Forex/Currency Basics

What is currency market #

  • The currency market (foreign exchange market/Forex market/FX market) is the market for trading currencies.
  • In a currency transaction, a party purchases some quantity of one currency by paying for some quantity of another currency.
  • The currency market determines the relative values of currencies.

Market size and liquidity #

Largest and most liquid financial market in the world. (volume of trading) #

  • According to the Bank for International Settlements
    • In 1998, average daily turnover was 1.7 trillion.
    • As of April 2007 daily volume was 3.21 trillion.
    • As of April 2010, average daily turnover was estimated at $3.98 trillion,
      • $1.490 trillion in spot transactions
      • $475 billion in outright forwards
      • $1.765 trillion in foreign exchange swaps
      • $43 billion currency swaps
      • $207 billion in options and other products
    • Trading in forex markets averaged $5.3 trillion per day in April 2013.(Foreign exchange swaps, $2.2 trillion per day; spot trading $2.0 trillion per day in April 2013)

Foreign exchange trading volume by country #

  • Rank in 2010: UK(36.7%),US(17.9%),Japan(6.2%)
  • Rank in 2013: UK(41%), US(19%),Singapore(5.7%),Japan(5.6%),Hong Kong(4.1%)
  • Currently The biggest geographic trading center is UK, primarily London.

Trading characteristics #

Uniqueness of forex market #

  • Largest financial market & Largest asset class in the world with huge trading volume, therefore highest liquidity
    • liquidity means how quick an asset can be converted into cash)
      • This means 1 a trader can enter or exit the market easily in almost any market condition.
      • 2 Almost instantaneous transactions.
    • Almost impossible to manipulate. No one can corner the market.
  • 24 hours continuous operation except weekends,from 22:00 GMT on Sunday (Sydney) until 22:00 GMT Friday (New York);
  • A large part of trading volume come from real world demand. Countries/Institutions/Corporations need to trade currencies regularly for various reasons.
  • Low Barriers to Entry
    • Free demo account
    • Very low minimum deposit
    • Micro Accounts
  • Low transaction cost
  • Allow very low Margin & high leverage
    • High leverage is a sword that may cut both ways
      • It can increase profit potential but is at the same time dangerously risky.
      • Risk can be managed and reduced. Forex can be less riskier than other market, if you choose lower leverage and learn how to manage risk.
  • Geographically decentralized; No central exchange or clearing house. An over-the-counter(OTC) market where brokers/dealers negotiate directly with one another
  • Limited cross-border regulation.
    • because there is no centralized location or exchange
  • No insider trading. Major news that affect the exchange rates is released publicly(often on scheduled dates). Traders receive the same news at the same time.
  • Trading opportunities. You can long or short a currency pair as per the market movement

Market participants #

  • Traders include large banks, central banks, institutional investors, currency speculators, corporations, governments, other financial institutions, and retail traders.

Forex market have several levels depend on the amount of money traded. #

  • The higher the level, the lower the spreads(bid ask difference).
  • At The top level is the interbank market(which consists of largest commercial banks and securities dealers, and accounts for 39% of all transactions in 2010).
  • At the relatively lower level are smaller banks, large multi-national corporations , large hedge funds, and some retail market makers.
  • Retail traders are at the lowest level.

National Central banks #

  • Have substantial foreign exchange reserves to stabilize the market.
  • Have target rates for their currencies.
  • Will try to control the money supply, inflation, interest rates.
  • Often, the rumor of a central bank foreign exchange intervention might be enough to stabilize a currency. Aggressive intervention might be used when needed.
  • The effectiveness of their intervention is uncertain. The market can easily overwhelm any central bank.

Commercial companies / Exporters and Importers #

  • Any firm that partakes in exports or imports
  • Commercial companies and multinational corporations need foreign exchange to pay for goods or services.
  • Multinational corporations also need to hedge risk and pay employees in different countries.

Hedge funds #

  • Hedge funds have a reputation for aggressive currency speculation. They control and borrow billions of dollars, which may overwhelm intervention by central banks.

Investment management firms #

  • They need to acquire the currency of the foreign country to makes investments in a foreign country.

  • For example, an investment manager having an international equity portfolio might need foreign currencies to pay for foreign securities purchases.

Non-bank foreign exchange companies #

They offer currency exchange and international payments to private individuals and companies. (They do not offer speculative trading services).

Money transfer/remittance companies and bureaux de change #

  • Money transfer companies/remittance companies perform high-volume low-value transfers generally by economic migrants back to their home country.
  • Bureaux de change or currency transfer companies provide low value foreign exchange services for travelers.

Retail FX Brokers #

They act as intermediaries and provide platforms that allow small retail traders to participate in the FX market.

Retail Speculators/Traders #

Individual investors participate indirectly through retail forex brokers or banks.