Trading Strategies and Risk Management. Speculation in the Foreign Exchange Market


Elaboration, 2018
12 Pages

Free online reading

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Executive Summary
Trading is done in various commodities and is as well carried out in different markets.
Amongst all the popular traded commodities like shares, gold, cryptocurrencies,
trading in currency has seen to be the most popular. The Foreign Exchange market is
the place where trading in currencies is carried out. The growing demand among most
people of exchanging their domestic currencies in order to carry out any foreign trade
or business has made this as the primary reason of the FX market being one the
largest and most liquid financial market worldwide. This report is based on the
analysis conducted as per the results of a demo trading session undertaken over
easyMarkets platform. The main aim of the analysis is to recognize the type of trading
strategies that are applied by traders while carrying out transaction in various
currency pairs along with the applying one of the strategies in the demo trading
undertaken. The results are based on the 13 trades that were carried out. The later part
of report also highlights the importance and application of risk management tool in
order to hedge maximum amount of risk involved. The concluding statement out
together the importance of hedging tools stating they might not be able to mitigate or
eliminate the risk completely yet does make sure that some amount of it covered thus
deceasing the risk of exposure to at least some extent.

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Introduction
There is no exact strategy or factors that could be used to analyze movements in the
exchange rate and enable efficient decision making. Since there are a lot of factors
that have to be measured and quantified that the most common strategy that the
traders tend to follow is the trend, i.e. timing of the market is kept into consideration
( Gencay, et al., 2003). It is generally believed by some of the most successful forex
traders that the foreign exchange market tends to have a cycle which is in process due
to the presence of human behavior in the exchange rate market. Successful
transactions can be carried out depending upon the trader's ability to chart the trends
and effective predictions for future movements (Castrén, et al., 2006). This report will
highlight the trading strategy that is used in carrying out transactions in the currencies
traded, with explanations for any profit or loss incurred while carrying out the
transaction along with any hedging activities undertaken in the process.
Trading Strategies
There are a variety of techniques and strategies that is used by the forex traders in
order to analyze the best available entry and exit points and the accurate timing
considered for buying and selling currencies. Now, there are quite a few trading
techniques that are existent in the foreign exchange market, which can be Active
trading technique, and the long term, buy and hold technique (Shiryaev, et al., 2008).
Where active trading involves the process where securities are bought and sold
depending upon the short-term movements in the securities towards profit by
analyzing the short-term stock chart. On the other hand, the buy and hold technique
suggest holding of securities over long period as the movements in the prices might
be able to outweigh the movements undergone in short term ( Ling, et al., 2014).
Since strategies under active technique believe on the fact that the most profits within
a market lies only when transaction are done taking into consideration short-term
movements in prices, which has led to this technique being most commonly used.
Listed below are the most common trading strategies under the Active technique:
Day Trading
One of the most popular and commonly used trading style is Day Trading. The style
as suggested by the name involves buying and selling transactions of securities within

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the same day. No position is supposed to be held overnight and all the traded
positions are supposed to be closed on the same day they are opened (Johnson, 2011).
This form of trading is also aimed at putting the market timing to test where trades are
traded within the same day. This strategy of trading is generally carried out by the
traders who are well-acquainted with the market like the professional traders and
specialist.
Position Trading
There has been a lot of speculations relating to this strategy of trading undertaken by
traders. As some consider it as a long-term, buy and hold strategy yet it has also been
argued that when this strategy is used by professional traders it is like an active
trading technique as well. The application of this strategy is based on the usage of
long term charts along with few other methods in determining the trends within the
prevailing price direction of the securities (Tharp, 2013). The trading under this type
is considered to prevail for weeks or longer, all dependent on the ongoing trend.
Swing Trading
This strategy is aimed at putting its focus on achieving smaller amounts of gains
spread over short term trends and avoid as much losses as possible. The trading
positions under this strategy is held for up to a few days and can be stretched over a
week. And the gains can be smaller at start yet the consistency in their flow can result
into significant returns at the end ( Ally Financial , 2017). The main goal involves
identifying the prevailing trend and then taking steps to capture those small gains with
this type of strategy. Most of the swing traders generally work keeping the main trend
as the base of their analysis that implies that if the trend in a security goes up, the
trader will opt for buying the shares, call options or go for future contracts ( Ally
Financial , 2017). And if the ongoing trend seems to fall the trader has the option for
shorting the shares or going for future contracts and buy put options.
Scalping
This strategy has reported to be considered the quickest one that is employed by the
active traders. This involves the process of exploiting the various price gaps that
occurs because of the bid-ask spreads. The main line of working of this strategy

