The Basics of Tariffs And Trade Barriers

International trade increases the number of goods that domestic consumers can choose from, decreases the cost of those goods through increased competition, and allows domestic industries to ship their products abroad. While all of these effects seem beneficial, free trade isn't widely accepted as completely beneficial to all parties. In fact, President Trump's presidential campaign last fall was vehemently anti-trade. This article will examine why some share this anti-trade sentiment and look at how countries react to the variety of factors that attempt to influence trade. (To start with a discussion on trade, see What Is International Trade? and The Globalization Debate.) 

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What Is a Tariff?

 

In simplest terms, a tariff is a tax. It adds to the cost of imported goods and is one of several trade policies that a country can enact.

 

Why Are Tariffs and Trade Barriers Used?

 

Tariffs are often created to protect infant industries and developing economies but are also used by more advanced economies with developed industries. Here are five of the top reasons tariffs are used:

1. Protecting Domestic Employment The levying of tariffs is often highly politicized. The possibility of increased competition from imported goods can threaten domestic industries. These domestic companies may fire workers or shift production abroad to cut costs, which means higher unemployment and a less happy electorate. The unemployment argument often shifts to domestic industries complaining about cheap foreign labor, and how poor working conditions and lack of regulation allow foreign companies to produce goods more cheaply. In economics, however, countries will continue to produce goods until they no longer have a comparative advantage (not to be confused with an absolute advantage).
2. Protecting Consumers A government may levy a tariff on products that it feels could endanger its population. For example, South Korea may place a tariff on imported beef from the United States if it thinks that the goods could be tainted with disease.
3. Infant Industries The use of tariffs to protect infant industries can be seen by the Import Substitution Industrialization (ISI) strategy employed by many developing nations. The government of a developing economy will levy tariffs on imported goods in industries in which it wants to foster growth. This increases the prices of imported goods and creates a domestic market for domestically produced goods while protecting those industries from being forced out by more competitive pricing. It decreases unemployment and allows developing countries to shift from agricultural products to finished goods.
   Criticisms of this sort of protectionist strategy revolve around the cost of subsidizing the development of infant industries. If an industry develops without competition, it could wind up producing lower quality goods, and the subsidies required to keep the state-backed industry afloat could sap economic growth.
4. National Security
   Barriers are also employed by developed countries to protect certain industries that are deemed strategically important, such as those supporting national security. Defense industries are often viewed as vital to state interests, and often enjoy significant levels of protection. For example, while both Western Europe and the United States are industrialized, both are very protective of defense-oriented companies.
5. Retaliation Countries may also set tariffs as a retaliation technique if they think that a trading partner has not played by the rules. For example, if France believes that the United States has allowed its wine producers to call its domestically produced sparkling wines "Champagne" (a name specific to the Champagne region of France) for too long, it may levy a tariff on imported meat from the United States. If the U.S. agrees to crack down on the improper labeling, France is likely to stop its retaliation. Retaliation can also be employed if a trading partner goes against the government's foreign policy objectives.

 

Types of Tariffs and Trade Barriers

 

There are several types of tariffs and barriers that a government can employ:

• Specific tariffs
• Ad valorem tariffs
• Licenses
• Import quotas
• Voluntary export restraints
• Local content requirements

Specific Tariffs 

A fixed fee levied on one unit of an imported good is referred to as a specific tariff. This tariff can vary according to the type of good imported. For example, a country could levy a $15 tariff on each pair of shoes imported, but levy a $300 tariff on each computer imported.

Ad Valorem Tariffs 

The phrase ad valorem is Latin for "according to value," and this type of tariff is levied on a good based on a percentage of that good's value. An example of an ad valorem tariff would be a 15% tariff levied by Japan on U.S. automobiles. The 15% is a price increase on the value of the automobile, so a $10,000 vehicle now costs $11,500 to Japanese consumers. This price increase protects domestic producers from being undercut but also keeps prices artificially high for Japanese car shoppers.
Non-tariff barriers to trade include:

Licenses

A license is granted to a business by the government and allows the business to import a certain type of good into the country. For example, there could be a restriction on imported cheese, and licenses would be granted to certain companies allowing them to act as importers. This creates a restriction on competition and increases prices faced by consumers. 

Import Quotas 

An import quota is a restriction placed on the amount of a particular good that can be imported. This sort of barrier is often associated with the issuance of licenses. For example, a country may place a quota on the volume of imported citrus fruit that is allowed.

Voluntary Export Restraints (VER) 

This type of trade barrier is "voluntary" in that it is created by the exporting country rather than the importing one. A voluntary export restraint is usually levied at the behest of the importing country and could be accompanied by a reciprocal VER. For example, Brazil could place a VER on the exportation of sugar to Canada, based on a request by Canada. Canada could then place a VER on the exportation of coal to Brazil. This increases the price of both coal and sugar but protects the domestic industries.

Local Content Requirement 

Instead of placing a quota on the number of goods that can be imported, the government can require that a certain percentage of a good be made domestically. The restriction can be a percentage of the good itself or a percentage of the value of the good. For example, a restriction on the import of computers might say that 25% of the pieces used to make the computer are made domestically, or can say that 15% of the value of the good must come from domestically produced components.
In the final section, we'll examine who benefits from tariffs and how they affect the price of goods.

Who Benefits?

 

The benefits of tariffs are uneven. Because a tariff is a tax, the government will see increased revenue as imports enter the domestic market. Domestic industries also benefit from a reduction in competition, since import prices are artificially inflated. Unfortunately for consumers - both individual consumers and businesses - higher import prices mean higher prices for goods. If the price of steel is inflated due to tariffs, individual consumers pay more for products using steel, and businesses pay more for steel that they use to make goods. In short, tariffs and trade barriers tend to be pro-producer and anti-consumer.
The effect of tariffs and trade barriers on businesses, consumers and the government shifts over time. In the short run, higher prices for goods can reduce consumption by individual consumers and by businesses. During this period, businesses will profit, and the government will see an increase in revenue from duties. In the long term, businesses may see a decline in efficiency due to a lack of competition, and may also see a reduction in profits due to the emergence of substitutes for their products. For the government, the long-term effect of subsidies is an increase in the demand for public services, since increased prices, especially in foodstuffs, leave less disposable income. (For related reading, check out In Praise Of Trade Deficits.)


How Do Tariffs Affect Prices?


Tariffs increase the prices of imported goods. Because of this, domestic producers are not forced to reduce their prices from increased competition, and domestic consumers are left paying higher prices as a result. Tariffs also reduce efficiencies by allowing companies that would not exist in a more competitive market to remain open.

 

Tariffs and Modern Trade

 

The role tariffs play in international trade has declined in modern times. One of the primary reasons for the decline is the introduction of international organizations designed to improve free trade, such as the World Trade Organization (WTO). Such organizations make it more difficult for a country to levy tariffs and taxes on imported goods, and can reduce the likelihood of retaliatory taxes. Because of this, countries have shifted to non-tariff barriers, such as quotas and export restraints. Organizations like the WTO attempt to reduce production and consumption distortions created by tariffs. These distortions are the result of domestic producers making goods due to inflated prices, and consumers purchasing fewer goods because prices have increased. (To learn about the WTO's efforts, read What Is The World Trade Organization?)
Since the 1930s, many developed countries have reduced tariffs and trade barriers, which has improved global integration and brought about globalization. Multilateral agreements between governments increase the likelihood of tariff reduction, while enforcement of binding agreements reduces uncertainty.

 

The Bottom Line

 

Free trade benefits consumers through increased choice and reduced prices, but because the global economy brings with it uncertainty, many governments impose tariffs and other trade barriers to protect the industry. There is a delicate balance between the pursuit of efficiencies and the government's need to ensure low unemployment.

