The Forex Market
The Forex Market - text
The foreign exchange market, also known as the FX or Forex market, is the largest and most traded financial market in the world. The FX market has grown to a daily trade volume of over $5 trillion a day which is over 200 times bigger than the New York Stock Exchange.
Historically, the major players in the FX market were large central banks, multinational firms and big financial institutions. While these organizations are still the major players in the market, the growth of online brokers and technology has made it possible for individual retail traders to access this market and trade on a level playing field with the big players.
Participation in the Forex market
Many of us will have participated in the FX market before if we have ever travelled to a country that has a different currency to our own. We have all seen the foreign exchange booths where different exchange rates are listed on a digital screen.
As an example, assume we are going on a holiday from the United Kingdom to the US and we see that the exchange rate on offer is 1 Pound for $1.50. This is the equivalent of $1 equaling approximately 67 pence.
We decide to exchange £1,000 for $1,500 dollars.
Now assume we didn’t spend all of our $1,500 dollars and return to the United Kingdom with $500 dollars one week later. The exchange rate has changed and now £1 equals $1 dollar 25 cent. This is the equivalent of $1 dollar equaling 80 pence.
This means that the dollar strengthened against the pound over that period of time. So we exchange our $500 dollars back to sterling at a rate of $1 dollar for 80 pence and get back £400 pound. We get more pounds for our dollars.
By default we have just made a profit in the FX Market.
What is traded?
A country’s currency is a direct reflection of what the market thinks about the current and future health of its economy. A recessionary, stagnant economy will result in a weak currency, while a surging, growing economy will result in a strong currency. We are therefore speculating on the strength and weaknesses of one economy or country against another.
When trading FX, currencies are abbreviated into three letter symbols. For example the euro is the EUR, the US Dollar is the USD, the Japanese Yen is the JPY, the UK pound is the GBP and so on. Currencies are generally split into two categories – the major currencies and the minor currencies.
As you would guess the majors are the currencies of the major global economies – the US, Japan, UK, Euro Zone, Canada, Australia, Switzerland and New Zealand.
The majors are by far the most frequently traded currencies and make up around 90% of the FX market. A noticeable absentee is the Chinese Yuan as the Chinese government restricts trading of its currency.
Minor or exotic currencies are so-called as they are the currencies of less prominent or emerging economies such as the Hong Kong Dollar, Mexican Peso, Swedish Krona, Hungarian Forint and so on. They are traded in smaller quantities when compared to the majors and often the cost of trade is much higher due to their illiquidity.