Forex Management

Chapter – 3
Forex Trading and Contracts
Foreign Exchange Market (Forex or FX)
It is the place where people buy and sell currencies of different countries. It is the largest financial
market in the world with a daily turnover of over $7 trillion.

Unlike stock markets, forex doesn’t have a single central exchange. It runs 24 hours a day, from
Monday to Friday, across major financial centers like London, New York, Tokyo, and Sydney.

Forex trading infrastructure and networks:

1. Infrastructure of Forex Trading: Forex trading depends on a well-organized system that
connects buyers and sellers of currencies. The infrastructure includes:
a. Market Participants (Who takes part in forex?)
1. Central Banks: Control the money supply and interest rates. Intervene in the forex
market to stabilize their currency. Example: RBI (India), Federal Reserve (USA)

2. Commercial Banks: Biggest players in the forex market. Trade currencies for
themselves and their clients. Example: HDFC Bank, Citibank, HSBC.

3. Corporations (Companies): Importing and exporting companies exchange foreign

currencies for trade. They use forex to protect themselves from currency fluctuations.

4. Investment Firms and Hedge Funds: Buy and sell large amounts of currency to
make profits. Use strategies like speculation and arbitrage.

5. Retail Traders (Individuals): Small traders who use online platforms to buy/sell
currency pairs. They mostly trade through forex brokers.

b. Trading Platforms (How do people trade?) Forex trading is done using software called
trading platforms. These platforms are available on desktop, mobile, and web. Some
popular platforms are:

• MetaTrader 4 (MT4) – Most widely used by retail traders.

• MetaTrader 5 (MT5) – Supports more instruments like stocks and futures.

• cTrader, TradingView, NinjaTrader – Used for advanced analysis.

These platforms allow users to see live prices, place buy and sell orders, use charts and
indicators.

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c. Forex Brokers (Middlemen): You cannot directly access the market as a retail trader. You
need to go through a broker.

Types of brokers:

1. Dealing Desk Broker (Market Maker): A market maker broker is a type of forex broker
that does not send your order to the real market. Instead, the broker takes the opposite side
of your trade. They act like a mini market just for you.

2. No Dealing Desk Broker (NDD): Broker is a type of forex broker that does NOT take the
opposite side of your trade. Instead, it acts like a bridge, it sends your trade directly to the
real forex market (banks, financial institutions, or other traders).
d. Liquidity Providers: Big banks or institutions that provide currency pairs at buy/sell
rates. Ensure there is always someone to take the other side of a trade. Examples: Barclays,
Deutsche Bank, JPMorgan Chase.

2. Forex Trading Network: The forex market is made of different levels:

a. Interbank Network: The top level where big banks trade directly with each other. Only
available to large financial institutions. High trading volumes and low transaction costs.
b. Electronic Communication Network (ECN): A digital network that matches buy and sell
orders from different traders. Very transparent. No conflict of interest as brokers only
connects buyers and sellers.
c. Retail Trader Network: This is where small traders like you and me participate. Retail
traders use online brokers who connect them to the market.

3. Technology Behind Forex Trading: The forex market uses advanced technology to make
trading fast and smooth.
a. Real-Time Data Feeds: Provide live currency prices and charts. Help traders make
informed decisions.
b. FIX Protocol: A communication system used between financial institutions. Helps send
orders and updates instantly.
c. API (Application Programming Interface) and Automated Trading: It is a software
bridge that allows two different systems (like your trading app and a broker's server) to talk
to each other. It let your computer automatically connect, send, and receive information
from another system without you doing it manually.

4. Security and Regulation: Forex trading needs to be safe and fair. That’s why many
countries have regulatory bodies. Ex: India – SEBI, USA – National Futures Associations

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etc. They make sure brokers are licensed, traders’ funds are protected, brokers follow fair
trading practices.
5. Supporting Systems: Forex infrastructure is supported by:

• Data Centers: Physical places where servers are stored.

• Cloud Computing: Cloud computing means using the internet to store and run
programs or data, instead of using your own computer. Ex: When you store files in
Google Drive, they are saved on Google's servers, not your laptop.
• Internet Backbone: Fast and stable internet required for trading. The Internet Backbone
is the main, high-speed “highway” that carries internet data across the world.
• Customer Support: Traders may face issues like login errors, withdrawal delays, or trade
rejections. Brokers offer help through: Live chat, Email, Ticketing system (formal
complaints and tracking issues)

Controls on Placing Orders:

When an individual or business wants to place an order for importing goods or services from
another country, there are several regulatory controls and steps they must follow to ensure the
transaction is legal, safe, and compliant with foreign exchange laws.