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By Brent Radcliffe | Updated April 18, 2017 — 2:50 PM EDT

Read more: The Basics Of Tariffs And Trade Barriers http://www.investopedia.com/articles/economics/08/tariff-trade-barrier-basics.asp#ixzz4ninRhH1V

 Disclaimer…The subject matters expressed above is based purely on technical analysis and personal opinions of the writer. it is not a solicitation to buy or sell.

Beware False Signals From The P/E Ratio

The price-to-earnings ratio (P/E) is a fairly simple tool for assessing company value. Judging by how often the P/E ratio gets touted - by Wall Street analysts, the financial media and colleagues at the office water cooler - it's tempting to think it's a fool-proof tool for making wise stock investment choices. Think again; the P/E ratio is not always reliable. There are plenty of reasons to be wary of P/E-based stock valuations.


Tutorial: Financial Ratios

Calculating the P/E ratio - Quick Review
On the surface, calculating the price-to-earnings is fairly straightforward. The first step in generating a P/E ratio is to calculate earnings per share or EPS. Typically, EPS equals the company's after tax profits divided by the number of shares in issue

EPS = Post-Tax Profits / Number of Shares

From the EPS, we can calculate the P/E ratio. The P/E ratio equals the company's current market share price divided by the earnings per share for the previous year.

P/E = Share Price / EPS

The P/E ratio is supposed to tells investors how many years' worth of current earnings a company will need to produce in order to arrive at its current market share value. So, let's say the imaginary company Widget Corp. earned $1 per share over the past year and it's trading at $10.00 per share. The P/E ratio would be $10/$1 = 10. What this tells us is that the market prices it at 10 times earnings. Or in other words, for every share purchased, it will take 10 years of cumulative earnings to equate to the current share price. Naturally, investors want to be able to buy more earnings for every dollar they pay, so the lower the P/E ratio, the less expensive the stock.

The ratio sound simple enough, but let's look at some of the dangers associated with taking P/E ratios at face value.

The first part of the P/E equation - price - is straightforward. We can be fairly confident what the market price is. On the other hand, coming up with an appropriate earnings number can be tricky. You have to make a lot of decisions how to define earnings.

What's in those Earnings?
For starters, earnings aren't always clear cut. Earnings can be affected by unusual gains or losses which sometimes obscure the true nature of the earnings metric. What's more, reported earnings can be manipulated by company management to meet earnings expectations, while creative accounting choices - shifting depreciation policies or adding or subtracting non-recurring gains and expenses - can make bottom line earnings numbers bigger and, in turn, P/E ratios, smaller and the stock appear less expensive. Investors need to be wary of how companies arrive at their reported EPS numbers. Appropriate adjustments often have to be done in order to obtain a more accurate measure of earnings than what is reported on the balance sheet.

Trailing or Forward Earnings?
Then there is the matter of whether to use trailing earnings or forward earnings figures.

Located right in the company's latest published income statement, historic earnings are easy to find. Unfortunately, they are not much use for investors, since they say very little about what earnings are in store for the year and years ahead. It's the company's future earnings that investors are interested in most since as they reflect a stock's future prospects.

Forward earnings (also called future earnings) are based on the opinions of Wall Street analysts. Analysts, if anything, typically tend to be over-optimistic in their assumptions and educated guesses. At the end of the day, forward earnings suffer the problem of being a lot more useful than historic earnings but prone to inaccuracies.

What about Growth?
The biggest limitation of the P/E ratio: it tells investors next-to-nothing about the company's EPS growth prospects. If the company is growing quickly, you will be comfortable buying it even it had a high P/E ratio, knowing that growth in EPS will bring the P/E back down to a lower level. If it isn't growing quickly, you might shop around for a stock with a lower P/E ratio. It is often difficult to tell if a high P/E multiple is the result of expected growth or if the stock is simply overvalued.

A P/E ratio, even one calculated using a forward earnings estimate, doesn't always tell you whether or not the P/E is appropriate to the company's forecasted growth rate. So, to address this limitation, we turn to another ratio, the PEG ratio:

PEG = PE/forecast EPS growth rate over the next twelve months

In a nutshell, the lower the PEG ratio, the better. A PEG of one suggests that the P/E is in line with growth; below one implies that you are buying EPS growth for relatively little; a PEG greater than one could mean the stock is overpriced. However, even when the P/E ratio is standardized for growth, you are basing your investment decision on outside estimates, which may be wrong. (Learn how this simple calculation can help you determine a stock's earnings potential. Read PEG Ratio Nails Down Value Stocks.)

What about Debt?
Finally, there's the tricky issue of a company's debt load. The P/E ratio does nothing to factor in the amount of debt that a company carries on its balance sheet. Debt levels have an impact on financial performance and valuation, yet the P/E doesn't allow investors to make apples-to-apples comparisons between debt-free firms and those bogged down with outstanding loans and liabilities.

One way to address this limitation is to consider a company's enterprise value or EV in place of its Price or P.

(simplified) EV = Market Capitalization + Net Debt

Let's say the Widget Corp., with a market share price of $10 per share, also carried the equivalent of $3 per share of net debt on its balance sheet. The company, then, would have total enterprise value of $13 per share. If Widget Corp. produced EPS this year of $1, its P/E ratio would be 10. But more sophisticated investors would perform the calculation with enterprise value in the numerator and EBITDA in the denominator.

The Bottom Line
Sure, the P/E ratio is popular and easy to calculate. But it has big shortcomings that investors need to consider when using it to assess stock values. Use it carefully. No single ratio can tell you all you need to know about a stock. Be sure to use a variety of ratios to get a fuller picture of financial performance and stock valuation.

By Ben McClure

Source : http://www.investopedia.com/

Disclaimer…The subject matters expressed above is based purely on technical analysis and personal opinions of the writer. it is not a solicitation to buy or sell.

Recession And Depression: They Aren't So Bad

Recessions and depressions have occurred many times throughout history. To many, they bring fear and uncertainty, but they are actually a natural part of the economic cycle. Unfortunately, there are a lot of myths surrounding market cycles, but in order understand them, we must look beyond these myths. In this article, we'll examine recession and depression, how they work and what they really mean for investors.


What Is a Recession?
First, let's take a look at recessions. There are two definitions of recession: one defines a recession as two consecutive quarters of negative economic growth, and the second (according to the National Bureau of Economic Research (NBER)) defines a recession as a significant decline in national economic activity that lasts more than just a few months.


How It Works
The growth of our economy rests upon the balance between the production and consumption of goods and services. As the economy grows, so do incomes and consumer spending, which continues the cycle of growth. However, because the world is not perfect, at some point, the economy has to slow. This slow down could be caused by something as simple as an oversupply, where producers manufacture too many goods. When this happens, the demand for those goods will drop. This causes earnings to slow, incomes to drop and the equity markets to fall. (To learn more, read Understanding Supply Side Economics.)


Historical Examples
Since the mid-1850s the U.S. had 32 recessions, and according to the NBER, most have varied in length, with the average recession lasting 10 months. The shortest recession on record lasted six months, from January 1980 to July 1980. Two of the longest recessions lasted for 16 months. These were the recessions of November 1973 to March 1975 and July 1981 to November 1982.


What Is a Depression?
A depression is a severe economic catastrophe in which real gross domestic product (GDP) falls by at least 10%. A depression is much more severe than a recession and the effects of a depression can last for years. It is known to cause calamities in banking, trade and manufacturing, as well as falling prices, very tight credit, low investment, rising bankruptcies and high unemployment. As such, getting through a depression can be a challenge for consumers and businesses alike, given the overall economic backdrop. (To learn more, read The Importance Of Inflation and GDP.)


How It Works
Depressions occur when a number of factors come together at one time. These factors start off with overproduction and decreasing demand and are followed by fear that develops as businesses and investors panic. The combination of excess supply and fear causes business spending and investments to drop. As the economy starts to slow, unemployment rises and wages drop. These falling wages cause consumers to cut back spending even more, putting additional pressure on unemployment and wages. This begins a cycle in which the purchasing power of consumers is eroded severely making them unable to make their mortgage payments; this forces banks to tighten their lending standards, which eventually leads to bankruptcies.


