Report on Forecasting Techniques in Foreign Exchange Markets (Part-2)

9.0 Discussion

9.1 Business utilization of technical analysis

9.1.1 Bangladesh inter-bank Foreign Exchange Market

9.1.1. a Inter-Bank Transaction in Foreign Exchange

The volume of inter-bank foreign exchange transaction maintained a downward trend till year 2006 but started to move upward from the year 2006. In year 2006-2007, the inter-bank transactions in foreign exchange were totaled US$13,705,791.14, which has increased by 6,709,141.064 compared with the preceding year total US$ 6,996,650.076 (See appendix 1).

Total transactions in the inter-bank foreign exchange market from the year 2002-2007 were given into a graph as under.

Capture

Monthly position of inter-bank transactions was uneven over the period due to unpredictable demand and supply position in the inter-bank market.

Month-wise position of inter-bank transaction in foreign exchange for last twelve months is given below in a graphical form. It appears from the graph that the highest transaction took place in June-July 2007, over the last 12 months period (see appendix 2).

Capture

Inter-bank foreign exchange transactions have been going on smoothly despite declining the trend of transaction volume from July 2007. The transactions equivalent in million U.S.

Dollar in the inter-bank foreign exchange market during July-Sept, 2007 were the followings- 17914318.18, 16027368.42, and

10396500(equivalent in US Dollar), from which we can see very easily that the transaction volume is declining month by month.

9.1.1. b Quarterly transactions of USD/BDT and Other FCY/BDT Transaction

FCY/BDT Market has experienced much unsteady condition over the period in current year.

The volume of other FCY/BDT transactions incredibly increased during second quarter, the amount equal to 1478914.474, and after that during third and forth quarter it again declined and reach almost to its earlier position.

On the other hand, USD/BDT transactions decreased from 13738515.63 to 10706875 during the second quarter, but after that it again started moving upward and reached to15385873.02 during the fourth quarter (see appendix 4).

This is happened mainly due to supply of U.S. Dollar in the inter-bank forex market and price hike of importable products like petroleum & petroleum products and other essential commodities in the international market. A comparative position showing quarterly movement of USD/BDT and other FCY/BDT transactions for the current year is given in graph:

Capture

The volume of BDT trades against USD decline during the second quarter due to the higher demand of import payments as well as the official rate declared against the USD/BDT by the central bank. According to the official sources from Central Bank USD/BDT rates are 68.61 taka (as of Nov 07) whereas the underlying rates of BDT against FCY reaches Tk69.50. Comparing average TT clean buying rates of the commercial banks operated into this market stands at 68.80 on 15Nov06 and selling rates at 69.80 (refers appendix 6). The difference between these 1..00 taka between the official and actual markets rates insist the volume of FCY deals against BDT thus originating more cross currency trading.

9.2 The use of Technical analysis in Bangladesh

The use of forecasting techniques can play major role in the increasing amount of transactions into the inter-bank foreign exchange markets in the third currency. The reasons underlying these transactions are mainly the Spot currency speculations as well as the obligations arise from the imports and governments payments.

In order to   minimize the risk and to gain the opportunity over the global currency markets the introduction of the technical analysis help the speculators and give the importer or exporter the opportunity to hedge their currency positions.

9.2.1 Importers point of views

If major trends can be identified in advance the dealers can advise the importer in advance to cover the risk through forwards or even within the day transactions.

Suppose an importer opens a L/C of GBP1.00 million and the current market rate against GBP= USD 2.0655 and USD= TK 68.6050. if the documents have to retire today the importer have to pay Tk141.7036 million today.

But utilizing the technical analysis, if the major trends can be identified, the importer can hedge their obligations as per the trend, i.e. if the trend is upward in both GBP/USD and USD/BDT, hedge it today through spot of forward or if the trend in downward use the maximum period before the payments due date.

9.2.2 Exporters point of views

Similar to an importer, if an exporter due to receive currency like GBP or USD against the export documents, can position accordingly to the major outlooks of the underlying currency he/she will receive.

In the current scenario in USD/BDT as the market is in favor of USD, the exporter should try to lag his/her export proceeds in order to get deprecated rates over Taka.

10.0 Significance of the Study

The foreign exchange market has played a vital role in the last decade or so in guiding the purchase and sale of goods, services and raw materials globally. The market directly affects country’s bond, equities, private property, manufacturing and all assets that are available to foreign investors. The market is a stabilizing factor in the world system of monetary exchange and was created not by design but by necessity.

