indeed!

The US experienced the symptoms of stagflation during the decade starting 1970, when inflation peaked to almost 15% and unemployment touched a high of 9%. Though, the present rates of inflation and unemployment are much more moderate compared to the rates in the 70s, the dilemma appears to be the same. The moderation in the rates indicates that the economy has matured substantially. An economy may be termed as mature when it is marked by low unemployment and low inflation rates, which are manageable cyclically. The combination of the present inflationary trend and increasing unemployment rate lead to a situation that is more difficult for the Fed to manage. The combination of these two movements also challenges the key assumption that the US economy can grow without generating inflation.
US Fed

So what are the options that the US Fed is left with to fight stagflation? Will it raise interest rates to fight inflationary expectations or will it lower interest rates to spur the economy and generate employment. Alternatively, the Fed might adopt a wait and watch stance and keep the interest rates unchanged for some time.
Fed’s Options

OPTION 1
Raise interest rates
If the Fed raises interest rates, it may squeeze out liquidity from the economy and manage to dampen price increase. However, raising interest rates is likely to make money more expensive for industry and will squeeze economic growth further. Unless inflation shows signs of shooting up, the Fed is unlikely to adopt this option.
UNLIKELY

OPTION 2
Lower interest rates
Given the existing macroeconomic scenario of weak growth, the real estate market being stumped by high interest rates and rising unemployment, the Fed’s choice may be to lower interest rates. This will be based on the projections for inflation and if the projection is moderate, the Fed may resort to slicing interest rates just one more time.
LIKELY

OPTION 3
Keep interest rates unchanged
The Fed having lowered interest rates twice in a row in January 2008, could possibly adopt a wait and watch situation and leave interest rates unchanged.
This move will imply that the Fed is not addressing either the issue of fighting inflation or inducing industry to invest more, which could have led to enhancement of employment
UNLIKELY

Dr. Pipslow - babypips

Forget that Perfect Trade

When you're risking your own money, do you feel the need to find that secret information that nobody yet knows or find the perfect trade setup?

Some traders are so obsessed with trying to find the perfect trade that they end up not trading enough to come out profitable. Trading is not the line of work you want to be if you're a perfectionist. You can plan a trade systematically only to end up losing money because an unforeseen event invalidates the trade setup you so thought was sooo perfect and your trade slaps you in the face and goes against you.

While you don't want to become a careless and impulsive trader, you don't want to be an extreme perfectionist either. Remember there's no such thing as a guaranteed profit.

Instead of being perfect, try being average. For all the "A" students out there, I know this almost sounds blasphemous since I'm basically suggesting you strive for a "C" grade. But give it a try.

Rather than look for the "perfect" setup, just find a profitable setup. Yes, you might make less profit per trade, but you'll feel better. Compare how it feels to strive for perfect standards versus average standards. You may find that you prefer average standards since you're more relaxed. Since you'll be putting on more trades, your profits will improve.

Trading is all about probabilities. You must make many trades to get the law of averages to work in your favor. As long as the setups are solid, and you're using sound money management and risk control, you'll make enough trades to come out ahead. You'll be able to get the losing trades "off your back" and focus on winning trades.

If you're an uptight perfectionist, you'll always be on edge and will hardly be able to execute any trades. This will be your downfall because you won't be able to pull the trigger on traders that were "less than perfect" but were profitable.

Dare to be average and see what happens. A student who makes straight "A's" may be smarter but the "C" student sitting behind him may be richer.

Big Pippin - Babypips

EUR/USD
The Euro finally took a plunge like I thought it would but today's strong move could mean a retracement tomorrow or a continuation of the trend. The pair seems to have found support at the 3700 and although daily stochastics are trending down nicely now, 4hr stochastics are in oversold territory. If the pair can break below 3700 to around 3675, then I would watch for the Euro to continue down to at least 3650.

GBP/USD
The Sterling is in a similar situation as the Euro. It's fallen pretty hard today and we could see a retracement tomorrow or we could see a continuation. The Sterling has found support at the 2.0500 mark. If the pair can break below 2.0500 to around 2.0475 then I would expect it to at least go to 2.0450. If not, look for the Sterling to bounce back up to around 2.0550.