Historical Examples
Throughout history, there are several examples of depressions. The most well-known is the Great Depression of the 1930s. However, this one title actually covers two depressions that took place during that time. The first depression occurred from August 1929 to March 1933, during which GDP growth declined by 33%. The second depression ran from May 1937 to June 1938, during which GDP growth declined by 18.2%. In addition, the Great Depression was preceded by another economic depression, which occurred from 1893 to 1898. (To learn more, read What Caused The Great Depression?)

What Can We Learn?
Recessions and depressions provide us with both negatives and positives that we can use to gain a greater understanding of how they work and how to survive them.

Negatives of Recessions and Depressions
There are many negative consequences of recessions and depressions. Let's take a look at a few:

1. Rising unemployment

Generally, rising unemployment is a classic sign of both recessions and depressions. As consumers cut their spending, businesses cut payrolls in order to cope with falling earnings. The difference between the two is that the unemployment rate in a recession is less severe than in a depression. As a basic rule, the unemployment rate for a recession is in the 5-11% range; by contrast, the unemployment during the first period of the Great Depression (1929-1933) went from 3% in 1929 to 25% by 1933.


2. Economic downturn

Recessions and depressions create a massive unwinding in the economy. During times of growth, businesses keep increasing supplies to meet consumer, demands, but at some point there will be too much supply in the economy. When this happens, the economy slows as demand drops. Recessions and depressions allow us to clear out the excesses of the economy, but the process can be painful and many suffer during this time.


3. Fear

Recessions and depressions create high amounts of fear. As the economy slows and unemployment rises, many consumers become fearful that things will not improve anytime soon. This fear causes them to cut back on spending, causing the economy to slow even more. (For related reading, see When Fear And Greed Take Over.)


4. Sinking values

Asset values sink in recessions and depressions because earnings slow along with the economy. This causes stock prices to fall because of the slowing earnings and negative outlooks from companies. In turn, these falling prices cause new investments for expansion to slow and can affect the asset values for many people.


Positives of Recessions and Depressions

There are many positives that take place as a result of recessions and depressions. They include:


1. Getting rid of excess

Economic decline allows the economy to clean out the excesses. During this process, inventories drop to more normal levels, allowing the economy to experience long-term growth as demand for products picks back up.


2. Balancing economic growth

Recessions and depressions help keep economic growth balanced. If the economy grew unchecked at an expansionist rate for many years, this could lead to uncontrolled inflation. By having recessions and depressions, consumers are forced to cut back in response to falling wages. These falling wages force prices to drop, creating a situation in which the economy can grow at normal levels without having prices run away.


3. Creating buying opportunities

Tough economic times can create massive buying opportunities in huge asset classes. As the economy runs its course, the markets will readjust to an expanding economy. This provides investors with an opportunity to make money as these low asset prices move back to normal.


4. Changing consumer attitudes

Economic hardship can create a change in the mindset of consumers. As consumers stop trying to live above their means, they are forced to live within the income they have. This generally causes the national savings rate to rise and allows investments in the economy to increase once again. (For related reading, see Stop Keeping Up With the Joneses - They're Broke.)


Conclusion

Clearly, both recessions and depressions have many effects on the overall economy. To survive and thrive in these environments requires that you understand what causes them and how those causes create positive and negative effects on the overall economy. Some of the positive effects include taking the excesses out of the economy, balancing economic growth, creating buying opportunities in different asset classes and creating changes in consumer attitudes. The negative effects include rising unemployment, a severe slowing in the economy, the creation of fear and the destruction of asset values. It is by carefully understanding what recessions and depressions are that we can learn how to spot them - and protect investments from them.

By Chris Seabury         

Source :

http://www.investopedia.com

Disclaimer…The subject matters expressed above is based purely on technical analysis and personal opinions of the writer. it is not a solicitation to buy or sell.

The Effects Of Currency Fluctuations On The Economy

Currency fluctuations are a natural outcome of the floating exchange rate system that is the norm for most major economies. The exchange rate of one currency versus the other is influenced by numerous fundamental and technical factors. These include relative supply and demand of the two currencies, economic performance, outlook for inflation, interest rate differentials, capital flows, technical support and resistance levels, and so on. As these factors are generally in a state of perpetual flux, currency values fluctuate from one moment to the next. But although a currency’s level is largely supposed to be determined by the underlying economy, the tables are often turned, as huge movements in a currency can dictate the economy’s fortunes. In this situation, a currency becomes the tail that wags the dog, in a manner of speaking.

Currency Effects are Far-Reaching
While the impact of a currency’s gyrations on an economy is far-reaching, most people do not pay particularly close attention to exchange rates because most of their business and transactions are conducted in their domestic currency. For the typical consumer, exchange rates only come into focus for occasional activities or transactions such as foreign travel, import payments or overseas remittances.

A common fallacy that most people harbor is that a strong domestic currency is a good thing, because it makes it cheaper to travel to Europe, for example, or to pay for an imported product. In reality, though, an unduly strong currency can exert a significant drag on the underlying economy over the long term, as entire industries are rendered uncompetitive and thousands of jobs are lost. And while consumers may disdain a weaker domestic currency because it makes cross-border shopping and overseas travel more expensive, a weak currency can actually result in more economic benefits.

The value of the domestic currency in the foreign exchange market is an important instrument in a central bank’s toolkit, as well as a key consideration when it sets monetary policy. Directly or indirectly, therefore, currency levels affect a number of key economic variables. They may play a role in the interest rate you pay on your mortgage, the returns on your investment portfolio, the price of groceries in your local supermarket, and even your job prospects.

Currency Impact on the Economy
A currency’s level has a direct impact on the following aspects of the economy:

Merchandise trade: This refers to a nation’s international trade, or its exports and imports. In general terms, a weaker currency will stimulate exports and make imports more expensive, thereby decreasing a nation’s trade deficit (or increasing surplus) over time.

A simple example will illustrate this concept. Assume you are a U.S. exporter who sold a million widgets at $10 each to a buyer in Europe two years ago, when the exchange rate was EUR 1=1.25 USD. The cost to your European buyer was therefore EUR 8 per widget. Your buyer is now negotiating a better price for a large order, and because the dollar has declined to 1.35 per euro, you can afford to give the buyer a price break while still clearing at least $10 per widget. Even if your new price is EUR 7.50, which amounts to a 6.25% discount from the previous price, your price in USD would be $10.13 at the current exchange rate. The depreciation in your domestic currency is the primary reason why your export business has remained competitive in international markets.

Conversely, a significantly stronger currency can reduce export competitiveness and make imports cheaper, which can cause the trade deficit to widen further, eventually weakening the currency in a self-adjusting mechanism. But before this happens, industry sectors that are highly export-oriented can be decimated by an unduly strong currency.

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Economic growth: The basic formula for an economy’s GDP is C + I + G + (X – M) where:
C = Consumption or consumer spending, the biggest component of an economy
I = Capital investment by businesses and households
G = Government spending
(X – M) = Exports minus imports, or net exports.

From this equation, it is clear that the higher the value of net exports, the higher a nation’s GDP. As discussed earlier, net exports have an inverse correlation with the strength of the domestic currency.

Capital flows: Foreign capital will tend to flow into countries that have strong governments, dynamic economies and stable currencies. A nation needs to have a relatively stable currency to attract investment capital from foreign investors. Otherwise, the prospect of exchange losses inflicted by currency depreciation may deter overseas investors.
Capital flows can be classified into two main types – foreign direct investment (FDI), in which foreign investors take stakes in existing companies or build new facilities overseas; and foreign portfolio investment, where foreign investors invest in overseas securities. FDI is a critical source of funding for growing economies such as China and India, whose growth would be constrained if capital was unavailable.