Foreign exchange rates also play a major role in determining who finances government deficits, which buys equities in companies and literally effects and influences the economic scenario of every nation to cope with the foreign exchange risk in an open market economy. The market has its own momentum and therefore it is crucial to follow a universal time tested policy to tackle the forces behind the free market system with minimal risk involvement.

The research will draw various forecasting techniques in the foreign exchange market, basics of the technical analysis, business utilization of the technical analysis and also the utilization of the technical analysis in Bangladesh.

And finally the research has also described about some of the mistakes made in the forex markets and also some techniques to avoid the mistakes in the forex markets which the dealers apply while doing their works.

11.0 Risks Involved in foreign exchange

On the foreign exchange market one discerns the following kinds of the risks:

  • Exchange rate risk;
  • Interest rate risk;
  • Credit risk;
  • Country risk.

11.1. Exchange Rate Risk

Exchange rate risk is a consequence of the continuous shift in the worldwide market supply and demand balance on an outstanding foreign exchange position. A position will be a subject to all the price changes as long as it is outstanding. In order to cut losses short and ride profitable positions that losses should be kept within manageable limits. The most popular steps are the position limit and the loss limit. The limits are a function of the policy of the banks along with the skills of the traders and their specific areas of expertise. There are two types of position limits: daylight and overnight.

1. The daylight position limit establishes the maximum amount of a certain currency which a trader is allowed to carry at any single time during.

The limit should reflect both the trader’s level of trading skills and the amount at which a trader peaks.

2. The overnight position limit which should be smaller than daylight limits refers to any outstanding position kept overnight by traders. Really, the majority of foreign exchange traders do not hold overnight positions.

The loss limit is a measure to avoid unsustainable losses made by traders; which is enforced by the senior officers in the dealing center. The loss limits are selected on a daily and monthly basis by top management.

The position and loss limits can now be implemented more conveniently with the help of computerized systems which enable the treasurer and the chief trader to have continuous, instantaneous, and comprehensive access to accurate figures for all the positions and the profit and loss. This information may also be delivered from all the branches abroad into the headquarters terminals.

Trading 106

11.2. Interest Rate Risk

Interest rate risk is pertinent to currency swaps, forward out rights, futures, and options. It refers to the profit and loss generated by both the fluctuations in the forward spreads and by forward amount mismatches and maturity gaps among transactions in the foreign exchange book. An amount mismatch is the difference between the spot and the forward amounts. For an active forward desk the complete elimination of maturity gaps is virtually impossible. However, this may not be a serious problem if the amounts involved in these mismatches are small. On a daily basis, traders balance the net payments and receipts for each currency through a special type of swap, called tomorrow/next or rollover.

To minimize interest rate risk, management sets limits on the total size of mismatches. The policies differ among banks, but a common approach is to separate the mismatches, based on their maturity dates, into up to six months and past six months. All the transactions are entered in computerized systems in order to calculate the positions for all the delivery dates and the profit and loss. Continuous analysis of the interest rate environment is necessary to forecast any changes that may impact on the outstanding gaps.

11.3. Credit Risk

Credit risk is connected with the possibility that an outstanding currency position may not be repaid as agreed, due to a voluntary or involuntary action by a counter party. In these cases, trading occurs on regulated exchanges, where all trades are settled by the clearing house. On such exchanges, traders of all sizes can deal without any credit concern.

The following forms of credit risk are known:

1. Replacement risk which occurs when counter parties of the failed bank find their books unbalanced to the extent of their exposure to the insolvent party. To rebalance their books, these banks enter new transactions.

2. Settlement risk which occurs because of different time zones on different continents. Such a way, currencies may be credited at different times during the day. Australian and New Zealand dollars are credited first, then Japanese yen, followed by the European currencies and ending with the U.S. dollar. Therefore, payment may be made to a party that will declare insolvency (or be declared insolvent) immediately after, but prior to executing its own payments.

The credit risk for instruments traded off regulated exchanges is to be minimized through the customers’ creditworthiness. Commercial and investment banks, trading companies, and banks’ customers must have credit lines with each other to be able to trade. Even after the credit lines are extended, the counter parties’ financial soundness should be continuously monitored. Along with the market value of their currency portfolios, end users, in assessing the credit risk, must consider also the potential portfolios exposure. The latter may be determined through probability analysis over the time to maturity of the outstanding position. For the same purposes netting is used.            Netting is a process that enables institutions to settle only their net positions with one another not trade by trade but at the end of the day, in a single transaction. If signs of payment difficulty of a bank are shown, a group of large banks may provide short-term backing from a common reserve pool.

