www.fx1618.com CURRENCY TRADING How to Access and Trade the World’s Biggest Market Philip Gotthelf John Wiley & Sons, Inc. www.fx1618.com www.fx1618.com CURRENCY TRADING How to Access and Trade the World’s Biggest Market Philip Gotthelf John Wiley & Sons, Inc. www.fx1618.com Copyright © 2003 by Philip Gotthelf. All rights reserved. Published by John Wiley & Sons, Inc., Hoboken, New Jersey Published simultaneously in Canada No part of this publication may be reproduced, stored in a retrieval system, or transmitted in any form or by any means, electronic, mechanical, photocopying, recording, scanning, or otherwise, except as permitted under Section 107 or 108 of the 1976 United States copyright Act, without either the prior written permission of the Publisher, or authorization through payment of the appropriate per-copy fee to the Copyright Clearance Center, Inc., 222 Rosewood Drive, Danvers, MA 01923, 978-750-8400, fax 978-750-4470, or on the web at www.copyright.com. Requests to the Publisher for permission should be addressed to the Permissions Department, John Wiley & Sons, Inc., 111 River Street, Hoboken, NJ 07030, 201-748-6011, fax 201-748-6008, e-mail: [email protected]. Limit of Liability/Disclaimer of Warranty: While the publisher and author have used their best efforts in preparing this book, they make no representations or warranties with respect to the accuracy or completeness of the contents of this book and specifically disclaim any implied warranties of merchantability or fitness for a particular purpose. No warranty may be created or extended by sales representatives or written sales materials. The advice and strategies contained herein may not be suitable for your situation. You should consult with a professional where appropriate. Neither the publisher nor author shall be liable for any loss of profit or any other commercial damages, including but not limited to special, incidental, consequential, or other damages. For general information on our other products and services, or technical support, please contact our Customer Care Department within the United States at 800-762-2974, outside the United States at 317-572-3993 or fax 317- 572-4002. Wiley also publishes its books in a variety of electronic formats. Some content that appears in print may not be available in electronic books. For more information about Wiley products, visit our web site at www.wiley.com. Library of Congress Cataloging-in-Publication Data Gotthelf, Philip. Currency trading: how to access and trade the world’s biggest market / Philip Gotthelf. p.cm.--(wiley trading) Includes index. ISBN 0-471-21554-6 (alk. paper) 1. Foreign exchange futures. 2. Foreign exchange market. I. title. II. Series. HG3853.G68 2003 332.45--dc21 2002190743 Printed in the United States of America 10987654321 www.fx1618.com This book is dedicated to my wife, Paula and my daughters, Jenna and Rikki. Their permission to write instead of play is responsible for this book. www.fx1618.com Founded in 1807, John Wiley & Sons is the oldest independent publishing company in the United States. With offices in North America, Europe, Australia and Asia, Wiley is globally committed to developing and marketing print and electronic products and services to our customers’ professional and personal knowledge and understanding. The Wiley Trading series features books by traders who have survived the market’s ever changing temperament and have prospered—some by reinventing systems, others by getting back to basics. Whether a novice trader, professional or somewhere in-between, these books will provide the advice and strategies needed to prosper today and well into he future. For a list of available titles, please visit our Web site at www.WileyFinance.com. www.fx1618.com ACKNOWLEDGMENTS Special thanks are extended to those who helped compile facts, figures, and assisted in linguistic constructs that readers should be able to understand. I thank my wife, Paula for her patience and editing skills. I am sure her comments improved the quality of this book. Thanks to my associates Ron Goodis and Martin C. Niemi for working out trading examples and helping to acquire facts and graphic figures. I am forever grateful to Robert W. Hafer who provided access to charts and data while he was with Bridge/ Commodity Research Bureau. I want to thank the many indi- viduals at the International Monetary Market (IMM) of the Chicago Mercantile Exchange and my friends at FINEX for providing contract specifications and access to international monetary statistics. Thanks are extended to various Refco FX Associates and Bruce Pollack for providing screen shots and per- mission to use them. Special acknowledgement is extended to Edward M. Bern- stein, Esq. whose diligent efforts provided me with the time to complete another text. In turn, Ed and I thank Robert LoBue, Esq. and Stuart Karl, Esq. for their persistence and