INTRODUCTION TO THE FOREX MARKET - Lesson 1

In this lesson you will learn:

  • What is the Forex Market
  • Why the Forex Market is considered unique
  • Who are the Market Participants

 

The modern foreign exchange market, is often referred to as: Forex, FX, or a currency market. It is a global decentralized or "Over the Counter" (OTC) market for trading currencies and it began to take shape from the 1970's onwards. The forex market includes all aspects of buying, selling and exchanging currencies at their current, or their future determined prices.

 The forex market is the largest global market there is, according to the BIS (bank of international settlements), daily forex turnover for 2016 was on average $5.1 trillion each trading day. The main participants in this market are international banks. In 2106 Citi was responsible for the highest percentage of forex trades at 12.9%. JP Morgan with 8.8%, UBS at 8.8%. Deutsche 7.9% and BoAML 6.4% made up rest of the top five forex trading institutions.

 The most traded currencies by value are the: USA dollar at 87.6%, Euro at 31.3%, Yen at 21.6%, sterling at 12.8%, Australian dollar at 6.9%, Canadian dollar at 5.1% and the Swiss franc at 4.8%. Each value is actually doubled (totaling 200%), due to currencies being traded as currency pairs. On the spot market, according to the 2016 BIS Triennial Survey, the most traded currency pairs were:

EURUSD: 23.0%     USDJPY: 17.7%    GBPUSD: 9.2% 

The largest geographical trading center for forex is in London, United Kingdom. It is estimated that London accounts for approx. 35% of all foreign exchange transactions. As an example of London's dominance and importance; when the IMF (International Monetary Fund) calculates the value of its SDR (special drawing rights) each trading day, they use the London market prices precisely at noon London (GMT) time that day. The SDR comprises a basket of international currencies, similar to how the dollar index is calculated.

The forex market principally exists for institutional traders to exchange currencies on behalf of their clients, its secondary purpose; as a vehicle for speculation, is in many ways a by-product of its original purpose.

 The forex market assists international trade and investment by enabling currency conversion, for example; through the ability to engage in forex exchange, a company based in Britain can import goods from the Eurozone and pay with euros, despite its domestic currency being in pounds sterling. The typical forex currency transaction involves buying a quantity of one currency with another.

 The foreign exchange market is considered to be unique because it has the following characteristics:

  • Huge trading volume of circa $5.1 trillion a day, representing the largest asset class in the world, resulting in high liquidity.
  • Global reach, with a continuous operation and access 24 hours a day five days a week; trading from 22:00 GMT on Sunday (Sydney) until 22:00 GMT Friday (New York).
  • The complex variety of factors and news events that affect exchange rates.
  • Low margins of relative profit, compared with other markets of fixed income.
  • The use of leverage to potentially enhance profit and loss margins.

 

Forex market trading takes place mainly through financial institutions and investment banks, operating on several levels. The transactions are typically conducted through a smaller number of financial firms referred to as "dealers". The majority of forex dealers are banks, therefore this layer of trading is referred to as the "interbank market". Trades between foreign exchange dealers can involve hundreds of millions of units of currency. Forex trading is unique due to the sovereignty issues preventing an overall supervisor from actually regulating the industry and activities. 

Forex Trading History for Individual Traders

Before the creation of forex trading platforms in the late 90s, forex trading was mainly restricted to large financial institutions. With the growth of the internet, trading software, and forex brokers allowing trading on margin, retail trading began to take hold. Individual, private traders are now able to trade what we term "spot currency trades" with brokers, dealers and market makers on what's termed "margin"; traders need to only risk a small percentage of the actual trade size, to buy and sell currency pairs in seconds.

The first generation of forex online trading platforms went live in the late 1990's. Internet technology allowed retail foreign exchange trading to develop straightforward ways for customers to access markets to trade currency pairs by trading from their own computers.

Trading platforms were originally based on basic programs easily downloaded to personal computers, for example; the increasingly popular MetaTrader 4, advanced features such as charting and technical analysis tools followed on quickly. The next leap forward witnessed the move to what's termed "web-based platforms" and mobile devices such as; tablets and smartphones. Over recent years, since approximately 2010, there's been a strong focus on developments to integrate automated trading tools into the platforms, social trading and copy/mirror trading in the forex market, has also grown significantly.

According to the recent BIS survey referenced earlier, the two main centers for private individual FX speculative trading are the USA and the U.K., a situation that's remained unchanged since modern 'internet' trading began in the 1990's. The report suggests that retail trading accounts for (a highly significant) 5.5% of the daily turnover in the overall $5.1 trillion a day turnover.

The market participants involved in forex trading are mainly: commercial companies, central banks,  foreign exchange fixing, investment management firms, non-bank forex firms, money transfer/bureaux de change firms, governments, central banks and retail foreign exchange traders.

Retail forex trading is the aspect of trading private individuals and traders are involved in, they conduct their forex transactions (trades) through two main types of retail forex brokers who offer the opportunity for speculative currency trading; brokers, or dealers/market makers. Brokers act as agent of the customer in FX market to get the best prices in the market for retails order by dealing on behalf of the retail customer. Brokers will charge a commission, or "mark-up" in addition to the price obtained in the market, in order to make a profit. Whereas dealers, or market makers, act as principals in the transaction, in effect trading versus the retail customer, quoting a price they as dealers/market makers are willing to deal at.

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