Successful Trading 108

11.4. Country Risk

The failure to receive an expected payment due to government interference amounts to the insolvency of an individual bank or institution, a situation described under credit risk. Country risk refers to the government’s interference in the foreign exchange markets and falls under the joint responsibility of the treasurer and the credit department. Outside the major economies, controls on foreign exchange activities are still present and actively implemented.

For the traders it is important to know or be able to anticipate any restrictive changes concerning the free flow of currencies. If this is possible, though trading in the affected currency will dry up considerably, it is still a manageable situation

12.0 Recommendation

Followings are some methods of avoiding foreign exchange risks:

  • · Don’t read the news-analyze the news: Many times, seemingly straight forward news releases from government agencies are really public relation vehicles to advance a particular point of view or policy. Such “news,” in the forex markets more than any other, is used as a tool to affect the investment psychology of the crowd. Such media manipulation is not inherently a negative. Governments and traders try to do that all the time. The new forex trader must realize that it is important to read the news to assess the message behind the drums.
  • · Don’t trade surges: A price surge is a signature of panic or surprise. In Reproduction or use of the text or pictorial content in any manner without written permission is prohibited. Copyright 2002 by Futures Magazine Group, 250 S. Wacker Dr., Suite 1150, Chicago, IL60606 these events, professional traders take cover and see what happens. The retail trader also should let the market digest such shocks.

Trading during an announcement or right before, or amid some turmoil, minimizes the odds of predicting the probable direction. Technical indicators during surge periods will be distorted. You should wait for a confirmation of the new direction and remember that price action will tend to revert to pre-surge ranges providing nothing fundamental has occurred.

  • Simple is better: The desire to achieve great gains in forex trading can drive us to keep adding indicators in a never-ending quest for the impossible dream.

Similarly, trading with a dozen indicators is not necessary. Many indicators just add redundant information. Indicators should be used that give clues to:1) trend direction, 2) resistance, 3) support and 4) buying and selling pres sure.

13.0 Conclusion

Technical analysts consider the market to be 80% psychological and 20% logical. Fundamental analysts consider the market to be 20% psychological and 80% logical. It may be open for debate, but there is no questioning on the current price. After all, it is available for all to see and nobody doubts its legitimacy. The price set by the market reflects the sum knowledge of all participants, and we are not dealing with lightweights here. These participants have considered (discounted) everything under the sun and settled on a price to buy or sell. These are the forces of supply and demand at work. By examining price action to determine which force is prevailing, technical analysis focuses directly on the bottom line: What is the price? Where has it been? Where is it going?

Even though there are some universal principles and rules that can be applied, it must be remembered that technical analysis is more a practitioner’s things form than a science. As over time form, it is subject to interpretation. However, it is also flexible in approach and each trader should use only that which suits his/her style.  Developing a style takes time, effort and dedication, but the rewards can be significant.

Today’s markets are incredibly volatile. Plus, thousands competing against HSBC who are constantly looking for an “edge”. The market risk is very real, and can be daunting if HSBC is not prepared. That’s why need a trading strategy that will help to reduce risk and ensure reward.

Appendix

Appendix1: Inter-Bank Transaction in Foreign Exchange on Yearly Basis:

Calendar YearTotal transactions(Spot and Forward-equivalent in US Dollar)
02-03

11,574,579.44

03-04

10,754,685.92

04-05

8,590,738.175

05-06

6,996,650.076

06-07

13,705,791.14

Appendix 2: Month to Month Inter-Bank Transaction in Foreign Exchange:

Month

Amount(Equivalent in US Dollar)

Sep-06

13,673,250

Oct-06

9,867222.222

Nov-06

8,601,500

Dec-06

13,885,833.33

Jan-07

12,730,526.32

Feb-07

13,128,947.37

Mar-07

14,814,868.42

Apr-07

13,628,571.43

May-07

14,623,809.52

Jun-07

17,905,238.1

Jul-07

17,914,318.18

Aug-07

16,027,368.42

Sep-07

10,396,500

Appendix3: Quarterly transactions of USD/BDT and Other FCY/BDT Transaction in the inter-bank markets:

Quarters of year July2006-Jun2007USD/BDT TransactionFCY/BDT Transaction
1st Quarter

13738515.63

746,640.625

2nd Quarter

10706875

1,478,914.474

3rd Quarter

13558114.04

677,216.4388

4th Quarter

15385873.02

675,238.0952

Appendix 4: Summary of 23 months Moving Average Calculations:

                                         Summary of the 12 months moving average calculation
MonthDaily market RateMoving average forecastForecast errorSquared forecast error

