The Foreign Exchange Market (FOREX)

The Foreign Exchange marketTHE FOREIGN EXCHANGE MARKET

The FOReign EXchange is a global market where one currency is exchanged for another. The Forex market has no specific geographic location as transactions are executed through the electronic network of banks. Anyone with a computer and internet access can buy and sell currencies through a Forex broker. Today, the FOREX market has a daily turnover of 4-5 trillion US dollars. The FOREX market operates 24 hours and 5 days a week, from Monday through Friday.

 

Short Introduction to the Foreign Exchange Market

The Foreign Exchange Market (FOREX) was introduced in the '70s when the global currency trading system was changed from a system of fixed currency value to a variable rate system. Fixed exchange rate system started in 1944 based on the agreement of “Bretton Woods”.

In 1977, the average daily turnover of the Forex market amounted just 6 billion US dollars. In 1987, daily turnover reached 600 billion dollars and in 1997 daily turnover reached 1.2 trillion dollars. In 2007, daily turnover reached 3.2 trillion dollars and nowadays the daily turnover of the Forex market is estimated at 4-5 trillion dollars on a daily basis. Most of the daily market activity takes place in the UK (36%), followed by the U.S. (17%) and Japan (6%). 

Chart: Forex Market Activity
FOREX Market Activity

» Forex Pairs & Statistics | » Forex Seasonality Calendar

Why Participate in the Forex Market?

The are two reasons to participate in the international FOREX market:

1) Hedging against Currency Risk

FOREX market offers the chance of covering against the abnormal fluctuations of a particular currency. Currency risk is a market-risk that is incorporated in international activities. For example, a US importer who imports goods from Europe may hedge against his exposure on Eurodollar exchange rate. ► Learn about Investment Risk

2) Market Speculation

Speculation on the FOREX market is a common practice in the US, Europe, and Asia. Thousands of companies and individual traders speculate on the FOREX market on a daily basis. 

Day Trade Resources | ► Trading Tips

 

Main Currency Analysis Methods

In order to analyze the Forex market, currency traders use fundamental and technical analysis.  Trade Strategy

1) FUNDAMENTAL ANALYSIS

The fundamental analysis investigates facts and macroeconomic figures related to the reference economy but also analyze the global economic and political content. The analysis consists of variables such are interest rates, inflation, unemployment rate, GDP growth, industrial production, public and private debt, and many others. Central banks and their monetary policies play also an important role and influence the fluctuations of the international exchange rates.

More on Fundamental Analysis

2) TECHNICAL ANALYSIS OF A CURRENCY PAIR

Technical analysis in the FOREX market is the process of analyzing the movements of the currencies exchange rate in order to identify similarities with past patterns. Technical analysis is actually measuring the psychology of the market. Many automated systems are used to trade the FOREX market using technical analysis without human interference which is called FOREX robots.

More on Forex Technical Analysis | ► Technical Analysis Guide

 

 

Currency Symbols

The table below (press the slider) shows the symbols of the major international currencies.

Table: Major Currency symbols

Currency

Symbol

Euro

EUR

US Dollar

USD

British Pound

GBP

Japanese Yen

JPY

Swiss franc

CHF

Australian dollar

AUD

Canadian Dollar

CAD

New Zealand dollar

NZD

Swedish krone

SEK

Danish krone

DKK

Norwegian krone

NOK

Singapore Dollar

SGD

Major Pairs of Currencies

Hundreds of different currency pairs are offered in the Forex market.

The major currency pairs include:

(1) EUR/USD

(2) USD/JPY

(3) GBP/USD

The above pairs are characterized by:

(i) Enormous liquidity and high volume activity

(ii) Tight spreads (spread is the difference between the highest buying price and the lowest selling price)

 

How to Trade the Forex Market? (Financial Instruments)

Here are four different ways to participate in the Forex market:

(1) FX SPOT TRADING

Market Size: 1.5 trillion US dollars daily transactions

The spot market represents a direct transaction between a buyer and a seller. This type of transactions consist of cash and are delivered after a two-day period (T +2). Note that in an exception, some rates apply a single delivery day (T +1). FX Spot Trading activity is the largest of the Forex market and it is carried out through the banks' electronic network.

