Yeah, good question. I think about that also, in the terms of getting a good bargain on relative price.
Just to state here, I can’t answer that question. I just think about this also.
My thoughts.
Everything is relative. So, I think the answers are in the factors that make traders (banks, institutions) believe what is cheap or expensive. And also relative to time. Either long term or short. We know those who have the more pull in the interbank want to get in on what is relatively cheap compared to where it would end up in an amount of time. We know when we see big wicks that someone is trying to move a pair to a better price, then get in on the opposite side.
But I can see that you are generally talking about cheap or expensive. And I would like to know what are all the factors that constitute that.
Hey…I just thought of something Pip.
Speaking of AUD/NZD, tomorrow (tues) there’s supposed to be a dairy auction, and given that, that possibly can be a bearish catalyst for the NZD. (whatever the price comes out to be) . So, watch out for that. I think it will be very interesting.
Ok Pip…just some thoughts of mine. I’m on the same lines as you on the subject. Always questions. Which makes us traders.
[I]“Burgernomics was never intended as a precise gauge of currency misalignment, merely a tool to make exchange-rate theory more digestible. Yet the Big Mac index has become a global standard, included in several economic textbooks and the subject of at least 20 academic studies. For those who take their fast food more seriously, we have also calculated a gourmet version of the index.”[/I]
Actually cheap and expensive called on how many lots you are treading in forex market. It also varies time to time. Consider the pair AUD/NZD 1.06814251, here 1 lot is a expensive order. But currency like USD/JPY the 2nd digit after point is too easy to up and down. So if you make here a little lot order, then it will be considered as cheap order. I can not give the correct source. But when you read a lot of journals or signals, then you will mean the same thing.
Your question goes to the very heart of speculation. Every trader wants to buy the currency pair when it’s cheap and sell when it’s expensive, but how best to determine this?
There are countless different ways with new approaches being developed every day. That said, most methods can be divided into 3 categories: fundamental, technical and sentiment-based: The Big Three | Three Types of Analysis | Kindergarten
[B]Fundamental[/B] analysis looks at economic data like GDP, inflation, employment and even the Big Mac Index to determine whether a currency is undervalued (cheap) or overvalued (expensive).
[B]Technical[/B] analysis uses chart indicators like RSI and MACD to determine whether a currency pair is oversold (cheap) or overbought (expensive). Technical traders also use Fibonacci retracements, moving averages, trend lines/channels and pivots to find levels of support and resistance. When prices are trading near support, that could indicate the pair is cheap. When prices are trading near resistance, that could indicate the pair is expensive.
[B]Sentiment-based[/B] indicators like COT and SSI look at how traders are already positioned in the market. When retail traders are net short a given currency pair, that could indicate the price is cheap. When retail traders are net long a currency pair, that could indicate the price is expensive.
This would be an example of technical analysis. You looked the charts and saw that AUD/NZD is trading near support.
Neither of these traits of a currency pair is an indication of whether the pair is cheap or expensive.
The value of a pip is determined they second currency in the pair (AKA the counter currency or quote currency). In this case, it’s the New Zealand dollar.
Let’s go through a quick example to understand pip cost. Suppose I bought 1 micro lot (1k) of AUD/NZD at 1.0680. That means I bought 1000.00 Australian dollars for which I paid 1068.00 New Zealand dollars. I later close my 1k AUD/NZD long position at 1.0681 meaning I made a 1 pip profit. That means I sold 1000 Australian dollars for which I received 1068.10 New Zealand dollars. My profit of 1 pip equals 0.10 New Zealand dollars or 10 New Zealand cents. That means 1 pip on a 1k AUD/NZD trade equal 10 New Zealand cents.
Since you have a GBP-denominated account, the value of this pip for you is determined by the GBP/NZD exchange rate. Suppose GBP/NZD is trading at 1.9379. If you divide 0.10 NZD by the 1.9379 GBP/NZD exchange rate, you get about 0.0516 GBP or about 5 pence. That means the value of 1 pip on 1k GBP/NZD trade is 5 pence. This has nothing to do with whether AUD/NZD is cheap or expensive, and everything to do with NZD being the counter currency of pair.
I think I might know why you feel the minimum margin requirement (MMR) should be lower than it is. It has to do with rounding. I will explain:
The MMR is determined by the first currency in the pair (AKA the base currency). In this case it’s the Australian dollar. The default MMR setting on your FXCM UK account is 0.5%. That means you would have to set aside 5 AUD as MMR for a 1k (1000 AUD) position.
