Definition of FOREX (Foreign Exchange) Market The foreign exchange (currency or forex) market exists wherever one currency is traded for another. Forex market is the largest market in the world, in terms of cash value traded, and includes trading between large banks, central banks, currency speculators, multinational corporations, governments, and other financial markets and institutions. Retail traders (small speculators) are a small part of this market may only participate indirectly through forex brokers or market maker or banks.
The Foreign Exchange
MarketAccording to the BIS study Triennial Central Bank Survey 2004, average daily turnover in traditional foreign exchange markets was estimated at $1,880 billion. Daily averages in April for different years, in billions of US dollars, are presented on the chart below:
With international trade, the currency of one country must be exchanged for that of another for settlement of a transaction. Institutions and corporations in the international market place oftentimes need a certain currency to complete a deal, or to guard themselves from the effects of currency swings and rate changes. This system involving the exchange of different currencies has created the Foreign Exchange market, or FOREX, or FX. and more correctly known as the Global Interbank Currency Exchange Market.Like stocks, gold and real estate investments, Foreign Exchange has become a very important tool for the investment community. Forex trading provides certain additional advantages:
Margin System You can enjoy the benefits of leverage on contracts up to fifty times your margin deposit. That is, with 1% of the absolute value of contracts, you can enter the largest marketplace in the world. As long as you are able to maintain your margin requirements on the full contract value, you can remain indefinitely in the market.
Maximum LiquidityBeing the largest market in the world with over $1.6 Trillion bought and sold daily, huge volume of transactions are readily executed and cleared. Unlike futures or the stock market, there is never a lack of buyers or sellers on the forex market. Therefore, it gives the investor the prerogative to open or close a position at will.Attractive PricingForex quotes are based on spot prices regardless of the transaction size. Prices are quoted on a net basis.
Effective ExecutionForex trade orders are executed and confirmed online or manually via a recorded phone call. Customers know immediately the rate at which the order is executed. Confirmed orders will always receive a single price execution.Flexible SettlementForex system contracts opened can be rolled over daily for an indefinite period subject to roll-over fees.Hedging ToolInvestors involved in international trade can minimize their currency exposure risks by using a Forex trading system
Operation Of The Forex Market
The International Forex Market is a non-physical market and has no central exchange. The major participants in this foreign exchange trading market are Central Banks, prime multinational banks, large corporations, brokerage houses and individual investors. Forex agents offer various services to investors, including financial analysis, information gathering and market situation updates. Most transactions are conducted via the telephone or through online forex trading system.
The high liquidity in the forex market is due to the enormous volume of transactions generated by the primary market called the "interbank market" where banks, large financial institutions, insurance companies and other large corporations deal with each other in huge quantities to manage their own currency risks. The secondary over-the-counter market, where retail clients participate in forex transactions, has benefited from this liquidity provided by the big institutions.
The growth of the average daily volume of Forex trading has been phenomenal and is now currently trading currency to the tune of $1.6 trillion a day, having grown 50% in the last decade from an already large $1.0 trillion a day in 1992. It reached a high level in 2001 with approximately $2.2 trillion but adjusted back to the current $1.6 trillion by 2003. This was likely due to the birth of the single Euro currency in place of the then existing 12 European currencies.
The largest part of the largest financial market in the world consists overwhelmingly of speculation, in the form of spot forex trades (95%). The remaining 5% consists of companies swapping currencies back to their home currency to repatriate profits, forwards moves, and all other transactions.
The Traded Currencies
The six major currencies of Forex dominate the overall market share. 76% of all trades have both currencies in the currency pair as a major, and more than 98% of all trades involve at least one major.
Both of these figures are well beyond what would be expected if foreign currency trading were based solely on the majors' share of world GDP (74.5%), demonstrating the value the majors command abroad relative to other currencies. Another way thinking about the majors' predominance in the currency markets is to compare the rest of the world's economic output (25.5%), to the less than 2% share of Forex speculation that does not have a major on either side of the currency pair.
The most common currency pairs are EUR/USD (30%), USD/JPY (20%), GBP/USD (11%), and USD/CHF (5%), which together totals 66% (two-thirds) of all Forex spot trades.
The Dollar, Euro, Yen, and Pound are the most traded currencies. The six majors combine for a huge bulk of the trading transactions in a single day. Corporations and banks have known this for years, and have often used Forex for hedging purposes. With the increase in global trade, multinational corporations have likewise used the forex market to manage their risk in changes in currency rates.(Source: SGFS; Bank of International Settlements, Triennial Central Bank Survey.)
Why Trade Forex?
The transformation of the world economy into a global dimension and the dawn of technological advancement create unprecedented opportunities particularly with the emergence of new markets with considerable growth potential. This scenario likewise underscores the fact that up-to-date information in this modern age is a valuable commodity made possible by breakthroughs in information technology. Now world events are digested in a matter of seconds providing the backbone for vital investment decision making. Among the most dynamic of the markets which is highly sensitive to political and economic changes is the Foreign Exchange Market (FOREX).
Whether we like it or not, radical changes in foreign exchange rates affect an individual's or institution's overall investment portfolio. If your holdings are all in US Dollars, you have chosen to hold the dollar and give up other major currencies. Indirectly, this makes you a currency investor. By investing in, and with, the US currency, then your portfolio becomes dependent on the integrity and value of the US Dollar. Without realizing it, this may have worked against you due to the decline of the value of the US Dollar against other major currencies.
The FOREX market provides the investor a valuable tool in managing the effects of the foreign exchange risk by taking advantage of fluctuations in exchange rates. It is a means by which one can readily access this global market 24 hours a day and be able to hedge his/her outstanding US Dollar-based holdings. In a time when the speed of business increases on a daily basis, you need the ability to react swiftly. This change has created a condition that may leave investors out of the game without being aware of lost opportunities or erosion in their capital assets.
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