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involves a transaction carrying out at the bid price and then closing it at the ask price.
The difference that arises out the two is the gain that is received between the two
prices (Robles, 2016). The positions under this are supposed to be held for a shorter
period so that the least amount of risk is being involved.
Analysis of the Approach Adopted
In order to carry out a trading transaction, one not only has to adopt a strategy that has
to be employed but also decide the markets that are available for trading in currencies
like the available foreign exchange market, the derivates market and the exchange-
traded funds market. In this analysis, transactions have been carried out in a forex
market, where 13 trades have been undertaken to form the base of the analysis.
Transactions carried out in the forex market involves large financial institutions who
are willing to trade in currencies either for getting immediate delivery or for a later
date. Out of the 12 trades that have been undertaken 6 out them are based on day-
trading strategy and rest 6 have been on Position trading, i.e. they are held for a more
than over a day before the decision of selling them off was undertaken and the rest
one got under pending orders.
It is generally considered that in currency trading, there are four major currency pairs
that are in existence, i.e., EUR/USD, USD/JPY, GBP/USD, USD/CHF (FXCM,
2018). It was made sure while putting day trading strategy in use that trading in at
least two out of the four stated currency pairs should be undertaken.
The EUR/USD
Since the United States and the European Union are considered to be the two of the
largest economies in the world, there percentage of being traded is also very high. In
the year 2016, the percentage of trades involved in this pair was accounted to be
around 23%. Being such a popular pair for trading among investors although it
doesn't provide much of arbitrage opportunities to its investors yet it offering the
most liquidity remains to be a popular choice for traders wanting to either buy or sell
(Yahoo Finance, 2018). Another aspect of this pair is the high amount of volatility
being involved. Therefore, this combination of highly liquid and highly volatile
makes this pair an appropriate choice for applying day trading strategy, resulting to
which a profit of 36 AUD was occurred as well. Here is the chart showing 5 year data

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of EUR/USD where the position of Euro in terms of US dollar is depicted (Appendix
1).
Figure 1 Chart showing the Euro weakened relative to the U.S dollar, Source: (XE
Corporation, 2018)
USD/JPY
As per reported by the World Bank, Japanese economy is as well considered to be
amongst the largest national economies. Since Japan has been largely involved with
huge amounts of trades with USA, Asia and Europe, majority of the MNCs have been
indulging into getting their local currency to yen and vice versa. Therefore, due to
availability of low interest rates USD/YEN is as well one of the preferred pairs for the
investors to trade in (FX , 2018). This currency pair as well offers the most liquidity
thus making it an excellent option for day trading as it is suitable for both new comers
and experienced investors. The factors that were taken into consideration while
trading in this currency pair was a close look on economic growth of the Japanese
economy which has a direct effect on its currency. Since Japan's economy is heavily
dependent on exports to its major trading partner, any slow growth in them will
automatically affect the yen to weaken (FX , 2018). After careful consideration the
trade was undertaken will resulted as a profit of 133.97 AUD (Appendix1). Following

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is the chart showing the 5 year data depicting the change in currency rate of USD to
JPY
Figure 2: XE Currency Charts: USD to JPY Source: (XE Corporation, 2018)
Now, when trading in currencies is undertaken along with the deciding the strategy to
be opted to carry out the transaction, another important thing that is to remember is
that transactions in foreign currency are highly volatile that makes me prone to
uncertain fluctuations leading to considerable risk. And mitigating that risk is as much
of importance as any other decision taken while carrying out the trading process.
Traders in the international markets make sure to hedge their foreign currency
exposure in order to get as much profits as possible with minimum amount of risk
involved.
In Brief, there are four type of hedging techniques that is used by traders to mitigate
any significant risks involved, i.e., Forward and future contracts, options and swaps.
The hedging technique that is being used in the analysis undertaken is the use of
forward contracts. This is the most commonly used hedging technique that involves
getting into a contract where the buying or selling price of a currency is pre specified
to be carried out at some time in future (Wu, 2018). Thus making the use of this
technique most popular and efficient for risk management.

