WHAT IS FOREX?
FOREIGN EXCHANGE MARKET
(Let me
explain to you
once and for all how to make
real money with online Forex trading)
The foreign exchange market or currency market or Forex is the market where one
currency is traded for another. It is one of the largest markets in the world.
Market participants
Some of the participants in this market are simply seeking to exchange a foreign
currency for their own, like multinational corporations which must pay wages and
other expenses in different nations than they sell products in. However, a large
part of the market is made up of currency traders, who speculate on movements in
exchange rates, much like others would speculate on movements of stock prices.
Currency traders try to take advantage of even small fluctuations in exchange
rates. Sometimes they are able to profit from arbitrage.
According to the Bank for International Settlements' last triennal study (April
2004) (Triennial Central Bank Survey of Foreign Exchange and Derivatives Market
Activity 2004 - Final Results), transactions :
were strictly interdealer (ie interbank) for 53 % ;
for 33 % involved a dealer (ie a bank) and a fund manager or some other non-bank
financial institution;
and for only 14 % were between a dealer and a non-financial company.
Market liquidity
Foreign exchange markets are unique in the financial world in that exchange
rates are highly sensitive to a great variety of factors, many different types
of investors have access to the market, the market is very liquid, and
currencies are traded around the clock. The main international banks continually
provide the market with both bid (buy) and ask (sell) offers.
Top 5 Most Traded Currencies Rank Currency ISO 4217 Code Symbol
1 United States Dollar USD $
2 Eurozone Euro EUR €
3 Japanese Yen JPY ¥
4 British Pound Sterling GBP £
5 Swiss Franc CHF
In the foreign exchange market there is little or no 'inside information'.
Exchange rate fluctuations are usually caused by actual monetary flows as well
as anticipations on global macroeconomic conditions. Significant news is
released publicly so, at least in theory, everyone in the world receives the
same news at the same time.
Currencies are traded against one another. Each pair of currencies thus
constitutes an individual product and is traditionally noted XXX/YYY, where YYY
is the ISO 4217 international three-letter code of the currency into which the
price of one unit of XXX currency is expressed. For instance, EUR/USD is the
price of the euro expressed in US dollars, as in 1 euro = 1.2045 dollar.
On the spot market, according to the BIS study, the most heavily traded products
were :
EUR/USD - 28 %
USD/JPY - 17 %
GBP/USD (also called cable) - 14 %
and the US currency was involved 89% of transactions, followed by the euro
(37%), the yen (20%) and sterling (17%). Although trading in the euro has grown
considerably since the currency's creation in January 1999, the foreign exchange
market is thus still overwhelmingly dollar-centered. For instance, trading the
euro versus a non-European currency ZZZ will usually involve two trades: EUR/USD
and USD/ZZZ. The only exception to this is EUR/JPY, which is an established
traded currency pair in the interbank spot market.
Around-the-clock market
Big foreign exchange trading centres are located in Hong Kong, Singapore, Paris
and Frankfurt amongst others, while the biggest three are New York, Tokyo and
London, of which London is the largest. The foreign exchange market is open 24
hours per day throughout the week (closing worldwide Friday afternoon at 5pm New
York time, ie 2100 GMT, and reopening Sunday 1900 GMT when Wellington, New
Zealand opens on their Monday morning). If the European Market is closed the
Asian Market or US will be open on the other hand and so all world currencies
can be continually in trade. Traders can react to news when it breaks, rather
than waiting for the market to open, as is the case with most other markets.
Market Size
Average daily international foreign exchange trading volume was $1.9 trillion in
April 2004 according to the above-mentioned BIS study :
$600 billion spot
$1,300 billion in derivatives, ie
$200 billion in outright forwards
$1,000 billion in forex swaps
$100 billion in options.
For various reasons, exchange-traded derivatives never caught on the Forex
market as they did on all other financial markets (although attempts to launch
currency futures in the early 70s actually predate interest rate or stock index
futures).
Bid/Offer spread
Like any market there is a bid/offer spread (difference between buying price and
selling price). On major currency crosses, the difference between the price at
which a market maker will sell ("ask", or "offer") to a wholesale customer and
the price at which the same market-maker will buy ("bid") from the same
wholesale customer is minimal, usually only 1 or 2 pips. In the EUR/USD price of
1.4238 a pip would be the '8' at the end. So the bid/ask quote of EUR/USD might
be 1.4238/1.4239.
This, of course, does not apply to retail customers. To individuals, banks will
routinely mark up the difference to say 1.4140 / 1.4340 for transfers, or say
1.3740 / 1.4740 for banknotes or travellers' cheques.
Currency speculation
In our floating point system every cash flow in the world is calculated in some
domestic currency. Any currency mismatch in cash flows, whatever they be, will
thus generate foreign-exchange risk.
The most widespread speculation is of the passive kind. Most people and firms
simply do not hedge foreign exchange risk on future cash flows, which amounts to
... reckless gambling, although it is generally not perceived as such.
Semi-passive speculation is the next most frequent kind. Investors will
routinely speculate on currency fluctuations and realize profits by parking
funds in one currency, and after it appreciates in value, switching to another.
However, a Belgian dentist who makes 20% in U.S. dollar term on an investment in
the DJIA, has to realize that if the U.S. dollar has gone down by 40% versus the
Euro, then he has actually lost money in terms of his domestic currency, the
Euro.
Active speculation is in fact rarer, since it involves setting up both a foreign
currency account and a credit line.
Individual currency speculators
Most individual currency speculators will trade using a broker which will
typically have a spread marked up to say 3-20 pips (so in our example
1.4237/1.4239 or 1.423/1.425). The broker will give their clients often huge
amounts of margin, thereby facilitating clients spending more money on the
bid/ask spread. The brokers are not regulated by the U.S. Securities and
Exchange Commission (since they do not sell securities), so they are not bound
by the same margin limits as stock brokerages. They do not typically charge
margin interest, however since currency trades must be settled in 2 days, they
will "resettle" open positions (again collecting the bid/ask spread).
Individual currency speculators can work during the day and trade in the
evenings, taking advantage of the market's 24h long trading day.
The source of this article is
Wikipedia, the free encyclopedia. The text of this
article is licensed under the
GFDL
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