How To Trade

121. A Trader's Introduction to the Euro

The Euro is now the official currency of 15 of the 27 member states in the European Union (EU), which makes it the currency used by over 320 Million people. Like Europe itself, the Euro has an interesting history, which we as traders must understand to have a full understanding of the fundamentals of the currency. There are two major factors which lead to the eventual formation of the European Union, and therefore the Euro, which are important for traders to understand.

1. The major powers in Europe had been battling each other for hundreds of years prior to World War II. Nothing like the decimation that the World Wars brought to Europe had ever been seen before however, so after World War II, there was a realization that a drastic reordering of the political landscape was needed, in order to put nationalistic rivalries to bed once and for all. 2. Also as a result of World War II, the world's power structure had shifted, and the major European countries who were once the superpowers of the world, were replaced by two new superpowers. The United States and The Soviet Union were now the unrivaled superpowers of the world, and as a result there was a keen awareness among the former world powers of Europe, that banding together was the only way for Europe to have comparable clout on the world stage. It was primarily as a result of these two factors that the European Coal and Steel Community (which eventually became the European Economic Community, the predecessor to the European Union) was founded in the 1950's with the general goals of:

1. Lowering trade barriers and facilitating economic cooperation for the benefit of the member nations.

2. Increasing Europe's clout on the world stage

3. Integrating the economies of the major countries in Europe to the point where they were too reliant on one another to go to war again. During the next several decades many things happened from a diplomatic and trade standpoint that are very interesting, and which can be read about by doing a search on google for the history of the European Union. The next important event for us as traders however, came with the ratification of something which is known as the Maastricht Treaty in the 1990's. [COLOR=#000000]Up to this point, the idea of a tie up between nations in Europe was primarily focused on removing trade barriers and promoting economic cooperation. With the Maastricht treaty, member countries moved from a simple economic cooperation, to the much grander ambition of political integration between member nations.

This is important to us as traders as it was here that plans for a single currency to be used among member nations was introduced, and therefore here that the basic fundamentals of the Euro were laid out. There were three steps outlined in the Maastricht treaty that had to be completed before the currency could be released which were:

1. Free circulation of capital among member countries.

2. The second, and most important step for us as traders to understand, was the coordination of economic policies. Once the Euro was introduced, each of the member countries would be bound by the monetary policy as set by the European Central Bank. With this in mind, you could not have countries with extremely different levels of inflation and interest rates, replace their currency with the Euro, without undermining the credibility and fundamentals of the currency. To make the currency credible, and to make its introduction as smooth as possible, member countries were required to keep inflation, interest rates, and debt below certain levels. Lastly, they were also required to maintain an exchange rate that was basically a banded peg, allowing their currency to fluctuate only within a narrow band.

3. In 1999 the European Central Bank was established and the eleven countries listed here began to use the Euro in electronic format only.

Spain, Portugal, Italy, Belgium, the Netherlands, Luxembourg, France, Germany, Austria, Ireland and Finland.

These countries formed what is known as the European Monetary Union, which is comprised of countries who are members of the European Union, and use the Euro as their currency.

Greece, the United Kingdom, Sweden, and Denmark (the other members of the European Union at the time) remained outside the European monetary Union for different reasons.

While this may seem a bit like a history lesson rather than a lesson in trading, it is very important for traders of the Euro to have an understanding of the history we have just gone over. As we will learn in coming lessons, it is because of this history that the Euro is where it is today, and many of the concepts we have just outlined still affect the value of the currency in today's market.

122. A Trader's Introduction to the Euro, Part II

As we discussed in our last lesson, the Euro was launched as an electronic currency on January 1st 1999. As you can see from this chart, the markets initial confidence in the Euro, and really the European Union as a whole, was initially not very high. Over the next year the currency sold off from just above 1.1600 dollars to 1 Euro at its inception, to a low point of around .8200 cents to 1 Euro towards the end of 2000. While the tables have turned now in the Euro's favor, it actually took the European Central Bank intervening in the markets and buying Euros, to keep the currency from sliding further in 2000.