Governments greatly prefer FDI to foreign portfolio investments, since the latter are often akin to “hot money” that can leave the country when the going gets tough. This phenomenon, referred to as “capital flight", can be sparked by any negative event, including an expected or anticipated devaluation of the currency.

Inflation: A devalued currency can result in “imported” inflation for countries that are substantial importers. A sudden decline of 20% in the domestic currency may result in imported products costing 25% more since a 20% decline means a 25% increase to get back to the original starting point.

Interest rates: As mentioned earlier, the exchange rate level is a key consideration for most central banks when setting monetary policy. For example, former Bank of Canada Governor Mark Carney said in a September 2012 speech that the bank takes the exchange rate of the Canadian dollar into account in setting monetary policy. Carney said that the persistent strength of the Canadian dollar was one of the reasons why Canada’s monetary policy had been “exceptionally accommodative” for so long.

A strong domestic currency exerts a drag on the economy, achieving the same end result as tighter monetary policy (i.e. higher interest rates). In addition, further tightening of monetary policy at a time when the domestic currency is already unduly strong may exacerbate the problem by attracting more hot money from foreign investors, who are seeking higher yielding investments (which would further push up the domestic currency).

The Global Influence of Currencies – Examples
The global forex market is by far the largest financial market with its daily trading volume of over $5 trillion - far exceeding that of other markets including equities, bonds and commodities. Despite such enormous trading volumes, currencies stay off the front pages most of the time. However, there are times when currencies move in dramatic fashion; during such times, the reverberations of these moves can be literally felt around the world. We list below a few such examples:

• The Asian crisis of 1997-98 – A prime example of the havoc that can be wreaked on an economy by adverse currency moves, the Asian crisis began with the devaluation of the Thai baht in July 1997. The devaluation occurred after the baht came under intense speculative attack, forcing Thailand’s central bank to abandon its peg to the U.S. dollar and float the currency. This triggered a financial collapse that spread like wildfire to the neighboring economies of Indonesia, Malaysia, South Korea and Hong Kong. The currency contagion led to a severe contraction in these economies as bankruptcies soared and stock markets plunged.
• China’s undervalued yuan: China held its yuan steady for a decade from 1994 to 2004, enabling its export juggernaut to gather tremendous momentum from an undervalued currency. This prompted a growing chorus of complaints from the U.S. and other nations that China was artificially suppressing the value of its currency to boost exports. China has since allowed the yuan to appreciate at a modest pace, from over 8 to the dollar in 2005 to just over 6 in 2013.
• Japanese yen’s gyrations from 2008 to mid-2013: The Japanese yen has been one of the most volatile currencies in the five years to mid-2013. As the global credit intensified from August 2008, the yen – which had been a favored currency for carry trades because of Japan’s near-zero interest rate policy – began appreciating sharply as panicked investors bought the currency in droves to repay yen-denominated loans. As a result, the yen appreciated by more than 25% against the U.S. dollar in the five months to January 2009. In 2013, Prime Minister Abe’s monetary stimulus and fiscal stimulus plans – nicknamed “Abenomics” – led to a 16% plunge in the yen within the first five months of the year.
• Euro fears (2010-12): Concerns that the deeply indebted nations of Greece, Portugal, Spain and Italy would be eventually forced out of the European Union, causing it to disintegrate, led the euro to plunge 20% in seven months, from a level of 1.51 in December 2009 to about 1.19 in June 2010. A respite that led the currency retracing all its losses over the next year proved to be temporary, as a resurgence of EU break-up fears again led to a 19% slump in the euro from May 2011 to July 2012.

How can an investor benefit?
Here are some suggestions to benefit from currency moves:

• Invest overseas: If you are a U.S-based investor and believe the USD is in a secular decline, invest in strong overseas markets, because your returns will be boosted by the appreciation in the foreign currency/s. Consider the example of the Canadian benchmark index – the TSX Composite – in the first decade of this millennium. While the S&P 500 was virtually flat over this period, the TSX generated total returns of about 72% (in Canadian $ terms) during this decade. But the steep appreciation of the Canadian dollar versus the U.S. dollar over these 10 years would have almost doubled returns for a U.S. investor to about 137% in total or 9% per annum.
• Invest in U.S. multinationals: The U.S. has the largest number of multinational companies, many of which derive a substantial part of their revenues and earnings from foreign countries. Earnings of U.S. multinationals are boosted by the weaker dollar, which should translate into higher stock prices when the greenback is weak.
• Refrain from borrowing in low-interest foreign currencies: This is admittedly not a pressing issue from 2008 onward, since U.S. interest rates have been at record lows for years. But at some point U.S. interest rates will revert to historically higher levels. At such times, investors who are tempted to borrow in foreign currencies with lower interest rates would be well served to remember the plight of those who had to repay borrowed yen in 2008. The moral of the story – never borrow in a foreign currency if it is liable to appreciate and you do not understand or cannot hedge the exchange risk.
• Hedge currency risk: Adverse currency moves can significantly impact your finances, especially if you have substantial forex exposure. But plenty of choices are available to hedge currency risk, from currency futures and forwards, to currency options and exchange-traded funds such as the Euro Currency Trust (FXE) and CurrencyShares Japanese Yen Trust (FXY). If your currency risk is large enough to keep you awake at nights, consider hedging this risk.

Conclusion
Currency moves can have a wide-ranging impact not just on a domestic economy, but also on the global one. Investors can use such moves to their advantage by investing overseas or in U.S. multinationals when the greenback is weak. Because currency moves can be a potent risk when one has a large forex exposure, it may be best to hedge this risk through the many hedging instruments available.

Source : http://www.investopedia.com

Disclaimer…The subject matters expressed above is based purely on technical analysis and personal opinions of the writer. it is not a solicitation to buy or sell.

Trade Forex On Herd Instinct

"Herd instinct" in the investing lexicon refers to the tendency of traders to blindly follow an established investment trend or pattern. Such traders are typically adherents of the well-known investment axiom "the trend is your friend." This principle is likely to provide better returns in forex trading than in equities trading for a couple of reasons.

Firstly, forex trading is arguably driven by technical analysis to a greater extent than stock trading, given that fundamental analysis plays a much bigger part in the latter than it does in the former. Secondly, while the forex market is the world's most liquid financial market with estimated daily turnover exceeding $4 trillion in 2010, just six currency pairs – USD/euro, USD/yen, USD/sterling, USD/Australian dollar, USD/Swiss franc and USD/Canadian dollar – accounted for two thirds of this trading volume. (Conversely, blue-chip stocks on the major global equity exchanges collectively number in the thousands).

These currencies are avidly watched by legions of currency traders around the world, and the same technical levels are monitored around-the-clock by these traders for buy and sell signals. Once a key technical gives way, other traders jump in and reinforce the initial trend, thus exacerbating the herd effect.

Using Herd Instinct in Forex
The guiding principle for using the herd instinct profitably in the forex market is a simple one – base your trades on the majority view and established trends in global markets. Being a contrarian may enable you to reap rewards in the stock market – assuming that you are astute enough to time the markets effectively – but it can be a recipe for disaster in the forex market, where a currency can defy fundamentals for so long and drift so far that it can test the resolve of the biggest and best traders.

The decline of the Japanese yen in 2013 is a prime example of the herd instinct at work. In April 2013, the Bank of Japan (BOJ) announced that it would buy government bonds and double the country's monetary base by 2014. The BOJ embarked on this unprecedented degree of monetary stimulus to foster growth and break the deflationary spiral that had plagued the Japanese economy for two decades. As a result, the short JPY/long USD trade was one of the most popular forex trades in the first half of 2013.

