What is Forex (the foreign exchange market) and how risky is it?
Forex or FX is an international market for trading currencies.
The foreign exchange market is what determines the relative values of different currencies. It subsequently enables currency conversion. The foreign exchange market is essential for international trade, i.e., importing and exporting products.
Large international banks mainly control Forex. It is also by far one of the most liquid markets.
It is an over-the-counter market, i.e., traders negotiate directly with each other. In other words, there is no form of central house.
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
- $43 billion in currency swaps
The Forex market is open 24 hours a day for five and a half days a week. The market opens in the main global financial centers. London, Tokyo, Hong Kong, Singapore, New York, for example, are major global financial centers. Sydney and Frankfurt are also major global financial centers.
Forex market size
Forex traders include governments, central banks, large banks, and financial institutions. Corporations and currency speculators are also Forex traders.
Just over one-third of all trading, i.e., 36.7%, occurs in the United Kingdom. The UK is, therefore, the leading center for foreign exchange trading.
Since 2004 foreign exchange trading has more than doubled.
Top 10 currency traders
|3||Barclays Investment Bank||10.24%|
|7||Royal Bank of Scotland||5.62%|
|10||Bank of America Merrill Lynch||3.08%|
Most traded currencies by value
|Rank||Currency||(Symbol)||% daily share(April 2010)|
|1||United States dollar||USD ($)||84.9%|
|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%|
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 to trade foreign exchange currencies: 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, i.e., up to two working days.
It is between two different currencies relative to their current market price. Supply and demand, i.e., market forces, influence their price.
There is no contract in the spot market, neither is there any interest involved in the transaction.
A Forward Transaction
A forward transaction does not involve an immediate exchange of money.
Instead, the parties agree to carry out the transaction on a specific future date. The traders decide on an exchange rate for that date, and the deal subsequently takes place on that date.
These are sold as a standard size and settlement date on public commodities markets. On average, a future contract length is around three months.
Types of exchange rate
There are two types of exchange rates:
1. A floating exchange rate, where the forces of supply and demand determine the value of a currency.
2. A fixed exchange rate, in which the government determines, i.e., ‘fixes,’ the value of a currency. It either pegs the currency to a major one or a basket of currencies. Alternatively, it may peg the currency to the value of a precious metal.