A Forex Market Overview
The Foreign Exchange market, also referred to as “forex”, or “Spot” is the largest financial market it the world. According to the Bank of International Settlements (it’s the bank of central banks, not accountable to any government, based in Switzerland), the FX daily turnover amounts to $5,3 trillion in 2013, up from $4 trillion in 2010 and $3,3 trillion in 2007.
Breakdown of the $5,3 trillion daily turnover of the forex market:
$2,046 trillion in spot transactions
$680 billion in outright forwards
$2,228 trillion in foreign exchange swaps
$54 billion in currency swaps
$337 billion in options and other products
Unlike other financial markets the (spot) forex market does not have either a physical or a centralized location. The forex market is considered an over the counter (OTC) or “interbank market”, due to the fact that the entire market is run electronically, within a network of banks continuously over a 24 hour period.
In the OTC market, participants determine who they want to trade with (bankers or investment firms) depending on trading conditions, attractiveness of prices and reputation of the trading counterpart.
At any time, somewhere around the world a financial center is open for business, and banks and other institutions exchange currencies every hour of the day and night.
Forex market participants
- Interbank Market
- Commercial Companies
- Central Banks
- Foreign Exchange fixing
- Hedge funds as speculators
- Investment Management firms
- Retail foreign exchange trades
- Non bank foreign exchange companies
- Money transfer/remittance companies
Where it all begun
Until the late 1990’s, the initial requirement was that you could trade only if you had about ten million dollars to start with. Forex was originally intended to be used by bankers and large institutions. However, because of the rise of the internet, online forex trading firms are now able to offer trading accounts to “retail” traders.
What does “trade” mean in the forex market?
Forex trading is the simultaneous buying of one currency and selling of another. Currencies are traded through a broker or dealer, and are traded in pairs: for example the Euro against the US dollar (EUR/USD).
Due to the fact that we are not buying or selling anything physical, some people might find it a bit confusing. Think of buying a currency as buying a share in a particular country. When we buy for example the USD, it is like we buy a share in the US economy; the price of the currency is a direct reflection of what the market thinks about the current and future health of the US economy.
In general, the exchange rate of a country’s currency versus other currencies is a reflection of the condition of that country’s economy, compared to the others.
Why trade foreign currencies?
Huge trading volume, extremely high liquidity (traders will always be able to buy and sell) – You are never “stuck” in a trade. You can even set your online trading platform to automatically close your position at your desired profit level (limit order), and/or close a trade if a trade is going against you (stop/loss order).
No centralized location
Variety of factors that affect the market (someone can trade with the fundamentals as well as the technical analysis)
Low margins (anyone can trade these amounts)
Use of leverage (good profits in respect to margins used) – a small margin deposit can control a much larger total contract value. Leverage gives the trader the ability to make nice profits, and at the same time keep risk capital to minimum. For example: forex brokers offer 1:200 leverage which means that a $50 dollar margin deposit would enable a trader buy or sell $10,000 worth of currencies. Similarly with $500 dollars, one could trade with $100,000 dollars and so on. But leverage is a double-edged sword: Without proper risk management, this high degree of leverage can lead to large losses the same way it can lead to higher profits.
Invest in either side (you can buy or sell or both and still make money)
Very low transaction costs -the retail transaction cost (the bid/ask spread) due to the high competition among firms, is always lower than 3 pips (under normal market conditions).
No commissions- no clearing fees, no exchange fees, no government fees, no brokerage fees. Brokers are compensated for their services through the bid-ask spread.
No fixed lot size- in the futures markets, lots or contract sizes are determined by the exchanges. In spot forex you determine your own lot size. This allows traders to participate with smalls accounts.
A 24/5 hour market- there is no waiting for the opening bell- from Sunday 20:15 GMT evening to Friday 22:00 GMT.
No one can corner the market- the foreign exchange market is so huge and has many participants that no single entity can control the market price for an extended period of time.
Free “demo” accounts, news, charts and analysis- most online forex brokers offer “demo” accounts to practice trading, along with breaking forex news and charting services. All free! These are very valuable resources for traders who would like to tone their trading skills with “play” money before opening a live trading account and risking real money.