January-06

68.65492

February-06

70.23846

March-06

72.13497

April-06

70.63066

70.34278333

0.287876667

0.082872975

May-06

69.89733

71.00136333

-1.104033333

1.218889601

June-06

70.2956

70.88765333

-0.592053333

0.35052715

July-06

70.37398

70.27453

0.09945

0.009890303

August-06

70.18733

70.18897

-0.00164

2.6896E-06

September-06

68.33639

70.28563667

-1.949246667

3.799562568

October-06

67.58447

69.63256667

-2.048096667

4.194699956

November-06

71.76473

68.70273

3.062

9.375844

December-06

70.11912

69.22853

0.89059

0.793150548

January-07

70.26637

69.82277333

0.443596667

0.196778003

February-07

69.4276

70.71674

-1.28914

1.66188194

March-07

69.21849

69.93769667

-0.719206667

0.517258229

April-07

69.28277

69.63748667

-0.354716667

0.125823914

May-07

69.3557

69.30962

0.04608

0.002123366

June-07

69.24568

69.28565333

-0.039973333

0.001597867

July-07

68.9061

69.29471667

-0.388616667

0.151022914

August-07

69.00869

69.16916

-0.16047

0.025750621

September-07

69.33975

69.05349

0.28626

0.081944788

October-07

69.423

69.08484667

0.338153333

0.114347677

November-07

69.57957

69.25714667

0.322423333

0.103956806

5. Summary of the 15 months exponential smoothing average calculation:

Summary of the 15 months exponential smoothing average calculation
MonthRate (Yt)Exponential Smoothing Forecast (Ft)Forecast Error

Jan-06

68.65492

Feb-06

70.23846

68.65492

1.58354

Mar-06

72.13497

68.971628

3.163342

Apr-06

70.63066

69.6042964

1.0263636

May-06

69.89733

69.8096

0.08773

Jun-06

70.2956

69.82718

0.46842

Jul-06

70.37398

69.9209

0.45308

Aug-06

70.18733

70.0115

0.17583

Sep-06

68.33639

70.0467

-1.71031

Oct-06

67.58447

69.7047

-2.12023

Nov-06

71.76473

69.2807

2.48403

Dec-06

70.11912

69.7775

0.34162

Jan-07

70.26637

69.8458

0.42057

Feb-07

69.4276

69.92994

-0.50234

Mar-07

69.21849

69.8295

-0.61101

Apr-07

69.28277

69.707298

-0.424528

May-07

69.3557

69.6223924

-0.2666924

Jun-07

69.24568

69.56905392

-0.32337392

6. Summary of the 12 months Seasonal irregular values:
Summary of the 12 months Seasonal irregular values
YearQuarterRateFour quarter totalFour quarter moving averageCentered moving averageSeasonal-Irregular Value

2006

1

70.34278

2

70.27453

3

69.63257

280.0726533

70.01816333

69.9300013

1.001260719

4

69.82277

279.3673567

69.84183917

69.7193625

1.00175671

2007

1

69.63749

278.3875433

69.59688583

69.5284208

1.000984705

2

69.29472

277.8398233

69.45995583

3

69.08485

7. Comparison of Different forecasted rates with the Actual Market rate:

                    Comparison of Different forecasted rates with the Actual Market rate
MonthMoving average forecastCentered moving averageExponential Smoothing Forecast (Ft)Actual Market Rate

Jan-06

68.65492

Feb-06

68.65492

70.23846

Mar-06

68.971628

72.13497

Apr-06

70.34278333

69.6042964

70.63066

May-06

71.00136333

69.8096

69.89733

Jun-06

70.88765333

69.82718

70.2956

Jul-06

70.27453

69.93000125

69.9209

70.37398

Aug-06

70.18897

69.93000125

70.0115

70.18733

Sep-06

70.28563667

69.93000125

70.0467

68.33639

Oct-06

69.63256667

69.7193625

69.7047

67.58447

Nov-06

68.70273

69.7193625

69.2807

71.76473

Dec-06

69.22853

69.7193625

69.7775

70.11912

Jan-07

69.82277333

69.52842083

69.8458

70.26637

Feb-07

70.71674

69.52842083

69.92994

69.4276

Mar-07

69.93769667

69.52842083

69.8295

69.21849

Apr-07

69.63748667

69.707298

69.28277

May-07

69.30962

69.6223924

69.3557

Jun-07

69.28565333

69.56905392

69.24568

Mean-

69.95031556

69.72592819

69.65374169

69.83414278

8. Exchange rates of Commercial Banks to public for Us Dollar

      U. S. Dollar

SL.