These controls are designed to:

• Prevent illegal money transfers

• Manage foreign exchange reserves.

• Ensure transparency and compliance with national policies

Key controls on placing orders:

1. Import/Export Licenses: Importers or exporters need a valid license or registration (like
IEC – Import Export Code before placing an international order. This is a mandatory
license for all businesses involved in foreign trade. Without an IEC, you cannot legally
import or export goods/services.
2. Know Your Customer (KYC) Norms: As per RBI and banking regulations, banks and
authorized dealers must verify the identity of the importer/exporter. This involves
submitting business registration, PAN, GST, address proof, etc.
3. Role of Authorized Dealers (Banks): All foreign exchange transactions must be routed
through Authorized Dealers (ADs) – usually commercial banks licensed by the RBI. The
importer must submit the Purchase Order or Proforma Invoice to the bank. The bank will

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check whether the transaction is permitted under the Foreign Exchange Management Act
(FEMA).
4. Submission of Required Documents: To place an international order and make payment,
the importer needs to submit: Proforma Invoice (from the foreign seller) Import License (if
applicable), IEC Code copy, KYC documents. These documents are verified by the bank
before the transaction is processed.
5. RBI Guidelines and Limits: RBI sets limits on how much foreign exchange can be sent
abroad. Under schemes like the Liberalized Remittance Scheme (LRS), individuals can
send up to USD 250,000 per year for permissible purposes. Any transaction exceeding set
limits needs prior approval from RBI.
6. Restricted and Prohibited Items: Some goods are restricted, prohibited, or require special
permission to import (e.g., arms, narcotics, endangered species).
7. Customs and Import Compliance: After the order is placed and goods are received, the
importer must: File a Bill of Entry, Pay customs duty. Submit the Exchange Control Copy
to the bank as proof that goods were received.
8. Payment Rules: All payments must follow RBI’s prescribed methods like: Advance
payment, Letter of Credit (LC), Documents Against Payment (DP), Documents Against
Acceptance (DA). No payments should be made in cash or through informal channels.

Direct and Indirect Quotas:

Direct Quotas: It tells how much Indian Rupees (₹) you need to buy 1 unit of foreign currency.
Foreign currency is fixed, Indian currency changes.

This is importers or buyer’s view

Example (India): US Dollar = ₹85 means you need ₹85 to get 1 Dollar. Here, the foreign currency
(USD) is fixed; the Indian Rupee (₹) is variable.

Indirect Quotas: It tells how much foreign currency you get for ₹1. Indian currency is fixed,
foreign currency changes.

This is exporters or seller’s view

Example (India): ₹1 = 0.012 US Dollar Means you get 0.012 Dollar for ₹1. Here, the home
currency (₹) is fixed; foreign currency (USD) is variable.

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Cross Rates:
A cross rate is the exchange rate between two foreign currencies (NOT involving your country’s
currency directly). Cross rate helps you convert one foreign currency into another by using a third
currency as a link.
Ex: Let’s say you want to find 1 Euro (EUR) = How many Japanese Yen (JPY)?

But no one gives this directly.

You know:

1 Euro = 1.17 USD

1 USD = 146 Yen

Now multiply:

1.17 × 146 = 171 Yen

1 Euro = 171 Yen (This is the cross rate)

Ex: 2

Let’s say you want to find 1 British Pound = ? INR

1 British Pound = 1.36 USD

1 USD = 85 INR

1.36 × 85 = 115.6 INR

So, the cross rate for GBP to INR is ₹103.75

Speculation:
Speculation means buying or selling something just to make a profit not because you need it, but
because you think the price will go up or down.

Ex: Let’s say today 1 USD = ₹85 You think the dollar will go up to ₹90 next week. So, you buy
dollars now. Next week: 1 USD = ₹90 you sell the dollars and earn ₹5 per dollar. That’s speculation
buying to make profit from price change.

Exchange arithmetic psychology of the forex trader:

Exchange arithmetic means doing simple math with exchange rates like converting currencies,
calculating profits/losses, or finding cross rates.
These calculations help in:

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a. Converting one currency into another

b. Calculating profit or loss on trades

c. Finding cross rates

d. Comparing rates between banks or dealers

a. Currency Conversion
Suppose: 1 USD = ₹85, You want to convert ₹16,000 to USD

Calculation:
₹16,000 ÷ 85 = 188 USD, so you get 200 US Dollars.

