What is The Forex Market?

Forex Market

Spot foreign Exchange markets allow market participations to exchange one currency for another currency. One counter party buys a specified currency from the other counter party in exchange for another currency. 

The relative amounts of the two currencies are determined by the foreign exchange rate between those two currencies. The deals could also be a currency against a precious metal. The date on which the two currencies are exchanged is known as the settlement date or value date.

Foreign exchange is the single largest market in the world. More than USD 1.4 trillion is traded in the FX market each day, according to the Bank of International Settlements, which monitors FX market activity.

To put this figure in perspective, the sum total of global trade in physical goods in one year accounts for the same amount of trade as a few days in the foreign exchange market. Hence the FX market is much, much bigger than other put together.

In the FX market, trades can be executed in variable amounts, dates and denominations. There are no standardized contract sizes or dates.

Foreign Exchange is traded over- the counter (OTC), operating worldwide, 24 hours a day.

A number of foreign exchange instruments, called derivatives are traded on exchanges

London in the world ‘s largest FX trading centre, followed by New York and the Singapore. Trading tends to occur in a centre during its normal working hours. As a result, trading stars in Asia, then moves to London at the end of the Asian working day and continues in New York at the end of the working day in London.

Factors Contributing to a Weak Currency

• Lower interest rates in home country than abroad
• Higher rates of inflation
• A domestic trade deficit relative to other countries
• A consistent government surplus
• Relative political / military stability in other countries
• Relative political / military stability in other countries
• A collapsing domestic financial market
• Weak domestic economy / stronger foreign economies
• Frequent or recent default on government debt
• Monetary policy that frequently changes objectives
• Foreign exchange exists as a result of:

Trading and investments

Companies who import or export goods are buying them in one currency and selling them in another. This means they pay out money in one currency and receive money in another. They therefore need to convert some of the money they receive into the currency in which they pay for goods. Similarly, a company that buys an asset in a foreign country has to pay for it in the local currency, and so will need to convert its home currency into the local foreign currency.

Characteristic Features Electronic link based between all major bank internationally. Trade on margins usually less than 2%. 2 Way market with opportunities to buy and sell new positions any time. Biggest markets with ready volumes round the clock. Market information well broadcasted and information generally available through regular media. Internationally accepted pricing structure. Track a dozen currency pairs at any given time. Traders 1 full year before expiration.

Speculation

The FX rate between two currencies varies in line with the relative supply and demand for the two currencies. Traders can make profits buying a currency at one rate and selling it at a more favourable rate.

Characteristic Challenges

Relatively small price change can result in substantial gains or losses. Needs close monitoring because of leverage. Chart patterns tend not to form as fully as in stocks. Analysis but timing for entry and exit point critical due to leverage. Basic trend analysis and traditional indicators are considered more reliable.

Hedging

Companies who have assets, such as factories, in foreign countries are exposed to the risk of those assets varying in value in their home currency due to fluctuations in the FX rate between the two relevant currencies. While the foreign assets may retain the same value over time in the foreign currency, they produce a profit or loss in the company’s domestic currency if the FX rate changes. Companies can eliminate these potential profits or losses by hedging. This involves executing an FX transaction which will exactly offset the profit or loss of the foreign asset caused by changes in the Fx rate.