Since you have a GBP-denominated account, the value of this MMR for you is determined by the GBP/AUD exchange rate. Suppose GBP/AUD is trading at 1.8140. If you divide 5 AUD by the 1.8140 GBP/AUD exchange rate, you get about 2.7563 GBP. However, when you look at the MMR column for your GBP-denominated trading account, the MMR for AUD/NZD says 4.00 GBP, which is much higher that 2.7563 GBP. That’s because GBP/AUD is a relatively volatile currency pair. The exchange rate changes by a large amount.
FXCM chose to add a buffer to the margin requirement for all non-GBP-based pairs in your account, so that your MMR does not have to change on a regular basis. The feedback we have received from most traders on this is that they prefer to know the margin requirement up front, rather than worry about it changing each time the GBP/AUD exchange rate changes.
So to be precise, since you have a GBP-denominated trading account, your MMR for all GBP-based currency pairs is exactly 0.5% while your MMR for non-GBP-based currency pairs is higher that 0.5% because of the buffer which gives allowance for any exchange rate volatility between GBP and the base currency of the pair in question.
As discussed above, what you’ve described is a form of technical analysis, but that is just one way to analyze whether a pair is cheap or expensive. However, I must warn that just because a pair is trading at historic lows does not mean it cannot trade even lower. If it was truly impossible for the price to trade any lower, why would anyone be willing to sell to you at the current price? Obviously, there are sellers at current levels who believe that prices could go lower or the market would already be trading higher.
I hope my explanation has made it clear that the margin requirement and cost per pip have nothing to do with whether a pair is cheap or expensive and are instead determined by the base currency and counter currency of the pair respectively.
I think this thread you started provides answers to this very question: 301 Moved Permanently
Based on strong/weak analysis, a currency pair can be considered strong if the base currency is strong and the counter currency is weak. Conversely, a pair can be considered weak if the base currency is weak and the counter currency is strong.
this was a wonderfully informative reply… I cannot thank you enough… Somehow I had the feeling that ‘cheap’ and ‘expensive’ were all terms relative to where that pair was historically (technically and fundamentally), but I thought that perhaps I was missing a trick.
Your explanation of pip and MMR costs was truly exhaustive… I have no more questions left, and I hope that your wonderfully detailed reply will be of use to many others… I wonder if it could be made into a saved/pinned thread, so that others may read this explanation… It could save a lot of other traders asking the same question!
Cheers!!!
PS - The calculations do seem a little complex … imagine having to do all of that for every trade! Maybe I will try some mechanical ‘pip cost calculator’ (and cheat my way to the answer)!
Note that the image above is from a USD-denominated FXCM US trading account which means the Pip Cost is shown in USD, not GBP, and the minimum margin requirement (MMR) is shown based on 2% margin as required by the CFTC which limits leverage in the US to 50:1.
I got on this thread late and you have had a lot of great input.
The question I first asked was, when Soros forced the UK out of the ERM in 1992 surely at some point the pound should have been cheap enough to cause a resumption of buying?
Well…No!
It dropped like a stone as the amount of insider money selling caused the order flow to head in one direction and stay there. This was precisely the reason why Pegs were invented and the ERM which was a precursor to the EURO.
My point is it will take more than an index to determine how cheap a currency is and if you imagine market makers who are in league with central banks have ultimate control of how cheap a currency gets or expensive. Note that the market makers are buying when you are selling and selling when you are buying.This makes near impossible for you to accurately plot oversold and overbought levels.
That said fundamentals are about the only reliable pointers if you like. COT for example is great to monitor large commercial interests, GDP growth usually signals interest rate rises to control any inflation leading to carry trade investors moving in, perhaps if the pound is languishing at lows after a few months of steady economic growth then it may well be cheap. CPI is another great measure. Compare these to what is on your chart a picture could form.
Like the USD for example is incredibly cheap a deliberate action by FED, if I bought now I would look to profit in a few years as economic climate will improve no doubt as the sector rotation cycle is showing we are moving into an early expansionary phase characterized by tech company expansions (Facebook 19 billion What’s app buy). These companies spend a small fortune in business sector intelligence so any major moves in tech markets should signal you.
Any currencies hanging on the low side in an early expansionary economic phase are cheap and will likely deliver large profits.
