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The Foreign Exchange market, also referred to as Forex, is the largest financial market in the world, with a volume of about $2 trillion a day.
It was established in 1971 with the abolishment of fixed currency exchanges. Any person, firm, or country may participate in this market. If you compare its trading volume to that of the New York Stock Exchange, it is about 80 times bigger.
The simple answer is money. Forex trading is the simultaneous buying of one currency and the selling of another.
Currencies are traded through a broker or dealer. Because you're are not buying anything physical, this kind of trading can be confusing.
Think of buying a currency as buying a share in a particular country.
When you buy, say, Japanese Yen, you are in effect buying a share in the Japanese economy, as the price of the currency is a direct reflection of what the market thinks about the current and future health of the Japanese economy, compared to the other countries' economies. Unlike other financial markets, the Forex market has neither a physical location nor a central exchange.
The Forex market is considered an Over-the-Counter or "Interbank" market, due to the fact that the entire market is run electronically, within a network of about 5000 trading institutions such as international banks, central government banks like the US Federal Reserve, and commercial companies and brokers.
Major trading centers are located in New York, Tokyo, London, Hong Kong, Singapore, Paris, and Frankfurt, and all trading is by telephone or over the Internet.
Businesses use the market to buy and sell products in other countries, but most of the activity on the FOREX is from currency traders who use it to attempt to generate profits from small movements in the market.
The most often traded or 'liquid' currencies are those of countries with stable governments, respected central banks, and low inflation. Today, over 85% of all daily transactions involve trading of the major currencies, including the US Dollar, Japanese Yen, Euro, British Pound, Swiss Franc, Canadian Dollar and Australian Dollar. 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, because the Forex market operates 24 hours a day.
Currency prices are affected by a variety of economic and political conditions, most importantly interest rates, inflation and political stability.
Economic factors include economic policy, disseminated by government agencies and central banks, economic conditions generally revealed through economic reports, and other economic indicators. No other market encompasses (and distills) as much of what is going on in the world at any given time as foreign exchange.
Governments sometimes participate in the Forex market to influence the value of their currencies, either by flooding the market with their domestic currency in an attempt to lower the price, or conversely buying in order to raise the price.
However, the size and volume of the Forex market makes it impossible for any one entity to "drive" the market for any length of time.
Even though there are many huge players in Forex, it is accessible to the small investor thanks to recent changes in the regulations.
Previously, there was a minimum transaction size and traders were required to meet strict financial requirements.
With the advent of Internet trading, regulations have been changed to allow large interbank units to be broken down into smaller lots.
Because of the size of the Foreign Exchange Market, investments are extremely liquid. International banks are continuously providing bid and ask offers and the high number of transactions each day means there is always a buyer or a seller for any currency.
The market is open 24 hours a day, 5 days a week. The market opens Monday morning Australian time and closes Friday afternoon New York time. Trades can be done on the Internet from anywhere.
Currency fluctuations are usually caused by changes in national economies. News about these changes is accessible to everyone at the same time – there can be no 'insider trading' in FOREX.
The Forex market is so vast and has so many participants that no single entity, not even a central bank, can control the market price for an extended period of time. As the market has grown, even central bank interventions have become increasingly ineffectual and short lived as a tool for controlling the value of a particular currency.
Unlike the US Equity markets, which require that investors only short a stock if the prior trade was equal to or lower than the short sale price, Forex markets allow the short sale of currencies without any requirements. Trading opportunities exist in the currency market regardless of whether a trader is long or short, or which way the market is moving. Since currency trading always involves buying one currency and selling another, there is no structural bias to the market.
The over-the-counter structure of the Forex market eliminates exchange and clearing fees, which in turn lowers transaction costs. Costs are further reduced by the efficiencies created by a purely electronic market place that allows clients to deal directly with the market maker, eliminating both ticket costs and middlemen. Because the currency market offers round-the-clock liquidity, traders receive tight, competitive spreads both intra-day and night.