The launch of the Euro was the largest monetary changeover ever, and as you can see, was not guaranteed success. As we touched on in our last lesson, getting a dozen countries, which varied widely in their economic and political clout, to give up control over their own monetary policy and switch to a more centralized monetary system, was no easy task.

As we learned about in module 8 of our basics of trading course, one of the most powerful tools that countries have to try and manage their business cycle is monetary policy, a tool which those adopting the Euro were essentially giving up. Although we have not seen a real test of this yet, you can imagine a situation where the economy of one of the major countries in the EMU such as Germany, goes into recession, but overall growth in the rest of the EMU is steady. If Germany were not part of the EMU, they could cut interest rates to try and bring their economy out of recession. Since they are however, their hands would be tied in this situation from a monetary policy standpoint, which may drive their economy deeper into recession than would otherwise be the case.

As we also learned about in module 8 of our free basics of trading course, countries have a second tool to manage the business cycle, which is Fiscal policy. As the EMU nations are still primarily independent from a fiscal policy standpoint, they do still have this in their toolbox. The issue here however, is that one of the ongoing requirements established in the Massstricht treaty for countries which join the EMU, is that member country's budget deficits must be less than 3% of GDP. So here again member nations are someone limited in what they can do to help their own economies, should it falter.

Of all the things to understand about the Euro from a fundamentals standpoint, it is this that is the most important, as it is here that a true test of the Euro, will eventually come.

So far I think most would agree that the Euro has been a resounding success, and since the original 12 countries replaced their currencies with the Euro as their paper currency in January of 2002, 3 more EU member nations have joined the EMU, and 5 other countries outside the EU have adopted the Euro as their official currency.

As a result of its success and the large combined economies that the currency represent, many feel that the Euro will one day replace the US Dollar as the premiere currency of the world. If you have thoughts on this I would love for you to share them in the comments section below.

Thats our lesson for today. In our next lesson we will look at the major economies of Europe which traders watch closely for fundamental direction in the currency so we hope to see you in that lesson.

123. A Trader's Introduction to the Euro, Part III


In our last lesson we continued our discussion of the Euro with a look at its introduction, and the major factors which will determine the long term fundamental direction of the currency. In today's lesson we are going to continue our free forex trading course, with a look at the major economies in the Eurozone and how each affects the value of the Euro.

As you can see from this graph, member countries Germany, France, Italy, and Spain make up over 75% of the Eurozone's GDP. As a result of this economic data out of these countries has the tendency to move the Euro the most, so traders naturally pay them more attention.

There are literally thousands of economic numbers released in the Eurozone however, like we covered in module 3 of this course, those that affect the current account (trade flows) or interest rates (capital flows) are going to have the greatest potential to move the currency. All of the indicators which we cover in module 8 of our basics of trading course, have a counterpart in the EU. Most of the time they are also named the same, and as they show the same things, traders can expect the market to react accordingly. The only thing to keep in mind here is that the economic climate in the United States vs. the Eurozone will differ at times, so traders and therefore the market may react differently to the same number out of the EU than they do out of the US.
The second thing that it is important to understand about EU economic releases, is the different mandate of the European Central Bank, versus the Federal Reserve. Where the Federal Reserve has a dual mandate of maximizing employment and maintaining price stability, the ECB's mandate is solely to maintain price stability. With this in mind, the ECB is normally seen as more hawkish than the federal reserve, meaning they are more likely to hold steady or raise interest rates when economic data show price increases, and less likely to cut interest rates as quickly as the fed when growth in the Eurozone slows.

I could spend many lessons covering each of the economic indicators and their relative importance to the market but in the interest of maximizing our learning I am going to instead defer to two free sites which do an excellent job here.

Fxwords.com and specifically their page on Euro-Zone Economic Indicators which I have included a link to below this video. As you can see here they categorize the major economic reports and then list them out with stars representing the relative importance of the indicator to the market. If you click on the link for each indicator it will take you to a page giving a definition as well as commentary on how traders should expect the release to affect the market.

Once you have an understanding of the economic indicators then you can get the date, time, and forecast for the release from the global calendar which you can find by click the calendar button at the top of Dailyfx.com. As you can see here the importance of the indicator to the market is also indicated with stars on the calendar, and the important indicators have links where you can go for more information.

