The Foreign Exchange market, also referred to as the "Forex" or "FX" market, is the largest financial market in the world, with a daily average turnover of over US$1.9 trillion - over 32 times larger than the combined volume of all U.S. equity markets.
The foreign exchange market grew out of the abandonment of the Bretton Woods Agreement and the progressive unwinding of the regime of fixed exchange rates in the 1970's.
Contrary to popular belief, the unification of many European currencies into one single currency (the Euro) has only strengthened and rendered more popular the use of foreign exchange as an investment, a hedging instrument and as a tool for speculation. The most marked development has been the growth of foreign exchange in the retail market, the tightening of spreads and drastic improvement of trading conditions for the small trader.
About 5% of daily turnover is from companies and governments that buy or sell products and services in a foreign country or must convert profits made in foreign currencies into their domestic currency. The other 95% is trading for profit, or speculation.
FX is the simultaneous buying of one currency and selling of another. Currencies are traded in pairs, for example Euro/US Dollar (EUR/USD) or US Dollar/Japanese Yen (USD/JPY).
For speculators, the best trading opportunities are with the most commonly traded (and therefore most liquid) currencies, called "the majors." Today, more than 85% of all daily transactions involve trading of the majors, which include the US Dollar, Japanese Yen, Euro, British Pound, Swiss Franc, Canadian Dollar and Australian Dollar.
A true 24-hour market, Forex trading begins each day in Auckland and Sydney and moves around the globe as the business day begins in each financial centre, then to Tokyo, Europe, London, and New York. Unlike any other financial market, investors can respond to currency fluctuations caused by economic, social and political events at the time they occur - day or night.
The FX market is considered an Over The Counter (OTC) or "interbank" market, due to the fact that transactions are conducted between two counterparts over the telephone or via an electronic network. Trading is not centralised on an exchange, as with the stock, futures and options markets.
Forex trading holds several attractions for the individual investor: -
- 24-hour dealing, London Sunday 10pm to London Friday 10pm
- A vast liquid market
- The ability to profit in rising or falling markets
- The logical impossibility of a simultaneous downturn in all markets
- Recognised instruments for controlling risk
- Leveraged trading with low margin requirements
- Zero dealing commission
- Varied dealing sizes
Currency Pairs and the Rate of Exchange
Every foreign exchange transaction is an exchange between two currencies, each denoted by a unique three-letter code. Currency pairings are expressed as two codes usually separated by a division symbol (e.g. GBP/USD), the first representing the "base currency" and the other the "secondary currency". The base currency is the one that you are buying or selling. The exchange rate is the price of one currency in terms of another. For example GBP/USD = 1.7545 denotes that one unit of sterling (the base currency) can be exchanged for 1.7545 US dollars (the secondary currency).
Majors and Crosses
Pairings with the US dollar are known as the "majors". The "big four" majors are:
EUR/USD (Euro/US dollar),
GBP/USD (Sterling/US dollar, known as "cable"),
USD/JPY (US dollar /Japanese yen),
USD/CHF (US dollar / Swiss franc).
Pairings of non-US dollar currencies are known as "crosses".
Cross rates can be derived for Sterling, Euro, Japanese Yen and the Swiss Franc from the aforementioned major pairs but other major currencies to be traded in pairs include the Canadian, Australian and New Zealand dollar, the Swedish, Norwegian and Czech Kronor and the South African Rand.
Spot forex is margined offering a high degree of leverage. As with all highly leveraged products this is a two edged sword as losses will be magnified in addition to profits. Leverage is best defined as the amount, expressed as a multiple, by which the notional amount traded exceeds the margin required to trade. For example, if the notional amount traded (also referred to as the "lot size" or "contract value") is $100,000 and the required margin is $1,000, the client can trade with 100 times leverage ($100,000/$1,000) or 1% margin.
Typical spot forex traders include individual investors, financial professionals and intermediaries, institutional investors and fund managers, introducing agents and brokers
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