While traders were already shorting the yen going into 2013 on account of Japan's aging population and massive government debt, the yen's descent picked up steam as traders and speculators grew increasingly confident that the Bank of Japan would continue to ease monetary policy. By the first week of May 2013, the yen was the biggest decliner of the major currencies for the year, with a 12.4% fall versus the U.S. dollar. With forex traders rushing to put on short JPY positions, the currency looked set to break the 100 barrier, at which point the herd instinct would have added to its downward momentum.

The short JPY/long USD trade had in fact superseded the short EUR/long USD trade by 2013 as the "go to" trade for trend followers, as the attention of currency bears shifted to the Japanese currency following the euro's rebound since mid-2012 from a low of around 1.20. This sentiment shift could be gauged by the performance of the two currencies versus the greenback in the one-year period ending May 7, 2013; while the euro had gained 0.2%, the yen was down 19.3%.

The herd instinct was also evident in the strength of the U.S. dollar against most major currencies by May 2013, with the greenback on the ascent against 13 of the 16 most widely-traded currencies. The unexpected strength of the U.S. dollar at that time was largely attributed to the rebounding U.S. economy, which had driven the Dow Jones Industrial Average and S&P 500 indexes to record highs, attracting further capital inflows in a virtuous circle.

Common Herd Instinct Forex Trades
Currency action over the years indicates that the following trades are the most common "herd instinct" ones. These are only suggestions, and if you intend to trade these currencies, it is strongly recommended that you conduct your own research and due diligence.

Read GFT’s free guide> Forex trading – 10 Tips.

As China is the world's biggest importer of numerous commodities, when the Chinese economy is growing strongly, currencies of commodity exporters such as Canada and Australia benefit. In the first decade of this millennium, as commodity demand soared due to the Chinese boom, the AUD and CAD surged 37% against the U.S. dollar. Therefore, consider going long CAD and AUD versus the greenback when the Chinese economy is expanding rapidly.

The AUD and CAD tend to do well when the global economy is growing strongly and demand for risk appetite is strong. Conversely, when fears abound about slow global growth and risk appetite shrinks, these commodity currencies decline and safe-haven currencies such as USD and Swiss franc (CHF) rise. At such times, popular herd instinct trades are short CAD or AUD and long USD or CHF.

While the Japanese yen had lost substantial ground by spring of 2013, it has tended to trade in a direction opposite to that of global risk appetite because of its popularity as a funding currency for "carry trades*." The carry trade strategy can be disastrous when risk appetite vanishes and panicked speculators rush to close their positions, because of the double whammy arising from the fire-sale of risky assets and the spike in the yen exchange rate due to demand for the currency to repay carry loans. More than $1 trillion had been invested in the yen carry trade by 2007, but as the global economy unraveled in 2008, the currency rose 20% versus the greenback that year.

Speculators who had borrowed yen to invest in AUD (which is equivalent to a long AUD/short JPY position) had the mortification of seeing the AUD plunge by a staggering 49% against the JPY in a one-year period, from October 2007 to October 2008. The bottom line is that the yen can often be exceptionally volatile, and before determining your entry into a currency carry trade based on the yen (such as long CAD/short JPY or even long EUR/short JPY), make sure you have planned your exit as well.

The Canadian dollar has a close positive correlation with crude oil prices because of Canada's status as a leading oil exporter. On the other hand, Japan is the world's biggest oil importer, making its economy vulnerable to high crude oil prices. If crude oil spikes, say because of a sudden conflict in the Middle East, consider long CAD/short JPY.

Global macroeconomic risk from 2010 to 2012 had centered on Europe and a potential break-up of the euro-area. While these fears have dissipated substantially from mid-2012 onward, an increase in eurozone concerns precipitated by another debt crisis in one or more of the most highly indebted nations could lead to a surge in short EUR/long USD or short EUR/long CHF positions.

Herd Instinct Tips
Inexperienced forex traders should note these "herd instinct" tips:

• Beware of a stale trend or a long-lived one, since it may be in danger of imminent reversal. Currency trends can reverse quite sharply, and being on the wrong end of a trend reversal can lead to catastrophic losses. By the same token, unless you're George Soros, don't be a currency contrarian.

• While playing a trend, plot your exit strategy in advance. Staying in a herd can provide safety in numbers, as long as you don't get crushed when the herd stampedes for the exits.
  
• Stop losses are very critical, since the inordinately high degree of leverage in retail forex can lead to financial ruin if strict trading discipline is not implemented.
  
• Don't forget that being long one currency means you are short the other. Short positions seem to warrant closer monitoring by traders, and this approach may help avoid the complacency that can turn a profitable position into a losing one.
  
• Adding to a losing position is not advisable, since "averaging down" is seldom a viable trading strategy in forex.

The Bottom Line
The herd instinct can help you profitably trade established trends in forex; but use caution and commonsense within the herd – use stop losses, avoid complacency and plan your exit strategy. As innumerable traders have discovered to their cost, the trend is your friend, but only until it comes to an end.

* In yen carry trades, speculators borrow the yen at near-zero interest rates, sell it for U.S. dollars and plough the proceeds into higher-yielding (and riskier) assets such as equities, other currencies or commodities. Steady yen depreciation is a prerequisite for such carry trades to be successful, because a smaller amount of foreign currency is required to repay the initial yen loan.

Posted  May 09 2013 Source : http://www.investopedia.com

Disclaimer…The subject matters expressed above is based purely on technical analysis and personal opinions of the writer. it is not a solicitation to buy or sell.

Top Investment Trends For 2013

The year 2013 is likely to bring more of what 2012 brought - a mix of strong bull and bear months in most stock indexes and commodities alike. Seeking out the top investment trends for 2013 will require some patience, or looking at some sectors … or countries … you may not have considered before. Technology still provides some opportunities, but this is where patience will be key. Emerging markets can be easily traded now through exchange traded funds (ETFs), providing a host of opportunities for those looking for a little foreign diversification - and some of these markets are still showing strength. Finally, gold was a hot topic in 2011, but with a more lateral movement in 2012 it received less focus; that could all change in 2013. By breaking down the charts, we look at key investments to watch for bullish activity in 2013.

Top Investment Trends For 2013: Technology

Technology led the market higher in 2012, with the Powershare QQQ (Nasdaq:QQQ), representing the Nasdaq 100 index, out pacing other major indexes, such as the S&P 500 SPDRS (ARCA:SPY). This strength makes the sector one of the ideal ones to watch during bullish months in 2013.

Much of the hype in technology was due to Apple (Nasdaq:AAPL), which was up more than 70% for 2012 in September, but fell hard off those highs in October and by November was only up about 30% - still a great year. The long-term chart of Apple provides clues as to what 2013 has in store for the stock, and how to trade it.

Figure 1: Apple 10-year monthly.

Image Courtesy: thinkorswim

Apple is currently in a pullback mode. Entry near the long-term trendline - requiring some patience - is a great trade candidate for 2013. The trendline currently intersects near $410. Therefore, through 2013 the $400 to $500 price range is the entry point based on the historic trendline.

Apple is still the leader in the technology space, and watching it provides insight into technology as a whole. If Apple's stock is strong in 2013, expect the entire technology sector to be strong. On the other hand, if Apple is weak it will likely pull the entire sector down .

Smartphones and tablet devices are everywhere, and it is questionable how much more market penetration can occur. Therefore, something new in the technology space is likely to be coming down the pipe in the next year or two - it may come from Apple, or it may come from somewhere else.

Top Investment Trends For 2013: Emerging Markets

Emerging markets are still providing a lot of opportunity. The growth potential in these markets is more significant than in the more developed and mature United States, United Kingdom and Canadian markets. While there are always blossoming stocks and money to be made in mature markets, emerging markets have more potential and have for the most part been outperforming the mature markets over the last several years. For example, Mexico, which is highlighted below, has performed more than nine times better than the S&P 500 over the last 10 years. Emerging markets are a mixed bag, however, as some have been performing exceptionally well over the last several years - a trend which quite possibly could continue into 2013 - while others have fallen and present an opportunity to buy at a "value" level.