124. A Trader's Introduction to the Yen

Japan has the second largest economy in the world behind the United States, and an economic history that is the starting point for understanding the fundamentals of the Yen. The first thing that it is important to understand from a fundamental standpoint about the Japanese economy, is that unlike the United States, Japan has very few natural resources. As a result of this, prior to World War II, Japan had a large military force, which it used to occupy Korea, Taiwan, and parts of China. The country saw this as necessary, because of the vulnerable position that its lack of natural resources would have otherwise put it into.

Like with Europe however, World War II, set the country back considerably from an economic standpoint, as according to wikipedia.org, 40% of its industrial plants and infrastructure were destroyed. While no one would obviously wish for that type of destruction, there was actually a silver lining in this for the Japanese Economy. As so much of their infrastructure had been destroyed, this gave the Japanese the ability to upgrade it significantly, ultimately giving them an edge over victor states, who now had much older factories.

After World War II the United States occupied Japan, which resulted in the building of a democratic nation, that was dominated by industry, instead of the military. As the Japanese were now putting all of the focus, which had before been put into the military, into rebuilding their industries, they were able to not only match their pre war production levels by 1950, but surpass them. In the decades that followed Japan proved very competitive on the international stage, and its economic growth in the 60's, 70's and 80's has been described as nothing short of astonishing.

If you were around living in the US during the 80's, you can probably remember the envy and fear among the US population, that Japan was quickly going to overcome the United States as the world's economic power house.

While I don't think there is any question that the quality of Japanese products and services has remained very high since the 80's, unfortunately Japan's economy derailed in the early 1990's, culminating in the busting of one of the most famous asset price bubbles in history.

In the decades following World War II the Japanese population had one of the highest savings rates in the world. As more money was being saved, this meant there was more money available for investment, making access to credit much easier than it had been in the past. As Japan's economy was and still is an export oriented economy, the value of the currency also went up dramatically during this time. The combination of a strong economy, easy access to credit, and a strengthening currency made Japanese assets especially attractive.

As its economy seemed unstoppable, and newly wealthy Japanese saved more and more money, much of that capital flowed into the stock and real estate markets. As you can see from this chart the stock market roared through the 1980s, almost quadrupling in value in 5 years. In the most expensive districts, according to wikipedia.org, real estate prices reached as high as $139,000 per square foot.

From the high of the stock and real estate markets in 1990, both markets made a slow and painful decline. It took until 2003 for the stock market to finally bottom, down from a top of around 39,000 to a bottom of around 7600. According to wikipedia.org, prices for the most expensive commercial real estate properties stood at 1/100th of their pre bubble bursting peak, and $20 Trillion in wealth had been wiped out in the stock and real estate markets.

While this may seem like a history lesson that is not relevant to traders, as we will learn in tomorrow's lesson, the affects of Japan's asset price bubble on the Yen are still being felt today, and therefore an understanding is necessary to know how today's market will react to different fundamental events.

125. A Trader's Introduction to the Yen, Part II

In our last lesson we began our discussion on on the Japanese Yen, with a look at the history of the Japanese economy, including the build up of what became one of the biggest asset price bubbles in history. In today's lesson we are going to continue this discussion by examining what happened from the early 1990's on from a monetary policy and economic standpoint, so we can understand the fundamental foundation on which the Yen sits today.

In 1989 the Bank of Japan (BOJ) began to raise interest rates, and the government instituted limits on total bank lending to the real estate sector, to try and reign in speculation which was driving stock and real estate prices to astronomically high levels. While the central bank was hoping to simply take the foot of the gas and tap the breaks on the economy, unfortunately the markets reaction was drastic, resulting in a stock market and real estate crash starting in 1990.
This was a "perfect storm" so to speak for the Japanese financial system and economy, as the effects of decline in real estate and stock market prices started a chain reaction, which reverberated throughout the economy and whole financial system. The first and perhaps most important thing to understand here, is that the economic slowdown, combined with drastic falls in the stock and real estate markets, caused the financial position of Japanese banks to rapidly deteriorate.

