Forex Market

The Forex market is made up of currency traders, who speculate on movements in exchange rates, much like others would speculate on movements of stock prices.

Currency traders try to take advantage of even small fluctuations in exchange rates. In the Foreign Exchange market there is little or no 'inside information'.

Exchange rate fluctuations are usually caused by actual monetary flows as well as anticipations on global macroeconomic conditions. Significant news is released publicly so, at least in theory, everyone in the world receives the same news at the same time.

Currencies are traded against one another. Each pair of currencies thus constitutes an individual product and is traditionally noted XXX/YYY, where YYY is the ISO 4217 international three-letter code of the currency into which the price of one unit of XXX currency is expressed. For instance, EUR/USD is the price of the euro expressed in US dollars, as in 1 euro = 1.2045 dollar.

Big foreign exchange trading centres are located in Hong Kong, Singapore ,Paris and Frankfurt amongst others, while the biggest three are New York,Tokyo and London, of which London is the largest. The foreign exchange market is open 24 hours per day throughout the week, because it functions through what is known as “interbank” market. Interbank is a term of what banks trade with each other without a central marketplace.

The Bank for International Settlements reported that global foreign exchange market turnover daily averages in April was $650 billion in 1998 (at constant exchange rates) and increased to $1.9 trillion in 2004 (Triennial Central Bank Survey of Foreign Exchange and Derivatives Market Activity 2004 - Final Results).

Each currency in the marketplace exists not on its own, but as a “cross” between itself and another currency. For example, if you travel to Europe and you have US Dollars, you will be exchanging your money at the rate set by EURUSD, which is known as a “pair”. A currency pair depicts a quotation of two different currencies. The first currency in the pair is the base currency. The second currency in the pair is labeled counter currency. Such a quotation depicts how many units of the counter currency are needed to buy one unit of the base currency.For example the quotation EURUSD 1.25 means that one euro is exchanged for 1.25 US dollar. If the quote moves from EURUSD 1.25 to EURUSD 1.29 the euro is getting stronger and the dollar weaker. On the other had if the quote moves from EURUSD 1.25 to EURUSD 1.21 the euro is getting weaker while the dollar is getting stronger.

Most currencies are paired with EUR and USD, and to other currencies to a lesser extent. The four “majors” are EURUSD (Euro/Dollar),
USDJPY (Dollar/Yen), GBPUSD (Pound/Dollar), and USDCHF (Dollar/Franc). The bid-ask spread is usually lowest for the four majors, because their volume is highest. This also means that the dealer will charge you less through the spread, whereas in trading less traded pairs, dealers will charge you more because they assume more risk in those transactions.

The spread is made up of pips, which is an incremental unit in Forex. In stock trading they are called ticks or points. In Forex, each currency may have a different incremental unit.Since dealers have control over accounts and trades, they provide loans to the trader. That is called a margin, or leverage – a loan from the dealer to the trader, based on trader’s equity. If the trader wants to trade EURUSD he would need $100K, but not if the dealer offers margin. Some dealers will allow you to trade with $500 (or $500 + spread) in your account. When you trade one contract with $500 in margin, you control $100,000. That’s leverage.