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Taking into context the trades, as mentioned above out of the 13 trades done, the later
6 trades were done on the basis of position trading strategy. Under which the trades
were held over a day and in order to mitigate any risk involved forward contracts
were used. Taking an example of a trade undertaken of currency pair EUR/JPY,
where the transaction was carried out at a Forward rate of 131.53 but it was noted to
went down to 131.0, which resulted into a considerable loss of -631.22 AUD
(Appendix 2). The possible reason leading to this loss in the currency pair could be,
since Yen is considered to be a low-yielding currency that played the part of attracting
traders that borrow at lower rate in Yen in order to buy currencies that would bring
them more returns like EUR. Now, this makes the currency pair highly sensitive to
swings in a prevailing market trend (Daily FX, 2018). Thus due to the Eurozone debt
crisis along with the anti-deflation policy introduced by the Bank of Japan might have
resulted into the making it highly volatile and thus justifying the loss occurred .
Figure 3 shows a chart of trends in the EUR/JPY over the years.
Figure 3: Chart showing EUR/YEN currency trend Source: (Daily FX, 2018)

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Conclusion
The foreign exchange market is considered to be one of the largest and the most
active in terms of trading, financial market worldwide. For a transaction to be
complete two different trades are to be involves, i.e., buying of the currency and then
selling it off. This report has highlighted the various strategies undertaken for carrying
our the trading process with focus on the one used while doing the trades for this
assignment. Also, the type of hedging technique adopted to mitigate any significant
risk. One important thing that was concluded was that although adopting a risk
management technique might or might not help in eliminating the risk completely yet
it is always preferred to undertake efficient hedging technique so that if not
completely at least to some level the risk should be mitigated.

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References
Ally Financial , 2017, Swing Trading Strategies, [Online], [Accessed 4 May 2018].
Available at: https://www.ally.com/do-it-right/investing/swing-trading-strategy-guide/
Gencay, R., Dacorogna, M., Olsen, R. & Pictet, O., 2003, Foreign exchange trading
models and market behavior, Journal of Economic Dynamics and Control, 27(1), pp.
909-911, retrieved 6 May 2018,
https://pdfs.semanticscholar.org/af34/341ea45dd7aa1aeb0e7d99dccde2fe9f6df6.pdf
Ling, F., Yat, D. & Muhamad , R., 2014, An Empirical Re-Investigation on the `Buy-
and-hold Strategy' in Four AsianMarkets: A 20 Years' Study, World Applied Sciences
Journal 3o, 1818(4952), pp. 226-237, retreived 6 May 2018,
https://umexpert.um.edu.my/file/publication/00004754_142448.pdf
Castrén, O., Osbat , C. & Sydow , M., 2006. WHAT DRIVES INVESTORS'
BEHAVIOUR IN DIFFERENT FX MARKET SEGMENTS? , European Central Bank,
Germany
Daily FX, 2018, EUR/JPY, [Online], [Accessed 6 May 2018].
Available at: https://www.dailyfx.com/eur-jpy
FX , 2018, USD/JPY: Dollar pares some of its gains as yields drop, [Online],
[Accessed 5 May 2018]
Available at: https://www.fxstreet.com/currencies/usdjpy.
FXCM, 2018, FXCM's Tradable Currency Pairs, [Online], [Accessed 6 May 2018]
Available at: https://www.fxcm.com/uk/forex/currency-pairs/
Johnson, R., 2011,Day Trading , Nassa Organisation. Florida
Robles, C., 2016. The Super Scalper Strategy, [Online], [Accessed 2 May 2018].
Available at: http://ww12.yourforexmentor.com/
Shiryaev, A., Zuoquon, X. & Zhuo, X., 2008, Thou Shalt Buy and Hold, University of
Columbia, New York
Tharp, V., 2013, Van Tharp's Definitive Guide to Position SizingSM Strategies,The
International Institute of Trading Mastery, New York
Wu, L., 2018, Forwards and Futures, [Online], [Accessed 6 May 2018].
Available at: http://faculty.baruch.cuny.edu/lwu/9797/lec1.pdf
XE Corporation, 2018, EUR to USD Chart, [Online], [Accessed 6 May 2018].
Available at: https://www.xe.com/currencycharts/?from=EUR&to=USD&view=5Y
XE Corporation, 2018, XE Currency Charts: USD to JPY, [Online], [Accessed 6 May
2018].
Available at: https://www.xe.com/currencycharts/?from=USD&to=JPY&view=5Y

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Yahoo Finance, 2018, EUR/USD, [Online], [Accessed 5 May 2018].
Available at: https://finance.yahoo.com/quote/EURUSD=X/

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Appendix
1. Day Trading
2. Forwards
3. Pending Orders
12 of 12 pages

Details

Title
Trading Strategies and Risk Management. Speculation in the Foreign Exchange Market
Author
Year
2018
Pages
12
Catalog Number
V427005
ISBN (Book)
9783668743458
File size
1001 KB
Language
English
Tags
trading, strategies, risk, management, speculation, foreign, exchange, market
Quote paper
Suvidha Sehgal (Author), 2018, Trading Strategies and Risk Management. Speculation in the Foreign Exchange Market, Munich, GRIN Verlag, https://www.grin.com/document/427005

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