Mexico
The Mexican market is accessible through the iShares MCSI Mexico (ARCA:EWW) ETF, and that ETF is up 481% over the last 10 years, as of Nov. 16, 2012. Compare that to the S&P 500 SPDR ETF (ARCA:SPY) which is up 53% over the same period. A new high at $69.01 was created in 2012, indicating this long-term uptrend is still intact.

Figure 2: Mexican ETF 10-year monthly.

Image Courtesy: thinkorswim

Look for that uptrend to continue into 2013. However, be aware of the 2011 to 2012 trendline. If the ETF drops below $60 it is an early warning that the ETF could fall even further into the $46 support area or below.

Malaysia
The Malaysian market is accessible through the iShares MCSI Malaysia (ARCA:EWM) ETF. Strength over the last 10 years - and up 204% as of Nov. 16, 2012 - shows this ETF is still in an uptrend which could continue into 2013. The Malaysian market is still holding up well, even as the U.S. indexes have fallen in late 2012.

Figure 3: Malaysian ETF 10-year monthly.

Image Courtesy: thinkorswim

If the Malaysian ETF rallies back above $15.21, the 2012 high, it is likely the 2011 high at $15.48 will also be reached and the uptrend is continuing. On the other hand, if those highs aren't reached, the market could be heading for a long-term downtrend if it moves below $13.47 - the June 2012 low.

South AfricaThe South African market is accessible through the iShares MCSI South Africa (ARCA:EZA) ETF; it is up 230.86% (as of Nov. 16, 2012) since inception in February 2003. The long-term trend is up, but the ETF currently trades within a triangle pattern. The triangle is typically a continuation pattern, indicating the long-term uptrend will resume, quite possibly in 2013.

Figure 4: The South African ETF 10-year monthly.

Image Courtesy:thinkorswim

A rally above $69 signals a resumption of the uptrend, targeting $88. On the other hand a decline below $60 indicates a downside move is likely coming, targeting $42.50.

Argentina
The Argentine market is accessible through the Global X Funds Argentina 20 (Nasdaq:ARGT). Through 2011 and 2012 the Argentine market has been in a downtrend, but over the last 10 years the overall trend is up. The recent down move is creating a possible entry point during 2013 for the next wave higher in the Argentine market. For a buy signal to occur, however, the index will need to rally above 2,600 - $9.25 on the ETF.

Figure 5: Argentine Index January 1999 to November 2012.

Image Courtesy: thinkorswim

The ETF has only been around since February 2011 and has low volume - usually less than 10,000 shares a day.

Top Investment Trends For 2013: Gold

The breakout of a triangle pattern in 2012 indicates a bullish year for gold in 2013. Triangles are traditionally continuation patterns, and the upside breakout indicates it is quite likely there is another higher wave already underway in gold. Based on the dimensions of the triangle, the long-term target is $2,080 for gold futures. Most of this advance is likely to occur in 2013.

Figure 6: December gold futures chart.

Image Courtesy:thinkorswim

In the meantime, $1,800 has posed a significant resistance. The price will need to get through that area before the target can be reached. An inability to clear resistance and a drop below $1,523 indicates the price is likely to slide lower.

Gold is also tradable through the SPDR Gold Trust (ARCA:GLD). The target for the ETF based on the triangle is $195. A drop below $148.25 is bearish and indicates a potential longer term decline into the $113 region. Resistance is between $175.46 and $174.

Top Investment Trends For 2013: Conclusion

When looking to the future, there is always uncertainty and there are no sure bets. Each opportunity presented, and this is not an exhaustive list, is unique and presents its own rewards and risks. Malaysia and Mexico are still strong and that could continue, while the technology sector in the U.S. - including Apple - requires a bit more of a pullback before it will likely present its best buying opportunity. South Africa and Argentina are in "wait-and-see" mode; if an upside breakout occurs it will likely trigger a longer term rise. Gold recently broke higher out of a triangle pattern and is likely starting its next advance. In each case, however, there are levels to watch which signal the price may fall instead of rise. Always know and manage your risk, and make 2013 a prosperous year.

by Cory Mitchell

Cory Mitchell is a proprietary trader and Chartered Market Technician specializing in short to medium-term technical strategies. He is the founder of VantagePointTrading.com, a website dedicated to trader education and market analysis.

Graduating with a business degree, Mitchell has been trading multiple markets and educating traders since 2005. He has been widely published and is a member of the Canadian Society of Technical Analysts and the Market Technicians Association. His free weekend newsletter includes trading strategies, tutorials, as well as stock and forex market analysis.

Source :www.investopedia.com

Disclaimer…The subject matters expressed above is based purely on technical analysis and personal opinions of the writer. it is not a solicitation to buy or sell.

Forex Market Sentiment Indicators

 According to the April, 2012 Foreign Exchange Committee's Semi-Annual Foreign Exchange Volume Survey, there are on average almost $4.3 billion of forex spot transactions on a daily basis. With so many participants - most of whom are trading for speculative reasons - gaining an edge in the forex market is crucial. Fundamental analysis provides a broad view of a currency pair's movements and technical analysis defines trends and helps to isolate turning points. Sentiment indicators are another tool that can alert traders to extreme conditions and likely price reversals, and can be used in conjunction with technical and fundamental analysis.

Sentiment IndicatorsSentiment indicators show the percentage, or raw data, of how many trades or traders have taken a particular position in a currency pair. For example, assume there are 100 traders trading a currency pair; if 60 of them are long and 40 are short, then 60% of traders are long on the currency pair.

When the percentage of trades or traders in one position reaches an extreme level, sentiment indicators become very useful. Assume our aforementioned currency pair continues to rise, and eventually 90 of the 100 traders are long (10 are short); there are very few traders left to keep pushing the trend up. Sentiment indicates it is time to begin watching for a price reversal. When the price moves lower and shows a signal it has topped, the sentiment trader enters short, assuming that those who are long will need to sell in order to avoid further losses as the price falls.

Sentiment indicators are not exact buy or sell signals. Wait for the price to confirm the reversal before acting on sentiment signals. Currencies can stay at extreme levels for long periods of time, and a reversal may not materialize immediately.

"Extreme levels" will vary from pair to pair. If the price of a currency pair has historically reversed when buying reaches 75%, when the number of longs reaches that level again, it is likely the pair is at an extreme, and you should watch for signs of a price reversal. If another pair has historically reversed when about 85% of traders are short, then you will watch for a reversal at or before this percentage level.

Sentiment indicators come in different forms and from different sources. One is not necessarily better than another, and they can be used in conjunction with one another or specific strategies can be tailored to the information you find easiest to interpret.

Commitment of Traders ReportsA popular tool used by futures traders is also applicable to spot forex traders. The Commitment of Traders (COT) is released every Friday by the Commodity Futures Trading Commission. The data is based on positions held as of the preceding Tuesday, which means the data is not real-time, but it's still useful.

Interpreting the actual publications released by the Commodity Futures Trading Commission can be confusing, and somewhat of an art. Therefore, charting the data and interpreting the levels shown is an easier way to gauge sentiment via the COT reports.

Barchart.com provides an easy way to chart COT data along with a particular futures price chart. The chart below shows the Daily Continuous Euro FX (December, 2012) futures contract with a Commitment of Traders Line Chart indicator added. The COT data is not displayed as a percentage of the number of traders short or long, but rather as the number of contracts that are short/long.

Figure 1. Daily Continuous December Euro FX Futures

Source: Barchart.com

Large speculators (green line) trade for profit and are trend followers. Commercials (red line) use futures markets to hedge, and, therefore, are counter-trend traders. Focus on large speculators; while these traders have deep pockets they can't withstand staying in losing trades for long. When too many speculators are on the same side of the market, there is a high probability of a reversal.