(2) FORWARD CONTRACTS

Market Size: 480 billion US dollars daily transactions

A currency transaction through a Forward Contract is a 'closed' agreement between two parties -that is delivered in the future. The buyer and the seller agree today to the terms of the delivery –but the delivery itself takes place at a pre-specified future date. The duration of a Forward Contract can be from one day to several years. Forward-type contracts are similar to Futures contracts (discussed below) with the difference that a forward contract is not traded to any market. Usually, a Forward agreement consists of a bank on one side and a large company or a large private investor on the other side.

(3) SWAPs CONTRACTS (FOREIGN EXCHANGE SWAP & CURRENCY SWAP)

Market Size: 1.8 trillion US dollars daily transactions

In a SWAP like transaction, a sale order of a currency and a purchase-order of currency are placed at the same time. At a specified date in the future, the two sides (buyer and seller) are forced to reverse the transaction. This method is mainly used for hedging against periodic currency risk.

(4) CURRENCY FUTURES & OPTIONS CONTRACTS

Market Size: 210 billion US dollars daily transactions (futures and options)

  • CURRENCY FUTURES CONTRACTS

Futures contracts can be bought nowadays in most international markets. Futures contracts are standardized contracts that are traded as any common financial securities. Futures are delivered in the future after a period of usually some months. Futures assume the existence of a percentage of the total transaction as collateral (margin). Usually, margin counts 5-15% of the total value of the transaction. Margin can be raised depending on future market movements, which is called Marginal Call. Futures can be used for hedging or speculation.

  • CURRENCY OPTIONS CONTRACTS

Options, unlike futures contracts, expose its holders to a fixed risk. An Option buyer has the right but not the obligation to carry out a transaction in the future. That means that no Marginal calls are applied. An option contract will be delivered at a specified price and a specified future date. Options are used for hedging risk but mainly for speculation.

Capital Leverage in the Forex Market

Online Forex offers capital leverage from 2 to 50 times, or even more. An investor holding $10,000 can buy or sell currencies worth $500,000. The capital leverage is attractive but it also masks enormous risks for investors -especially for those who are not familiar with risk management. Capital leverage can magnify return but risk and trading cost as well. ► The Trading Leverage Formula

 

Automated Forex Trading

Automated trading is a branch of systematic trading which combines computer software and hardware in order to generate non-stop trading activity, without human intervention. All automated trading systems are systematic, but not all systematic systems are automated.

Liquidity, extreme volume activity, and very tight spreads create an opportunity for the implementation of automated trading systems. An automated Forex trading system is taking into consideration key market data, such as price and volume, to recognize and trade short-term trends. By using technical analysis, an automated system can analyze the dynamics of demand/supply, and by comparing them to historical price behavior, can decide what and when to trade, without any human intervention.

► Automated Forex Trading Strategies

What is an Expert Advisor (EA)?

An Expert Advisor or else an E.A. or else a Forex Robot is a set of programmed analysis and techniques including indicators, special filters, and rules. Whenever all these tools agree upon forecasting the direction of a trend, a trading order is automatically executed. The trades may be either bullish or bearish aiming to trade any market conditions.

» More on Forex Expert Advisors (EAs)

 

ECN/STP Forex Brokers

Forex brokers are firms that offer their clients access to the Foreign Exchange market. There are two main categories of brokers:

  • ECN/STP Brokers (No-Dealing-Desk)

ECN/STP brokers place their client's orders directly in the global currency market without any human intervention. An ECN (Electronic Communications Network) is a Forex broker electronically connected to the ECN network of banks. An STP (Straight-Through-Processing) broker routes its client orders electronically to a liquidity provider.

  • Market Makers (Dealing-Desk firms)

Dealing-Desk (DD) means creating a market within the market. A Dealing-Desk firm acts as an intermediary between the trader and the Forex market.

» More about Forex Brokers | » Trading Platforms

 

The Foreign Exchange (Forex) Market

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