What is Forex (the foreign exchange market) and how risky is it?

Forex, also known as FX, is an international market for trading currencies.

The foreign exchange market is what determines the relative values of different currencies which enables currency conversion – essential for importing and exporting products.

Forex is mainly controlled by large international banks – it is by far one of the most liquid markets.

It is an over-the-counter market where traders negotiate directly with each other without any form of central house.

Forex
Forex traders try to take advantage of currency fluctuations by selling or buying individual currencies to speculate on their relative future values.

The average daily turnover in global foreign exchange markets is estimated at $3.98 trillion, according to the “Triennial Central Bank Survey of Foreign Exchange and Derivatives Market Activity in 2010”.

According to Oxford Dictionaries, ‘Forex’ is the abbreviation for ‘foreign exchange’.



 

On an average trading day the Forex market generates:

  • $1.765 trillion in foreign exchange swaps
  • $1.490 trillion in spot transactions
  • $475 billion in outright forwards
  • $207 billion in options and other products
  • $43 billion in currency swaps

The Forex market is open 24 hours a day for five and a half days a week. The market opens in the main global financial centers – London, Tokyo, Hong Kong, Singapore, New York, Sydney, and Frankfurt.

Forex market size

Forex traders include governments, central banks, large banks, financial institutions, corporations and currency speculators. 36.7% of all trading occurs in the United Kingdom, making it the leading centre for foreign exchange trading. Since 2004 foreign exchange trading has more than doubled. 

Top 10 currency traders 

1  Deutsche Bank 15.18%
2  Citi 14.90%
3  Barclays Investment Bank 10.24%
4  UBS AG 10.11%
5  HSBC 6.93%
6  JPMorgan 6.07%
7  Royal Bank of Scotland 5.62%
8  Credit Suisse 3.70%
9  Morgan Stanley 3.15%
10  Bank of America Merrill Lynch 3.08%

Most traded currencies by value

Rank  Currency (Symbol)  % daily share(April 2010)
1  United States dollar USD ($) 84.9%
2  Euro EUR (€) 39.1%
3  Japanese yen JPY (¥) 19.0%
4  Pound sterling GBP (£) 12.9%
5  Australian dollar AUD ($) 7.6%
6  Swiss franc CHF (Fr) 6.4%
7  Canadian dollar CAD ($) 5.3%
8  Hong Kong dollar HKD ($) 2.4%
9  Swedish krona SEK (kr) 2.2%
10  New Zealand dollar NZD ($) 1.6%
11  South Korean won KRW (₩) 1.5%
12  Singapore dollar SGD ($) 1.4%
13  Norwegian krone NOK (kr) 1.3%
14  Mexican peso MXN ($) 1.3%
15  Indian rupee INR 0.9%
Other 12.2%
Total 200%

The most traded currency pairs are (approximately):

  • EUR/USD: 28 percent
  • USD/JPY: 14 percent
  • GBP/USD:  9 percent

The three ways of trading Forex

There are three different ways that foreign exchange currencies are traded:  the spot market, the forwards market and the futures market.

The Spot Market – a spot trade is a ‘direct exchange’ with a very short time frame (up to two working days) between two different currencies relative to their current market price – which is influenced by supply and demand. There is no contract involved and there is no interest involved in the transaction.

A Forward Transaction – does not involve an immediate exchange of money. Instead,  the transaction is  agreed to be carried out on a specific future date. The traders decide on an exchange rate for that date and the deal takes place on that date.

Futures – These are sold as a standard size and settlement date on public commodities markets. On average, a future contract length is around 3 months.

Video – What is Forex?