Table of Contents
What Is the Forex Market?
The forex market allows participants, including banks, funds, and individuals, to buy, sell, or exchange currencies for both hedging and speculative purposes.
Understanding the Forex Market
- The foreign exchange (forex) market is the largest financial market in the world.
- It comprises banks, commercial companies, central banks, investment management firms, hedge funds, retail forex brokers, and investors.
- The forex market is not dominated by a single market exchange but by a global network of computers and brokers worldwide.
- Forex brokers act as market makers and may post bids and ask prices for a currency pair that differs from the market’s most competitive offer.
- The number of daily forex transactions registered in April 2019, according to the 2019 Triennial Central Bank Survey of FX and OTC derivatives markets.
- The forex market comprises two levels—the interbank market and the over-the-counter (OTC) market.
- The interbank market is where large banks trade currencies for hedging, balance sheet adjustments, and clients’ behalf. The OTC market, on the other hand, is where individuals trade through online platforms and brokers.
- From Monday morning in Asia to Friday afternoon in New York, the forex market is a 24-hour market, meaning it does not close overnight.
- This differs from markets equities, bonds, and commodities, which are all packed for a while, generally in New York late afternoon.
- However, as with most things, there are exceptions. Some emerging market currencies close for a time during the trading day.
Origins of the Forex Market
Up until World War I, currencies were pegged to precious metals, such as gold and silver. After the Second World War, the system collapsed and was replaced by the Bretton Woods Agreement. That agreement resulted in the creation of three international organizations to facilitate economic activity across the globe. They were the:
- International Monetary Fund (IMF)
- General Agreement on Tariffs and Trade (GATT)
- International Bank for Reconstruction and Development (IBRD)
The new system also replaced gold with the U.S. dollar as a peg for international currencies. The U.S. government promised to back up dollar supplies with equivalent gold reserves. But the Bretton Woods system became redundant in 1971 when U.S. President Richard Nixon announced the “temporary” suspension of the dollar’s convertibility into gold.
Currencies are now free to choose their peg, and their value is determined by supply and demand in international markets.
8 Basic Concepts of Forex Market
Unlike the stock market, where investors have thousands of stocks to choose from, in the currency market, you only need to follow eight major economies and then determine which will provide the best undervalued or overvalued opportunities. The following eight countries make up the majority of trade in the currency market:
- United States
- Eurozone (the ones to watch are Germany, France, Italy and Spain)
- United Kingdom
- New Zealand
These economies have the largest and most sophisticated financial markets in the world. By strictly focusing on these eight countries, we can earn interest income on the most creditworthy and liquid instruments in the financial markets.
Economic data is released from these countries on an almost daily basis, allowing investors to stay on top of the game when assessing each country’s health and its economy.
Why Trade in the Forex Market?
Forex is one of the highest trade financial instruments in the world. Around daily transactions of USD 5 trillion are taken place. Investors and traders quickly turn around with the currency fluctuation every day, due to which other financial markets are not as highly traded as forex.
Forex Market Hours
- As per Greenwich Mean Time (GMT), forex trading hours make headway worldwide.
- For example, the forex market is open in New York from 01:00 pm – 10:00 pm GMT; at 10:00 pm GMT, the Sydney market is open.
- Tokyo is available between 00:00 am to 9:00 am GMT. London opens at 8:00 am and closes at 05:00 pm GMT.
- This way complete the loop across the world for forex trading hours.
Financial Instruments to Trade in the Forex Market
Here we will list out different segments through which you can trade currency in the Forex Market.
1. Spot Trading
- At spot market prices quote at the moment in time where it got his name.
- A broker gives a spot price that the trader has to follow and then start the trade if he or she is interested, and it will most likely take two days for the transaction to deliver.
- Spot trading is a very common type of currency trading.
2. Forward Trading
- Buyer / Seller agrees to exchange currency at a future date at the future value. The broker and trader will quote the price depending on the value of the money in the future.
- It would usually take six months to fix the details but this may differ in other countries. In some countries, trade duration can be one month, three months, or one day as well.
- Depending upon the duration of the currency exchange, forward contracts are then negotiated between parties.
3. Future Trading
- Like a forward contract, broker and trader fix the price based on the money’s future value. Dealing will include the selected maturity date and fixed contract size.
- Usually, the duration of a future contract is 3 months and settled at a specific date.
- Due to which in terms of obligation between the parties are similar to forwarding contracts.
- This type of trading is mainly by traders, investors, or fund managers to hedge their open positions.
4. Swap Trading
- The most widely recognized kind of forward exchange is swap trading. In this, the buyer and seller exchange currency for a specific time and consent to turn around the business later.
- These are not exchange-traded or not standardize contracts.
- A deposit frequently requires keeping in mind the end goal to hold the position open until the exchange fully complete.
The forex market allows participants, including banks, funds, and individuals, to buy, sell or exchange currencies for both hedging and speculative purposes.
The forex market operates 24 hours, 5.5 days a week, and is responsible for trillions of dollars in daily trading activity.
It comprises two levels: the interbank market and the over-the-counter (OTC) market.