               Spot  Buying       Spot  Selling

No.

Name of Bank

T.T.

O.D.Sight

O.D.

T.T. &

B.C.

Clean

Exp. Bills

Transfer

O.D.

1

Agrani Bank

68.0200

68.0000

67.7500

68.9200

68.9700

2

Al-Arafah Islami Bank Limited

68.5500

68.4705

68.3900

69.6300

69.6500

3

Arab Bangladesh Bank Limited

69.0500

68.9500

68.5332

69.9400

69.9900

4

Bangladesh Krishi Bank

68.0700

68.0500

67.8300

68.9500

69.0000

5

Bangladesh Shilpa Bank

68.0200

68.0000

67.7400

68.9200

68.9700

6

BASIC Bank Limited

68.5500

68.4000

68.3000

69.5700

69.6000

7

Bank Asia Limited

68.9500

68.9069

68.4674

69.9000

69.9500

8

BRAC Bank Limited

68.7500

68.7264

68.7130

69.7000

69.7400

9

Citibank, N.A.

68.9000

68.8700

68.6656

69.9200

69.9500

10

Commercial Bank of Ceylon Ltd.

68.9000

68.8732

68.7641

69.9150

69.9450

11

Dhaka Bank Limited

68.8900

68.7369

68.4681

69.8200

69.8800

12

Dutch-Bangla Bank Limited

68.7200

68.6265

68.0786

69.7000

69.7500

13

Eastern Bank Limited

68.8500

68.7429

68.3910

69.8700

69.9000

14

EXIM Bank Limited

68.5500

68.4500

68.3539

69.4700

69.5000

15

First Security Bank Limited

68.0500

67.8650

67.5150

69.2000

69.2500

16

Habib Bank Limited

68.3000

68.4600

68.6200

69.4700

69.5000

17

HSBC Limited

68.8837

68.8795

68.6705

69.9206

69.9447

18

IFIC Bank Limited

68.6945

68.5075

68.1335

69.4775

69.5075

19

Islami Bank Bangladesh Limited

68.5000

68.4500

68.2500

69.4500

69.5000

20

Janata Bank

68.0200

68.0000

67.7400

68.9200

68.9700

21

Jamuna Bank Limited

68.6000

68.4105

68.1732

69.6750

69.7000

22

Mercantile Bank Limited

68.7000

68.5000

68.2592

69.6500

69.7000

23

Mutual Trust Bank Limited

68.7000

68.4023

68.1790

69.6700

69.7000

24

National Bank Limited

68.5000

68.4100

68.1600

69.4500

69.5000

25

NCC Bank Limited

68.9000

68.8000

68.7000

69.8500

69.9000

26

ONE Bank Limited

68.6340

68.6022

68.2147

69.5500

69.6000

27

Prime Bank Limited

68.9000

68.7124

68.4981

69.8500

69.9000

28

Pubali Bank Limited

68.4500

68.3500

68.3000

69.4500

69.5000

29

Rupali Bank Limited

68.2500

68.2000

68.0000

69.2300

69.2500

30

Shahjalal Islami Bank Limited

68.8500

68.6626

68.2074

69.8600

69.9000

31

Social Investment Bank Limited

68.9000

68.7401

68.1912

69.7500

69.8000

32

Sonali Bank

68.0200

68.0000

67.7400

68.9200

68.9700

33

Southeast Bank Limited

68.7500

68.5500

68.1000

69.6500

69.7500

34

Standard Bank Limited

68.9000

68.8001

68.7003

69.8600

69.9000

35

Standard Chartered Bank

68.9000

68.8770

68.8311

69.9200

69.9500

36

State Bank of India

68.6500

68.6175

68.3700

69.6500

69.7000

37

The City Bank Limited

68.9000

68.8062

68.4558

69.7800

69.8500

38

The Oriental Bank Limited

67.8000

67.6995

67.5682

68.8500

68.9000

39

The Premier Bank Limited

68.0500

67.8912

67.7551

69.2000

69.2500

40

The Trust Bank Limited

68.9500

68.8500

68.5500

69.8000

69.8500

41

United Commercial Bank Limited

68.8500

68.7500

68.5900

69.8200

69.8500

42

Uttara Bank Limited

68.4400

68.3403

68.1350

69.4500

59.5000

                Average

68.5908

68.4985

68.2631

69.5607

69.3664

 

 

Some More Parts-

Report on Forecasting Techniques in Foreign Exchange Markets (Part-1)

Report on Forecasting Techniques in Foreign Exchange Markets (Part-2)