FOREX — the foreign exchange market or currency market or Forex is the
market where one currency is traded for another. It is one of the largest
markets in the world.
Some of the participants in this market are simply seeking to exchange a
foreign currency for their own, like multinational corporations which must pay
wages and other expenses in different nations than they sell products in.
However, a large part of the 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.
Unlike stocks and futures exchange, foreign exchange is indeed an
interbank, over-the-counter (OTC) market which means there is no single
universal exchange for specific currency pair. The foreign exchange market
operates 24 hours per day throughout the week between individuals with Forex
brokers, brokers with banks, and banks with banks. If the European session is
ended the Asian session or US session will start, so all world currencies can
be continually in trade. Traders can react to news when it breaks, rather than
waiting for the market to open, as is the case with most other markets.
Average daily international foreign exchange trading volume was $4.0
trillion in April 2010 according to the BIS triennial report.
Like any market there is a bid/offer spread (difference between buying
price and selling price). On major currency crosses, the difference between
the price at which a market maker will sell ("ask", or "offer") to a wholesale
customer and the price at which the same market-maker will buy ("bid") from
the same wholesale customer is minimal, usually only 1 or 2 pips. In the
EUR/USD price of 1.4238 a pip would be the '8' at the end. So the bid/ask
quote of EUR/USD might be 1.4238/1.4239.
This, of course, does not apply to retail customers. Most individual
currency speculators will trade using a broker which will typically have a
spread marked up to say 3-20 pips (so in our example 1.4237/1.4239 or
1.423/1.425). The broker will give their clients often huge amounts of margin,
thereby facilitating clients spending more money on the bid/ask spread. The
brokers are not regulated by the U.S. Securities and Exchange Commission
(since they do not sell securities), so they are not bound by the same margin
limits as stock brokerages. They do not typically charge margin interest,
however since currency trades must be settled in 2 days, they will "resettle"
open positions (again collecting the bid/ask spread).
Individual currency speculators can work during the day and trade in the
evenings, taking advantage of the market's 24 hours long trading day.
If you want to know more about how to start trading in Forex, please, proceed
to our Forex for
dummies article.
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