Overview
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The foreign exchange market, often referred to as Forex or FX, is a generic term for global institutions that trade currencies. The Forex has no physical location or central exchange and is considered an over-the-counter (OTC) market.
The FX market operates via an elaborate network of telephones, faxes and computers connecting banks, corporations, institutional investors and individual investors exchanging one currency for another.
The FX market operates via an elaborate network of telephones, faxes and computers connecting banks, corporations, institutional investors and individual investors exchanging one currency for another.
Over the past few years, the currency market has grown in popularity and has become one of the most sought after investment vehicles.
The FX market operates via an elaborate network of telephones, faxes and computers connecting banks, corporations, institutional investors and individual investors exchanging one currency for another.
The FX market operates via an elaborate network of telephones, faxes and computers connecting banks, corporations, institutional investors and individual investors exchanging one currency for another.
The FX market is organized into a hierarchy with its members having different rankings. The positions of the participants in this hierarchy are determined by access to credit, volume, and sophistication.
At the top of this chain is the Interbank which generates the highest volume and is the credit approving system where banks trade solely on their credit relationships with each other.
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The banks with these established credit relationships, trade currencies with each other through interbank brokers or through electronic exchanges such as Reuters and EBS.
Other market players such as corporations and online brokers trade via large commercial banks and traditionally have not had access to the best rates available to the players trading in the Interbank.
As you proceed down the hierarchy to retail currency exchange business and their customers the rates have deteriorated even more.
Today, however, technology has unmasked the rate structure and since 1996 the retail customer can connect directly to the market makers at the banks via online trading opening up tremendous opportunity for the individual investor.
A Brief History
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The trading of currencies goes back as far as currencies have been in existence, but as a financial vehicle for the modern-day investors the FX market is relatively new.
In the past 60 years the foreign exchange market has undergone a renaissance beginning with the Bretton Woods Agreement in 1944.
In July 1944, representatives from 44 nations met in Bretton Woods, New Hampshire to plan a system for stabilizing the world economy following World War II, as economic conditions were seen as a major contributor to the collapse of social order leading up to the conflict.
Out of this agreement a post-war foreign exchange system was established which included (1) the creation of international organizations designed to promote fair trade and global economic balance.
These organizations include the International Monetary Fund (INF), World Bank and he General Agreement on Tariffs and Trade (GATT).
(2) The fixing of currencies in an exchange rate system that would tolerate fluctuations to the value of gold and (3) pegging the value of gold to the U.S. Dollar known as the gold standard.
The convertibility between gold and the U.S. dollar thrust the currency into the position of reserve currency of choice for the world.
In 1971 the Bretton Wood system of fixing the U.S. Dollar to the value of gold was officially abandoned due to a series of uncontrollable events that caused uncontrollable fluctuations in currencies.
In 1973 the U.S. President Richard M. Nixon abandoned the gold standard and thus the fixed rate exchange system, allowing currencies to float free on the market and transforming itself into the financial market we know today.
The Players
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Technology has allowed the FX market to transition from a basic currency exchange market to a speculative market ideal for trading. The major players in the Forex market are:
1. Commercial Banks
The Commercial and Investment banks are the largest player in the FX market. Their primary purpose is the buying and selling of currencies mainly on the behalf of their clients.
2.
Central Banks
Central Banks set monetary policy for their currency.
Their primary purpose is to set the appropriate economic conditions by controlling
the supply of money and setting the interest rates a currency operates under.
3.
Corporations
Corporations are importing and exporting in the international market. The
settlement of these transactions occurs in the currency of the local
country. Many multinational corporations impact the FX market by buying and
selling currency to hedge their future payment against currency devaluations.
4.
Hedge Funds
Hedge Funds are small players in the Forex market, but because of their aggressive and speculative approach can cause wild swings in the FX spot market.
5.
Individual Retail Investors
This is the new frontier. Until 1996 the currency market was only available to the big players listed above. Now the individual investor is participating in a somewhat even playing field with the big boys!
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Foreign Exchange vs. Stocks
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The Forex Market contains only six major currencies, U.S. Dollar (USD), Euro (EUR), British Pound (GPB), Swiss Franc (CHF), Japanese Yen (JPY), Canadian Dollar (CAD) and the Australian Dollar (AUD).
This allows a trader to focus on which currencies to trade. Most currency traders reside in one of the six major currency nations given added benefit to the understanding of the factors that impact a currency.
In the equities market, there are over 40,000 stocks to choose from. Which stocks do you choose?
On the stock markets, most people make money when the price of a stock is rising, but in down, bear market; there is little chance of making serious money for the retail investor.
One of the most exciting advantages of FX trading is the ability to generate profits whether a currency pair is 'up' or 'down'.
A trader can be profitable by buying the currency pair ‘long’ at one price and selling it later at a higher price or a 'short' position of selling the currency pair and buying it back at a lower price.
In either case, there is always a good market trading opportunity for a trader. The ability to sell currencies without any limitations is a distinct advantage over equity trading.
For example: If you think the EUR will increase in value versus the USD, then you will buy Euros and sell the US Dollar. You will be ‘long’ the EUR/USD pair.
Since the EUR is in the first position of the pair, it is our base currency for this trade.
If you think the US Dollar will increase in value against the Euro then you will sell Euros and buy Dollars. You will be ‘short’ EUR/USD pair. As long as the trader picks the right direction, a potential for success always exists.
The most existing advantage is that the Forex Market has a tendency to be in continuous motion resulting in numerous trading opportunities.
Here are some of the clear advantages of the Forex market over equities:
- Open 24 hours, 6 days a week
- Very low commission fees
- High liquidity enables you to get in and out of the market easily
- Able to succeed whether the market is up or down
- Narrower dealing spreads
- Increased leverage
- No one can corner the market
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