Reverse Conversion (USD to INR)

You have $100, and 1 USD = ₹85

Calculation:
100 × 85 = ₹8,500 you get ₹8,500

b. Profit/Loss Calculation in Forex

You buy $1,000 at ₹85, later sell it at ₹88

Profit = (88 – 85) × 1,000 = ₹3,000

c. Cross Currency Rates:

Let’s say you want to find 1 AUD = ? EURO

1 AUD = 0.65 USD

1 USD = 0.85 EUR

To find: 1 AUD = ? EUR

Solution:
0.65 × 0.85 = 0.5525 EUR

So, 1 AUD = 0.5525 EUR

d. Comparing rates between banks or dealers

When you want to buy or sell foreign currency, different banks or forex dealers may offer you
different exchange rates. Comparing rates means checking which bank or dealer gives the best
rate for your transaction.

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Ex: Suppose you want to buy $1,000 USD. SBI Rs. 85 = 85,000, HDFC – Rs. 83.7= 83,700,
Forex Dealer Rs. 84.5 = 84500.

So, you compare and choose HDFC because it is cheaper for buying USD.

Psychology of the Forex Trader:

Forex trading is not just numbers. A trader’s mindset and emotions have a huge impact on success
or failure. The psychology of a forex trader refers to the mental and emotional factors that influence
trading decisions.

Trader emotions & their effects

1. Fear: Fear of losing money or missing out on profits.

How it affects:

The trader closes trades too early, even when the market is going in their favor.

Hesitates to enter a trade, missing good opportunities.

2. Greed: A strong desire for more profit than planned.

How it affects:

You hold trades too long without a plan.

You risk more money than you should.

3. Overconfidence: Too much belief in your own skill, especially after a few wins.

How it affects:

The trader ignores market signals or trades without analysis or risk management

4. Regret: Feeling bad about a past trade — missed opportunity or loss.

How it affects:
You enter a “revenge trade” — trying to recover loss quickly.

You don’t follow your plan anymore.

5. Doubt: Lack of self-confidence in your analysis or decision.

How it affects:

You miss good trades because you’re unsure.

You change decisions too often, without clear reasons.

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Computerized Trading Programme:

A Computerized Trading Programme in Forex is a software system that automatically places buy
or sell orders in the currency market using pre-programmed trading strategies without manual
intervention. It is also commonly known as algorithmic trading, automated trading, or electronic
trading.

Features of the computerized forex trading system:

1. Automated order execution: Trades are executed instantly based on pre-defined criteria or
algorithms. Reduces human intervention and delays in order placement.
2. Real-Time market data: Live feeds of forex quotes and charts. Helps traders make timely
and informed decisions.
3. High-Speed Execution: Executes trades in milliseconds.
4. Technical analysis tools: Built-in indicators like Moving Averages supports chart patterns and
trend analysis.
5. Customizable dashboards Personalized interface for different currency pairs, news feeds, and
indicators. Improves usability and decision-making speed.
6. Access to global forex markets: Trades can be placed on various global currencies 24/5.
Cross-border accessibility with multi-currency support.
7. Security and encryption: Encrypted login, two-factor authentication (2FA), and secure
transaction channels. Ensures safe access and data privacy.
8. Integration with mobile & web platforms: Seamless trading across devices (desktop, tablet,
mobile). Notifications, alerts, and real-time sync available.
9. Emotion-free trading: Removes human emotions like fear, greed, or hesitation. Follows
logic-based rules consistently.

Information Analysis of Trading:

Information analysis in Forex trading is the process of collecting, interpreting, and applying
various data sources economic, technical, political, and psychological to make informed trading
decisions. Forex markets are highly dynamic, and traders depend on timely, accurate analysis to
predict price movements.

1. Technical Analysis: Study of historical price and volume data using charts and indicators.
It is to identify patterns, trends, and potential entry/exit points. Patterns head & shoulders,
double top/bottom, support & resistance key levels where prices may reverse or break
through. Example: If EUR/USD breaks above a resistance level with high volume, it may
signal a buying opportunity.
2. Fundamental Analysis: Analysis based on economic indicators, interest rates, and
political events. Purpose is to assess the intrinsic value of a currency and its long-term

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direction. Example: A rise in US interest rates usually strengthens the USD due to higher
capital inflows.
3. Sentiment Analysis: Evaluating the mood or psychology of the market participants.
Purpose is to understand if traders are predominantly bullish (expecting rise) or bearish
(expecting fall). Ex: News headlines, Social media trends
4. Quantitative Analysis: Use of mathematical and statistical models to analyze trading data.
Purpose is to improve decision-making by removing bias and optimizing trade rules. Tools
may be Regression analysis, Probability models
5. Event/News-Based Analysis: Assessing the impact of real-time global events on currency
prices. Purpose is to capture short-term price movements from major news announcements.
Major events may be Central bank press conferences, Inflation and GDP releases
unexpected events (e.g., natural disasters, political instability).

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