perseverance that aided in the growth of my nest egg and helped me pursue more extensive trading endeavors. Finally, I want to acknowledge a very special individual, Ariel Jacobs, who lost his life during the September 11th 2001 terrorist attack upon the World Trade Center. Ari worked for FutureSource as Senior Vice President/National Sales Director. Ari provided the original permission to include FutureSource data and statistics in this book. He left this world on his birthday and just prior to the birth of his first child. Those who knew him appreciated his youthful energy and sincerity. He was an asset to his company and his customers. He will be missed. www.fx1618.com v www.fx1618.com TABLE OF CONTENTS Introduction 1 Chapter 1 Money, Currency, and Foreign Exchange (Forex) 9 Chapter 2 Understanding Parity 23 Chapter 3 The Wealth of Nations 39 Chapter 4 Shifting Sands of Fundamental Analysis 63 Chapter 5 Interventions, Scams, Rouges, and Manipulations 99 Chapter 6 Understanding the Markets of Cash, Futures, and Options 115 Chapter 7 Practical Trading Strategies 159 Chapter 8 Market Behavior 193 Chapter 9 Great Expectations 269 Appendix 283 Index 299 www.fx1618.com vii www.fx1618.com INTRODUCTION In 1972, my father, the late Edward B. Gotthelf, met with Everett Harris, President of the Chicago Mercantile Exchange, to discuss promoting their new International Monetary Market (IMM). Major world currencies were being floated against the dollar under a new Smithsonian Agreement consummated in December 1971. The exchange was working swiftly to create foreign currency futures that would take advantage of an expanded fluctuation band from 1 to 4.5 percent. Although this was hardly the kind of dramatic swing seen in some agricultural markets, this evolu- tionary development represented the potential for a 9 percent trad- ing range from top to bottom. Approximately 4 months later, western Europe formulated their European Joint Float, which per- mitted a 2.5 percent intermember parity fluctuation labeled the snake and a 4.5 percent band against the dollar called the tunnel. Again, the implied range against the greenback was 9 percent. If memory serves me correctly, a gentleman named Mark Powers was involved in making currency futures a reality. This bold plan represented the birth of financial futures and a new era of derivative trading. Founders of currency futures appropriately reasoned that a 1 to 10 percent margin would magnify a 9 percent trading range by several hundred percent. Consider that a 5 per- cent move against the dollar translates into a nickel. If you only need .01 to .001¢ to accomplish this trade, your potential profit is 500 to 5,000 percent. Fortunately, no insider trading restrictions applied to com- modity markets. When I visited home from college, my father excitedly explained the enormous profit potentials represented by these new markets. He pointed out that certain currencies such as the Japanese yen and Mexican peso were being revalued against the dollar. However, IMM contracts hadn’t reflected the anticipated changes. www.fx1618.com 1 2 Currency Trading It was my first official venture into commodity trading. Using money earned through summer jobs and guitar perform- ances in coffee houses, I funded my first currency trading ven- ture. With less than $1,000, I took positions destined for realignment. Within a few months, a few hundred dollars in mar- gin ballooned into a whopping $7,000. Although this was not as impressive as Hillary Clinton’s alleged gains in soybeans and cat- tle, keep in mind that these were 1970’s dollars. I immediately took my newly found riches and went car shopping. For those familiar with cars of the 1970s, my choice narrowed down to the Alfa Romeo Berliner at $2,800 and the BMW 2002 Tii at $3,200. Imagine such prices! The remainder of my profits went toward paying taxes, tuition, and (of course) party expenses. Although the BMW represented the car at the time, I remem- ber thinking, “$400! How can I afford the extra $400?” As of this writing, $400 buys a modest New York dinner for four with a decent wine, very few drinks, and perhaps dessert. I bought the Alfa and admit that I drove that car for 17 years—until I married my wife Paula, who refused to push-start the vehicle on cold winter days. After all, we were married and she didn’t have to play that game anymore! Of course, the point of this introductory story is threefold. First, it exemplifies the enormous amplification a 9 percent max- imum trading range had when combined with a 1 percent initial margin requirement. In effect, 9 percent became almost 900 per- cent. By the 1990s, currencies bounced against each other in multiple percentages. Daily volume grew to average an astound- ing $1 trillion. World-renowned financier/investor George Soros realized more than $1 billion over a few days when currencies were adjusted in the fall of 1992.