are worth using. You also should know how other players use these
instruments and how that plays out in the Forex market.
In late November 2001, I noticed that the yen had been steadily
weakening against the U.S. dollar for the entire month. On the
third Friday of the month, I was surprised to see the yen move in a
strange fashion. It would start gaining value rapidly, and just as it
appeared to break out into a higher trading value, it would suddenly
fall back to lower levels.
This happened four or five times in late New York trading
alone. On the charts, it looked like the yen would rise and then hit
an electric fence. I had never seen anything like it. What was going
on? I then heard a rumor that explained this unique event. It turned
out that a Japanese importer had taken out a large put option to
protect his revenue in U.S. dollars. To ensure that this option didn’t
expire worthless, he had enlisted a few large banks to protect his
position. Whenever the yen weakened to the point of threatening
his position, the banks would start selling dollars, thereby causing
the yen to strengthen.
This is a pretty extreme example, but traders must understand
how their trading tools interact with others. There is no doubt that the
increased popularity and sophistication of financial derivatives has
complicated trading, especially in price discovery. Many inexperienced
Forex traders concentrate on the spot vehicle because of its relative
simplicity, but this focus handicaps their ability to trade effectively.
Why? Spot is traded “over the counter” (OTC), meaning outside
an organized exchange. No one can really keep track of it,
because many of the trades are occurring out of sight, in different
locations, and so on.
On an exchange, however, important information can be gleaned
from the ebb and flow of derivative trading and posted for investors
to see. The Chicago Mercantile Exchange, for example, reports outstanding
positions for options. This indicates what the market
thinks will happen in the future. In the fragmented, decentralized
Forex spot market, however, these kinds of indicators do not exist.
A good trader knows that it’s not just his investment that’s
important, but where he chooses to make his investment.
Read More : Derivatives and the Forex Market