Over the time period shown, when large speculators were short about 200,000 contracts, at least a short-term rally soon followed. This is not a definitive or "time-less" extreme level and may change over time.

Another way to use the COT data is to look for cross-overs. When large speculators move from a net short position to a net long position (or vice versa), it confirms the current trend and indicates there is still more room to move.

Figure 2. Weekly Continuous December Euro FX Futures

Source: Barchart.com

While the cross-over method is prone to provide some false signals, between 2010 and 2012 several large moves were captured using the method. When speculators move from net short to net long, look for the price of the euro futures, and by extension the EUR/USD, to appreciate. When speculators move from net long to net short, look for the price of the futures and related currency pairs to depreciate.

Futures Open Interest
The forex market is "over-the-counter" with independent brokers and traders all over the world creating a non-centralized market place. While some brokers publish the volume produced by their client orders, it does not compare to the volume or open interest data available from a centralized exchange, such as a futures exchange.

Statistics are available for all futures contracts traded, and open interest can help gauge sentiment. Open interest, simply defined, is the number of contracts that have not been settled and remain as open positions.

If the AUD/USD currency pair is trending higher, looking to open interest in Australian dollars futures provides additional insight into the pair. Increasing open interest as the price moves up indicates the trend is likely to continue. Leveling off or declining open interest signals the uptrend could be nearing an end.

The following table shows how open interest is typically interpreted for a futures contract.

Figure 3. Open Interest Interpretation

The data then must be applied to the forex market. For example, strength in euro futures (US dollar weakness) will likely keep pushing the EUR/USD higher. Weakness in Japanese yen futures (US dollar strength) will likely push the USD/JPY higher.

Futures volume and open interest information is available from CME Group and is also available through trading platforms such as TD Ameritrade's Thinkorswim.

Position Summaries by BrokerTo provide transparency to the over-the-counter forex market, many forex brokers publish the aggregate percentage of traders or trades that are currently long or short in a particular currency pair.

The data is only gathered from clients of that broker, and therefore provides a microcosmic view of market sentiment. The sentiment reading published by one broker may or may not be similar to the numbers published by other brokers. Small brokers with few clients are less likely to accurately represent the sentiment of the whole market (composed of all brokers and traders), while larger brokers with more clients compose a larger piece of the whole market, and therefore are likely to give a better indication of overall sentiment.

Many brokers provide a sentiment tool on their website free of charge. Check multiple brokers to see if sentiment readings are similar. When multiple brokers show extreme readings, it is highly likely a reversal is near. If the sentiment figures vary significantly between brokers, then this type of indicator shouldn't be used until the figures align.

The Swiss bank Dukascopy provides multiple sentiment tools, one of which is pictured below, based on their client orders.

Figure 4. Dukascopy Liquidity Consumer Sentiment Index (November 2, 2012)

Source: http://www.dukascopy.com/swiss/lv/marketwatch/sentiment/

Certain online sources have also developed their own sentiment indicators. DailyFx for example, publishes a free weekly Speculative Sentiment Index (SSI), combined with analysis and ideas on how to trade the data.

The Bottom LineForex sentiment indicators come in several forms and from many sources. Using multiple sentiment indicators in conjunction with fundamental and technical analysis provides a broad view of how traders are manoeuvring in the market. Sentiment indicators can alert you when a reversal is likely near - due to an extreme sentiment reading - and can also confirm a current trend. Sentiment indicators are not buy and sell signals on their own; look for the price to confirm what sentiment is indicating before acting on sentiment indicator readings. Losing trades still occur when using sentiment - extreme levels can last a long time, or a price reversal may be much smaller or larger than the sentiment readings indicate.

Source :  http://www.investopedia.com/

Disclaimer…The subject matters expressed above is based purely on technical analysis and personal opinions of the writer. it is not a solicitation to buy or sell.

Index Investing: What Is An Index?

An index is a statistical measure of the changes in a portfolio of stocks representing a portion of the overall market.

It would be too difficult to track every single security trading in the country. To get around this, we take a smaller sample of the market that is representative of the whole. Thus, just as pollsters use political surveys to gauge the sentiment of the population, investors use indexes to track the performance of the stock market. Ideally, a change in the price of an index represents an exactly proportional change in the stocks included in the index.

Mr. Charles Dow created the first and, consequently, most widely known index back in May of 1896. At that time, the Dow index contained 12 of the largest public companies in the U.S. Today, the Dow Jones Industrial Average (DJIA) contains 30 of the largest and most influential companies in the U.S.

Before the digital age, calculating the price of a stock market index had to be kept as simple as possible. The original DJIA was calculated by adding up the prices of the 12 companies and then dividing that number by 12. These calculations made the index truly nothing more than an average, but it served its purpose.

Today, the DJIA uses a slightly different methodology, called price-based weighting. In this system, the weight of each security is the stock's price relative to the sum of all the stock prices. The problem with price-based weighting is that a stock split changes the weight of a company in the index, even though there is no fundamental change in the business. For this reason, not too many indexes are weighted on price.

Most indexes weigh companies based on market capitalization. If a company's market cap is $1,000,000 and the value of all stocks in the index is $100,000,000, then the company would be worth 1% of the index. These types of systems are made possible by computers - most are calculated to the minute, so they are very accurate reflections of the market.

It's important to note that an index is nothing more than a list of stocks; anybody can create one. This was especially true during the dotcom bull market, when practically every publication created an index representing a section of new economy stocks. What sets the big indexes apart from the small ones is the reputation of the company that puts out the index. For example, the DJIA is owned by Dow Jones & Company, the same people who publish The Wall Street Journal.

Source : http://www.investopedia.com

Links :

Index Investing: The Dow Jones Industrial Average

Index Investing: The Standard & Poor's 500 Index

Index Investing: The Nasdaq Composite Index

Index Investing: The Wilshire 5000 Total Market Index

Index Investing: The Russell 2000 Index

Index Investing: Other Indexes

Index Investing: Index Funds

Disclaimer…The subject matters expressed above is based purely on technical analysis and personal opinions of the writer. it is not a solicitation to buy or sell.

Learn Forex: Basic Breakouts for Forex Trends

Forex pairs in this Article » AUD/USD


Article Summary: Trend traders enjoy the luxury of first identifying market direction prior to executing a trading strategy. Once found traders can employ a breakout strategy for entries.

As we discussed in an earlier edition of Trading Tips, there are many advantages of trading directional markets. Below we can see a prime example of a trending market in the AUDUSD. The pair has advanced over 449 pips since its September 2012 low was created at 1.0488. Notice the series of higher highs printed on the daily graph below. With such a strong uptrend in place, this makes the AUDUSD and ideal candidate for buying opportunities.

Today we will continue our discussion on trend trading basics, by identifying potential breakout trading opportunities with the daily trend.

Learn Forex - AUDUSD Daily Uptrend

(Created using FXCM's Marketscope 2.0 charts)

Trading Breakouts

Trading a breakout in an uptrend is a very straightforward process once you have identified the markets current high and low. Our current high resides at 1.0597 on the AUDUSD. This point is currently acting as a price ceiling or an area of resistance for the pair. Breakout traders will wait for price to breach this value, and create a new high before entering into the market. Traders will look to buy with the expectation of price continuing to rise and create a higher high in the market.

One of the most popular ways to trade breakouts is through the use of an entry order. An entry order can be set through the FXCM Trading station and allows you to set an order at a preset price. In the event that the market trades through that price, your order will be executed for you. This method of trading is very popular with traders that don't have the ability to constantly monitor charts. Regardless if you are in front of your charts or not, your trade is scheduled to execute as soon as s breakout occurs!

Learn Forex - AUDUSD Daily Breakout

(Created using FXCM's Marketscope 2.0 charts)

Stops and Limits

After finding a point to enter the market, it is always to manage a trades risk expectations. There are many ways to do this when trading trends, but the easiest way to find order placement is to turn again to our charts previously defined highs and lows. In an uptrend, traders can always turn towards the previous low as a line of support. Stop values can be placed under this value to exit positions in the event of the market turning.

