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FOREIGN EXCHANGE TRADING

Foreign exchange transactions encompass everything from the conversion of currencies by a traveler at an airport kiosk to billion-dollar payments made by corporations, financial institutions and governments. Transactions range from imports and exports to speculative positions with no underlying goods or services. Increasing globalization has led to a massive increase in the number of foreign exchange transactions in recent decades.

The foreign exchange market (Forex, FX, or currency market) is a global decentralized or over-the-counter (OTC) market for the trading of currencies. This market determines the foreign exchange rate. It includes all aspects of buying, selling and exchanging currencies at current or determined prices. In terms of trading volume, it is by far the largest market in the world, followed by the Credit market.

The main participants in this market are the larger international banks. Financial centersaround the world function as anchors of trading between a wide range of multiple types of buyers and sellers around the clock, with the exception of weekends. Since currencies are always traded in pairs, the foreign exchange market does not set a currency’s absolute value but rather determines its relative value by setting the market price of one currency if paid for with another. Ex: 1 USD is worth X CAD, or CHF, or JPY, etc.

The foreign exchange market works through financial institutions, and operates on several levels. Behind the scenes, banks turn to a smaller number of financial firms known as “dealers”, who are involved in large quantities of foreign exchange trading. Most foreign exchange dealers are banks, so this behind-the-scenes market is sometimes called the “interbank market” (although a few insurance companies and other kinds of financial firms are involved). Trades between foreign exchange dealers can be very large, involving hundreds of millions of dollars. Because of the sovereignty issue when involving two currencies, Forex has little (if any) supervisory entity regulating its actions.

The foreign exchange market assists international trade and investments by enabling currency conversion. For example, it permits a business in the United States to import goods from European Union member states, especially Eurozone members, and pay Euros, even though its income is in United States dollars. It also supports direct speculation and evaluation relative to the value of currencies and the carry trade speculation, based on the differential interest rate between two currencies. In a typical foreign exchange transaction, a party purchases some quantity of one currency by paying with some quantity of another currency.

The modern foreign exchange market began forming during the 1970s. This followed three decades of government restrictions on foreign exchange transactions under the Bretton Woods system of monetary management, which set out the rules for commercial and financial relations among the world’s major industrial states after World War II. Countries gradually switched to floating exchange ratesfrom the previous exchange rate regime, which remained fixed per the Bretton Woods system.

The Basics of Foreign Exchange

The global foreign exchange market is the largest and the most liquid financial market in the world, with average daily volumes in the trillions of dollars. Foreign exchange transactions can be done for spot or forward delivery. There is no centralized market for forex transactions, which are executed over the counter and around the clock. The largest foreign exchange markets are located in major financial centers like London, New York, Singapore, Tokyo, Frankfurt, Hong Kong and Sydney. The term foreign exchange is usually abbreviated as “forex” and occasionally as “FX.”

Size of the Foreign Exchange Market

The foreign exchange market is unique for several reasons, mainly because of its size. Trading volume in the forex market is generally very huge. As an example, trading in foreign exchange markets averaged $5.1 trillion per day in the past, according to the Bank for International Settlements, which is owned by 60 central banks, and is used to work in monetary and financial responsibility. The largest trading centers are London, New York, Singapore and Tokyo.

Trading in the Foreign Exchange Market

The market is open 24 hours a day, five days a week across major financial centers across the globe. This means that you can buy or sell currencies at any time during the day.

The foreign exchange market isn’t exactly a one-stop shop. There are a whole variety of different avenues that an investor can go through in order to execute forex trades. You can go through different dealers or through different financial centers which use a host of electronic networks.

From a historic standpoint, foreign exchange was once a concept for governments, large companies and hedge funds. But in today’s world, trading currencies is as easy as a click of a mouse accessibility is not an issue, which means anyone can do it. In fact, many investment firms offer the chance for individuals to open accounts and to trade currencies however and whenever they choose.

When you’re making trades in the forex market, you’re basically buying or selling the current of a particular country. But there’s no physical exchange of money from one hand to another. That’s contrary to what happens at a foreign exchange kiosk think of a tourist visiting Times Square in New York City from Japan. He may be converting his (physical) yen to actual U.S. dollar cash (and may be charged a commission fee to do so) so he can spend his money while he’s traveling. But in the world of electronic markets, traders are usually taking a position in a specific currency, with the hope that there will be some upward movement and strength in the currency that they’re buying (or weakness if they’re selling) so they can make a profit.

How Forex Markets Differ From Others

There are some fundamental differences between the foreign exchange and other markets. First of all, there are fewer rules, which means investors aren’t held to as strict standards or regulations as those in the stock, futures or options markets. That means there are no clearing houses and no central bodies that oversee the forex market. Second, since trades don’t take place on a traditional exchange, you won’t find the same fees or commissions that you would on another market. Next, there’s no cut-off as to when you can and cannot trade. Because the market is open 24 hours a day, you can trade at any time of day. Finally, because it’s such a liquid market, you can get in and out whenever you want and you can buy as much currency as you can afford.

Spot Market

Spot for most currencies is two business days; the major exception is the U.S. dollar versus the Canadian dollar, which settles on the next business day. Other pairs settle in two business days. During periods that have multiple holidays, such as Easter or Christmas, spot transactions can take as long as six days to settle. The price is established on the trade date, but money is exchanged on the value date.

The U.S. dollar is the most actively traded currency. The most common pairs are the USD versus the euro, Japanese yen, British pound and Swiss franc. Trading pairs that do not include the dollar are referred to as crosses. The most common crosses are the euro versus the pound and yen.

The spot market can be very volatile. Movement in the short term is dominated by technical trading, which focuses on direction and speed of movement. People who focus on technicals are often referred to as chartists. Long-term currency moves are driven by fundamental factors such as relative interest rates and economic growth.

Forward Market

A forward trade is any trade that settles further in the future than spot. The forward price is a combination of the spot rate plus or minus forward points that represent the interest rate differential between the two currencies. Most have a maturity less than a year in the future but longer is possible. Like with a spot, the price is set on the transaction date, but money is exchanged on the maturity date.

A forward contract is tailor-made to the requirements of the counterparties. They can be for any amount and settle on any date that is not a weekend or holiday in one of the countries.

Futures Market

A futures transaction is similar to a forward in that it settles later than a spot deal, but is for a standard size and settlement date and is traded on a commodities market. The exchange acts as the counter party.