It's Not That Complicated
By Ed Ponsi, FXEducator.com
Why does the British Pound continue to slide? The continuous downward trend is pretty obvious, but why? The British Pound has been falling hard vs. the U.S. Dollar for months, and bargain hunters trying to "buy low" have been slammed repeatedly. Note that since late 2007, the GBP/USD exchange rate has fallen by more than 7000 pips. The pair has remained trapped beneath its 10-week Exponential Moving Average since August (see figure 1).
Figure 1: GBP/USD has been in a downward spiral since late 2007. Source: Trade Station
Even after this crushing move, sentiment toward the British Pound remains negative. Sure, the U.K. economy is in trouble, but that is not a unique problem. Now, the British government is preparing to unleash a flood of cash in a bid to restart the economy. The Bank of England has announced that they are about to embark on quantitative easing, a strategy designed to relieve stress on the credit markets and fire up the economy. The Bank of England (BoE) has just committed to a 75 billion Pound asset buying spree designed to do just that.
Quantitative easing may sound complicated, but it's really very simple. The BoE will "print money" and use it to buy "gilts," a slang term for U.K. government bonds. Although quantitative easing is often described as "printing money," no new notes and coins are actually created. Instead, a central bank "creates" more money on its balance sheet, and then uses that money to buy the assets of commercial banks, such as home loans and government bonds, thereby pumping extra cash into the system. The commercial banks have accounts with the central bank, and the money will simply be credited to those accounts. One could say that the new funds are created electronically, rather than physically.
When a central bank floods the banking system with masses of money to shore up financial systems and promote lending, it is known as quantitative easing. The hope is that when the banks are flush with cash, they will lend some of that money out to businesses and consumers, who will continue to circulate the money, thus boosting the economy. The problem is, such a tactic can dilute the currency, and the perception that such dilution is about to occur is dragging the Pound down right now.
Question of the Week
Q) I recall you saying on one occasion that during the non farm labor report, stops are not guaranteed. So I phoned my broker and posed the question to him. He said that stops are never guaranteed. Do any Forex companies guarantee their customers' stops? I know there are companies that guarantee no negative account balance.
Ed Ponsi) Thank you for your questions. I'm not surprised that an employee of a specific broker has not heard of guaranteed stop losses, because many companies do not offer them, but they do indeed exist. These orders are referred to as GSLO's (Guaranteed Stop Loss Orders), although entries and exits can also be guaranteed under some circumstances. A common GSLO might guarantee your protective stop up to a certain size of trade, such as 20 standard lots. These orders provide an extra layer of security for traders who are concerned about gaps. For example, assume that a EUR/USD trader places a stop on a Friday afternoon at 1.2600. If EUR/USD closes on Friday at 1.2620, and opens on Sunday evening at 1.2580, a person who placed a GSLO at 1.2600 will have his or her order filled at exactly 1.2600. Not all brokers offer this feature, and some actually charge the client to use a GSLO, so check with your individual broker for details.
How can brokers afford to offer this type of protective stop? Compared to the equity markets, gaps are relatively rare and benign in the Forex market (although recent high volatility has caused an increase in the size of these gaps). There are two main reasons for this; first, the tremendous liquidity of the Forex markets (estimated at about $3.2 Trillion USD per day) means that there are available buyers and sellers at virtually every price point. The other reason is the lack of opening gaps, which only occur on the weekends due to the 24-hour, round-the-clock nature of the currency markets. In conclusion, gaps do occur in the Forex market, but traders can avoid them by using a GSLO or by closing all positions entirely prior to the weekend.
Regarding a guarantee that your account balance will not turn negative, this is pretty much standard operating procedure in the Forex world. Stock brokerages tend to close positions manually, whereas Forex brokers execute them automatically. Unlike the stock brokerage model, where a trader who fails to use good risk management could possibly lose a sum greater than the amount invested, most Forex accounts will automatically close out positions before the account equity turns negative. This is reflective of a superior use of technology by currency brokers; since they are newer than most stock brokerages, they did not suffer from antiquated procedures (such as literally calling a client who has received a margin call).
Also, the international nature of the Forex market would make it difficult and time consuming for creditors to chase debtors. For example, suppose a broker is located in Switzerland, and a client of the broker lives in Costa Rica. If the trader in Costa Rica fails to send funds owed to the broker in Switzerland, the broker may find it difficult to collect that money. In fact, that Swiss broker may have clients in 100 different countries, and the time and effort involved in chasing them around the world to collect funds would be too great. This is why many Forex brokers will automatically close trades before all of the funds are drained from an account.