USD/CHF
The Swissy has found slight resistance around 2150 which also happens to be right around its 50 EMA on the daily chart. Daily stochastics are trending up nice but 4hr stochastics are in overbought territory. I'm really not sure what to think here because the pair isn't really providing any good opportunities for trades. My advice would be to sit out on this pair for tomorrow.

USD/JPY
The Dollar found slight support at the 120.00 mark. Both 4hr and daily stochastics are in oversold territory which means we could see the pair head back up tomorrow. I also am more bullish than bearish on the pair since it fell hard for 3 straight days. Look for the pair to head back up to around the 121.00 mark.

Babypips

Be Picky

In the foreign exchange market, there are times to trade but there are more times to not trade.
In order to achieve success as a trader, you must be alert, selective, and not chase every single pip.

Don't chase price. Be patient.

When you go to the grocery store, you usually don't buy the first apple you pick up. Instead you look at several apples, comparing their shape, color, smell, etc. In other words, you're picky.

You should apply the same approach to trading. Be picky with your trades. Take only the ones with high probability setups.

Only trade when there is a good setup which means it meets all the rules in your trading system.
Stay out of the market when if it doesn't.
You do have a system right?

If you don't see any good trade setups or the current market conditions don't fit with your trading system, stay out!
Trade only when you see something. Don't trade when you don't see anything.

Simple.
Never trade just to be in the market.

Big Pippin - Babypips

Chart Analysis: What's going to happen next?
EUR/USD
The Euro still hasn't been able to do much ever since it reached the 3800 mark. Daily stochastics are still in overbought territory and with the way the Euro has been moving the past few days I think it might be time for the Euro to drop soon. Currently the Euro is trading right near 3800 and I would watch for it to drop to around 3750 sometime tomorrow.

GBP/USD
The Sterling is acting like the Yen was about a month ago. It just won't quit moving up! In fact the pair is making new 15 year highs each day. Both 4hr and daily stochastics are in overbought territory (which isn't a surprise considering the movements) so technically we should see a drop soon. The pair hit resistance at 2.0550 today and I would look for the pair to drop down to 2.0500 some time tomorrow.

USD/CHF
The Swissy is basically doing the exact opposite as the Euro. It is stuck at support at the 2000 mark and has been unable to break it for the past several days now. Daily stochastics are in oversold territory and just like the Euro, since the pair can't break support, I would expect this pair to rise in the short term. Look for the Swissy to make its way back up to 2050.

USD/JPY
The Yen has been ranging for the past few days and as a result, the Stochastics on both the 4hr and daily chart aren't really giving much at the moment. The only thing I have to go by is the fact that the 50 EMA on the daily chart has been acting as good support and if it holds true I would expect the Yen to move back up tomorrow. Currently the pair is trading around 121.86 and I would watch for it to move up to its 50 EMA on the 4hr chart at around 122.25.

Big Pippin - Babypips

EUR/USD
The Euro hasn't been dropping like I thought it would and actually rose up to 3800 but now looks like it has finally found resistance at 3800. Daily stochastics are in overbought territory and 4hr stochastics are trending down which means we could see some short term bearish movement. Currently the pair is trading at around 3775 and I would watch for it to continue falling to 3750.

GBP/USD
The Sterling just won't say die as it once again made a new 15 year high at 2.0400. Daily stochastics are in overbought territory and 4hr stochastics are trending down. Like the Euro, I would watch for the Sterling to drop tomorrow. Currently the pair is trading at around 2.0360 and I would watch for it to head down near the 2.0300 mark.

USD/CHF
The Swissy has been treading on the 2000 mark for several days now and it seems as though its proving to be a pretty stuff support level. Daily stochastics are in oversold territory and 4hr stochastics are trending up which means I would expect the pair to move up tomorrow. Currently the pair is at 2027 and I would watch for it to continue up to the 2050 level.

USD/JPY
The Yen has been moving crazy the past few days as it's been moving up and down. However, the one constant is that the 50 EMA on the daily chart has been a good support area. Now, we're at that support level again and 4hr stochastics are trending up which indicates that we could see some upward movement tomorrow. Since my theme for the tomorrow seems to be a bullish dollar day, it also fits!