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. #

  • 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 as speculators #

  • 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 #

For example, an investment manager having an international equity portfolio might need foreign currencies to pay for foreign securities purchases. Some investment management firms also speculate in the forex market.

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 foreign exchange traders #

Individual investors participate indirectly through retail forex brokers or banks.