Once a stop is set, traders can then manage their profit targets by using a positive risk: reward ratio of their choosing. Traders may also opt to lock in profit using a trailing stop or other methodology of their choosing.

---Written by Walker England, Trading Instructor

To contact Walker, email WEngland@FXCM.com . Follow me on Twitter at @WEnglandFX.

To be added to Walker's e-mail distribution list, send an email with the subject line "Distribution List" to WEngland@FXCM.com .

Been trading FX but wanting to learn more? Been trading other markets, but not sure where to start you forex analysis? Register and take this Trader Quiz where upon completion you will be provided with a curriculum of resources geared towards your learning experience.

Source : http://www.investopedia.com

Disclaimer…The subject matters expressed above is based purely on technical analysis and personal opinions of the writer. it is not a solicitation to buy or sell.

12 Things You Need To Know About Financial Statements

Knowing how to work with the numbers in a company's financial statements is an essential skill for stock investors. The meaningful interpretation and analysis of balance sheets, income statements and cash flow statements to discern a company's investment qualities is the basis for smart investment choices. However, the diversity of financial reporting requires that we first become familiar with certain general financial statement characteristics before focusing on individual corporate financials. In this article, we'll show you what the financial statements have to offer and how to use them to your advantage.

TUTORIAL: Advanced Financial Statement Analysis1. Financial Statements Are ScorecardsThere are millions of individual investors worldwide, and while a large percentage of these investors have chosen mutual funds as the vehicle of choice for their investing activities, a very large percentage of individual investors are also investing directly in stocks. Prudent investing practices dictate that we seek out quality companies with strong balance sheets, solid earnings and positive cash flows.

Whether you're a do-it-yourself or rely on guidance from an investment professional, learning certain fundamental financial statement analysis skills can be very useful - it's certainly not just for the experts. Over 30 years ago, businessman Robert Follet wrote a book entitled "How To Keep Score In Business" (1987). His principal point was that in business you keep score with dollars, and the scorecard is a financial statement. He recognized that "a lot of people don't understand keeping score in business. They get mixed up about profits, assets, cash flow and return on investment."

The same thing could be said today about a large portion of the investing public, especially when it comes to identifying investment values in financial statements. But don't let this intimidate you; it can be done. As Michael C. Thomsett says in "Mastering Fundamental Analysis" (1998):

"That there is no secret is the biggest secret of Wall Street - and of any specialized industry. Very little in the financial world is so complex that you cannot grasp it. The fundamentals - as their name implies - are basic and relatively uncomplicated. The only factor complicating financial information is jargon, overly complex statistical analysis and complex formulas that don't convey information any better than straight talk." (For more information, see Introduction To Fundamental Analysis and What Are Fundamentals?)

What follows is a brief discussion of 12 common financial statement characteristics to keep in mind before you start your analytical journey.

2. What Financial Statements to UseFor investment analysis purposes, the financial statements that are used are the balance sheet, the income statement and the cash flow statement. The statements of shareholders' equity and retained earnings, which are seldom presented, contain nice-to-know, but not critical, information, and are not used by financial analysts. A word of caution: there are those in the general investing public who tend to focus on just the income statement and the balance sheet, thereby relegating cash flow considerations to somewhat of a secondary status. That's a mistake; for now, simply make a permanent mental note that the cash flow statement contains critically important analytical data. (To learn more, check out Reading The Balance Sheet, Understanding The Income Statement and The Essentials Of Cash Flow.)
 

3. Knowing What's Behind the NumbersThe numbers in a company's financials reflect real world events. These numbers and the financial ratios/indicators that are derived from them for investment analysis are easier to understand if you can visualize the underlying realities of this essentially quantitative information. For example, before you start crunching numbers, have an understanding of what the company does, its products and/or services, and the industry in which it operates.

4. The Diversity of Financial ReportingDon't expect financial statements to fit into a single mold. Many articles and books on financial statement analysis take a one-size-fits-all approach. The less-experienced investor is going to get lost when he or she encounters a presentation of accounts that falls outside the mainstream or so-called "typical" company. Simply remember that the diverse nature of business activities results in a diversity of financial statement presentations. This is particularly true of the balance sheet; the income and cash flow statements are less susceptible to this phenomenon.

5. The Challenge of Understanding Financial JargonThe lack of any appreciable standardization of financial reporting terminology complicates the understanding of many financial statement account entries. This circumstance can be confusing for the beginning investor. There's little hope that things will change on this issue in the foreseeable future, but a good financial dictionary can help considerably.

6. Accounting Is an Art, Not a ScienceThe presentation of a company's financial position, as portrayed in its financial statements, is influenced by management estimates and judgments. In the best of circumstances, management is scrupulously honest and candid, while the outside auditors are demanding, strict and uncompromising. Whatever the case, the imprecision that can be inherently found in the accounting process means that the prudent investor should take an inquiring and skeptical approach toward financial statement analysis. (For related content, see Don't Forget To Read The Prospectus! and How To Read Footnotes - Part 2: Evaluating Accounting Risk.)

7. Two Key Accounting ConventionsGenerally accepted accounting principles (GAAP) are used to prepare financial statements. The sum total of these accounting concepts and assumptions is huge. For investors, a basic understanding of at least two of these conventions - historical cost and accrual accounting - is particularly important. According to GAAP, assets are valued at their purchase price (historical cost), which may be significantly different than their current market value. Revenues are recorded when goods or services are delivered and expenses recorded when incurred. Generally, this flow does not coincide with the actual receipt and disbursement of cash, which is why the cash flow becomes so important. 

8. Non-Financial Statement InformationInformation on the state of the economy, industry and competitive considerations, market forces, technological change, and the quality of management and the workforce are not directly reflected in a company's financial statements. Investors need to recognize that financial statement insights are but one piece, albeit an important one, of the larger investment information puzzle.

9. Financial Ratios and IndicatorsThe absolute numbers in financial statements are of little value for investment analysis, which must transform these numbers into meaningful relationships to judge a company's financial performance and condition. The resulting ratios and indicators must be viewed over extended periods to reflect trends. Here again, beware of the one-size-fits-all syndrome. Evaluative financial metrics can differ significantly by industry, company size and stage of development.

10. Notes to the Financial StatementsIt is difficult for financial statement numbers to provide the disclosure required by regulatory authorities. Professional analysts universally agree that a thorough understanding of the notes to financial statements is essential in order to properly evaluate a company's financial condition and performance. As noted by auditors on financial statements "the accompanying notes are an integral part of these financial statements." Take these noted comments seriously. (For more insight, see Footnotes: Start Reading The Fine Print.)

11. The Auditor's ReportPrudent investors should only consider investing in companies with audited financial statements, which are a requirement for all publicly traded companies. Before digging into a company's financials, the first thing to do is read the auditor's report. A "clean opinion" provides you with a green light to proceed. Qualifying remarks may be benign or serious; in the case of the latter, you may not want to proceed.

12. Consolidated Financial StatementsGenerally, the word "consolidated" appears in the title of a financial statement, as in a consolidated balance sheet. Consolidation of a parent company and its majority-owned (more that 50% ownership or "effective control") subsidiaries means that the combined activities of separate legal entities are expressed as one economic unit. The presumption is that a consolidation as one entity is more meaningful than separate statements for different entities.

Conclusion
The financial statement perspectives provided in this overview are meant to give readers the big picture. With these considerations in mind, beginning investors should be better prepared to cope with learning the analytical details of discerning the investment qualities reflected in a company's financials

Source: http://www.investopedia.com/

Disclaimer…The subject matters expressed above is based purely on technical analysis and personal opinions of the writer. it is not a solicitation to buy or sell.