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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.
| 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 largely 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
Unlike stocks and futures exchange, foreign exchange is indeed an interbank, over-the-counter (OTC) market which means there is no single universal exchange for specific currency pair. The foreign exchange market operates 24 hours per day throughout the week between individuals with forex brokers, brokers with banks, and banks with banks. If the European session is ended the Asian session or US session will start, 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 contracts 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.
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.
Many firms offer online FX trading allowing individuals to trade currencies between foreing accounts (such as FXCM, XE.com and others).
Forex Brokers
- Forex Trading - ACM, the leader in Online Currency Trading
- Aaron Trading Various online forex trading platfroms.
- Oanda operates 24 hours a day 7 days a week.
- FXCM start trading the currency market
- SNC Complete client satisfaction.
Community sites
- FxFisherman's Forex Portal provides forex trading systems and indicators with discussion forum at no cost.
- Forex Tsd Forex Trading system development forum
- Forex Trading Foreign Exchange Information Portal
- FXhill.com Forex Portal - Directory, News, Forum, Trading Strategies, Service Providers, Products, Institutions, Culture
External links
- Disk Lectures MBA level audio lecture with slideshow on Foreign Exchange
- Federal Reserve educational material
- Foreign Exchange related material from the Federal Reserve
- Blog for Newbies Forex Investors
- Forex Trading Courses
- Forex Trading Ideas | Improve your Forex trading resultsPlatform for novice Forex traders
- London FX Ltd introduction to FX spot trading terminology and conventions.
- Model Code from ACI - The Financial Markets Association, a Paris, France based industry association.
