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Archive for December, 2010

Don’t ever think that you can predict the impact of fundamental forex news released.

During news released the forex market is extraordinarily unpredictable and a specific currency pair might be moving in the complete opposite direction than what seems logical.

The forex market is always affected by several different kinds of information and individuals with their own idea of the importance of a news release.

Fundamental forex data releases of high importance are often regarded as the super events of forex trading.

Examples include:

The US Non-Farm Payroll,

The US Trade Balance,

The US Unemployment Claims

National Interest Rate Changes

These releases can ignite rapid price changes or spikes in most of currency pairs, especially if the releases are from the US. For particularly large movements to occur, the actual release must surprise the forex market by registering a notable discrepancy from its predicted value. Close correlations do not have the same impact as the market will have already priced the forecasted value.

If you could correctly predict and then capture the resulting price movements created by fundamental data releases, this would be very a profitable exercise. However, many forex traders, especially novices, do not realize how difficult this is to achieve on an ongoing basis. One of the main reasons for this is that many human minds contribute to the actions of the forex market, each with their own agenda. This feature is particularly evident with the release of highly important fundamental forex data.

The purpose of this article is to explain why this activity is prone to so many complexities as well as providing the basis for possible solutions. To begin with, let’s come up with a definition of what exactly fundamental forex data releases are.

Fundamental forex data release means any forex market news that impact national or international economies, either directly or indirectly, is considered fundamental events and can roughly be categorized into three types: economic/financial, political and unforeseen events.

Economic and financial forex data releases tend to have the biggest impact and are scrutinized by most forex investors because of the uncertainty of their outcome. As any significant difference between the actual result and it forecasted value can produce major changes in the values of currency pairs, these reports are kept under strict secrecy right up to the moment of their release. The deciding factor in whether such a fundamental news release will generate market movement depends on how close the result matches the economists’ prediction. A close correlation will cause little change as the forex market has already priced in this effect. However, if the release strays from the anticipated number then this could cause serious movements. Economic calendars are readily available detailing the exact time and dates of all fundamental forex data releases because of the impact they can have on the markets.

Political events that affect the forex market include government elections, G-7 and OPEC meetings and national crises etc. The majority of these events are forecasted well in advance. They can certainly affect the market in unforeseen ways, but most often not in the same manner as with economic/financial news.

Unforseen events, however, are per definition impossible to predict. Especially ones such as terrorist attacks and

global catastrophes are much more difficult to predict and as such can have dramatic effects on the markets.

Economic/financial and most political data is released at pre- defined times during the month and are in the online calendars often categorized as to have a high, medium or low impact on the value of its associated currency compared to others. In some ways, as the information is scheduled well in advanced, they are easier to deal with than random events. However, they still should not be underestimated because the price movement changes they produce can be extremely varied.

For instance, if there is a clear discrepancy between the actual and forecasted value, the market could select and then advance in its chosen direction generating a significant price change of the relevant currency pair. However, many times the market takes an immediate snapshot view of the release’s headlines and reacts accordingly by producing a surge in one direction only to completely reverse its decision minutes later after analyzing the details in more depth.

Sometimes a data release consists of a number of composite values- some of which concur with their predicted values whilst others do not. As a result, the forex market can become quite chaotic, adopting one opinion initially only to reverse it completely, hours or minutes later. Consequently, a false direction is often chosen just after the release that could be altered dramatically sometime later, after the forex market have settled on a truer meaning of the release’s data. Another aspect which should be taken into consideration is that some of the major forex market players might not agree on the forecasted value vs. the actual value and the impact it should have on a specific currency.

Beginners, in particular, seriously overestimate their abilities in dealing with fundamental events falsely, believing that they can successfully predict their outcomes. This is because their trading psychology is flawed in many ways that contribute to their erroneous actions. They have a tendency to ignore downside risks and focus on potential profits only. They believe that each new trade that they enter will make profit and fail to understand that they will be more successful if they adopt more sensible objectives. Their high profit expectations often lead to a demoralizing effect on the morale after they have amassed only a string of losses.

Fundamental data releases can sometimes produce dramatic price movements for currency pairs although the reasons for doing so are far from clear. The resulting changes can persist for some time, giving traders the impression that the market is on a run. However, this is no reason to enter trades, especially if you do not understand fully what is happening. Unfortunately, many beginners do exactly this.

There are so many dimensions which should be added to this picture, in order for it to make perfect sense. You will maybe have the chance to get the numbers of the news you are looking for, but not all the other important aspects. The only thing that is predictable about forex trading is that it is very unpredictable. With that being said, it does not mean that you cannot profit from it; you simply need to take the right approach.

Always ask your forex signal provider for an advise

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Fixed maturity plans (FMPs) were an innovation designed mainly to give investors a fairly certain rate of return in the backdrop of interest rate instability. FMPs are close-ended debt funds (investments can be made only during the new fund offer period) with a fixed maturity horizon (i.e. the investment maturity, which is fixed, is declared at the outset). They invest across debt instruments to arrive at a pre-determined yield. The pre-determined yield is the indicative yield that FMPs usually declare before hand at the time of new fund offer period (NFO). This way, investors are aware as to how much return their investment will deliver on maturity.

FMPs target the given yield by staying investing in the portfolio of debt instruments till maturity. Given the structure of FMPs, investors have an impression that their returns are always in positive terrain and that they can never turn negative. However, investors would do well to understand that by virtue of being market-linked, there is a possibility of debt investments going negative intermittently. So there could be phases when investors could find the net asset value (NAV) of their FMP investments dipping over a day or a week.

Why do debt funds turn negative?

A matter of intrigue for investors is how a debt fund can give a negative return. Usually, these are the investors who have been told that debt instruments can only move in one direction – upwards. To be sure, this is a fallacy. While relative to their equity counterparts, debt instruments do not venture into negative territory as often, they do when the situation warrants it. Debt instruments and by extension debt funds and FMPs are prone to a downturn particularly when there is pessimistic news on the economic front (i.e. inflation, interest rates among other factors).

An illustration

Still confused how a debt instrument can turn negative? A brief illustration should unravel this. For instance, let’s assume that a bond (we will call it Bond A) has a coupon rate of 8%. Suppose there is an increase in interest rates and the new bonds (Bond B) are issued with a coupon rate of 9%. With the introduction of Bond B at a higher coupon rate, the yield on A will adjust higher. This will result in a fall in the price of Bond A (since bond yields and prices are inversely related). Consequently debt funds that hold Bond A will be impacted. When there are many bonds like this in a debt portfolio, the cumulative impact on the NAV is negative.

Why FMPs are not at a risk

FMPs are structured in a manner so as to achieve the indicative return or yield on maturity. The operative word over here is ‘on maturity’ not in the intermittent period. Since they lock-in the yield at the time of investment and stay invested till maturity, the intermittent market fluctuations do not impact their maturity proceeds.

What should FMP investors do?

First and foremost do not get ruffled every time your FMP witnesses a dip in its value. However, there is something that you can do i.e. check whether the FMP is invested in instruments with the highest credit rating (like AAA or sovereign for instance). Since indicative portfolios are released by the fund house before the launch of the FMP, you have this opportunity before investing in the FMP. That way you can ensure that you earn a high yield at lower risk. Of course, if you find all this confusing and feel the need for professional assistance, your financial planner is best suited to help you identify the right FMP.