Much of the speculation that was sending real estate prices so high was being driven by loans from Japanese banks, which took the land they were making the loan on as collateral. As the quality of the loan was thus tied to the value of the real estate backing that loan, as real estate prices fell off a cliff so did the quality of the bank's loan portfolio's.

Secondly, large Japanese institutions such as banks cooperate with one another in Japan, and as a result of this Japanese banks hold large quantities of each others stock. Holdings of stock are considered an asset for the banks and were included in the banks capital numbers, which basically define how financially solid a banks balance sheet is. As the value of these stock holdings tumbled lower, so did the bank's capital position, putting further pressure on the stability of the individual banks in Japan, and the Japanese Banking System as a whole.

Thirdly, as the economy slowed as a result of all this, the individuals and corporations who had received loans began to have a harder time making their payments, further deteriorating the quality of the bank's loans, and stability of the banking system.

At least partially as a result of weak corporate governance, most will argue that Japanese banks did little to adjust to the financial difficulties they now faced, instead preferring to wait for stock and real estate prices to move back towards their pre bubble bursting levels. The government also did little to address the problem until 1995, when it became clear that without government intervention massive bank failures would result.


This history is important to us as traders for two reasons:

1. Reforms aimed at returning the stability of the Japanese financial system are still ongoing today, and it is these financial and structural reforms that traders watch closely when determining the fundamental direction of the Japanese Economy.

2. Japanese consumers, many of whom had lost large sums of money in the real estate and stock markets, lowered consumer spending significantly, resulting in prices actually starting to decrease towards the end of the 1990's, something which is known as deflation.

While many argue that the Bank of Japan acted too late they did eventually respond to the economic weakness with interest rate cuts driving interest rates in Japan down from over 8% in 1990, all the way to zero percent in 1999. While the Bank of Japan has increased interest rates in Japan to .5% since then, this is still by far the lowest rate of any of the the major economies of the world. As a result of this it is very cheap to borrow Japanese Yen, making it the primary funding currency for the carry trades

126. A Trader's Introduction to the Japanese Yen, Part III

As we touched on in our first lesson in this series, Japan has few natural resources of their own, so they are an economy that relies heavily on imports of natural resources such as oil. This is something to keep in mind when trading the currency, because as Japan imports almost 100% of its oil from overseas, increases and decreases in the price of oil will normally have an affect on the value of the Yen.

The second thing that it is important to keep in mind, is that the Japanese economy relies heavily on exports such as cars and electronics to grow their economy. As a result of this, the value of Japan's currency is an even more important factor in their economic growth than for countries which do not rely so heavily on exports to drive domestic growth. As we learned about in our lessons on trade flows, a stronger Yen automatically means that Japanese goods and services become more expensive for overseas consumers, which will hurt Japanese exports.

To keep the Yen from rising to the point where it would hurt the Japanese economy, the Bank of Japan is notorious for intervening in the foreign exchange markets, which can send the value of the yen plummeting.

Below is a graph provided by Dailyfx.com which shows some of the history of Japanese intervention, which as you can see tends to take place around the 100 level in the currency. As the BOJ has been so effective with intervention in the past, it has gotten to the point now where all they need to do is talk of intervention (something called verbal intervention) to yen based pairs rocketing higher.

As with all the currency pairs we are studying, there are many economic indicators which affect the value of the yen, that we could spend much time discussing. As we have already covered the major indicators for the US in module 8 of our basics of trading course, and as the indicators in Japan are much the same, in the interest of maximizing our learning time I am going to point you towards two free sites for more information.

127. A Trader's Introduction to the British Pound

The first video in our series on the British pound, its history, and what traders should know about it before trading the GBP.

128. A Trader's Introduction to the Swiss Franc

A look at the Swiss Franc, its historical use as a safe haven currency, its correlation to gold and the Euro, and other information that currency traders should know.

129. A Trader's Introduction to the Canadian Dollar

An introduction to the Canadian dollar, the factors that impact its value, and what forex traders should bear in mind.

130. A Trader's Introduction to the Australian Dollar

A look at what forex traders need to know about the currency of Australia, the Australian Dollar.