FOREX
: CURRENCY TRADING
The
foreign exchange (currency or forex or FX) market exists wherever one currency
is traded for another. It is by far the largest financial market in the world,
and includes trading between large banks, central banks, currency speculators,
multinational corporations, governments, and other financial markets and institutions.
The average daily trade in the global forex and related markets currently is
over US$ 3 trillion.
Average
Daily Global Turnover
Average daily global turnover in traditional foreign exchange market transactions
totaled $2.7 trillion in April 2006 according to IFSL estimates based on semi-annual
London, New York, Tokyo and Singapore Foreign Exchange Committee data. Overall
turnover, including non-traditional foreign exchange derivatives and products
traded on exchanges, averaged around $2.9 trillion a day. This was more than
ten times the size of the combined daily turnover on all the world’s equity
markets. Foreign exchange trading increased by 38% between April 2005 and April
2006 and has more than doubled since 2001. This is largely due to the growing
importance of foreign exchange as an asset class and an increase in fund management
assets, particularly of hedge funds and pension funds. The diverse selection
of execution venues such as internet trading platforms has also made it easier
for retail traders to trade in the foreign exchange market.
Ten Most Active Traders Account
The ten most active traders account for almost 73% of trading volume, according
to The Wall Street Journal Europe, (2/9/06 p. 20). These large international
banks continually provide the market with both bid (buy) and ask (sell) prices.
The bid/ask spread is the difference between the price at which a bank or market
maker will sell ("ask", or "offer") and the price at which
a market-maker will buy ("bid") from a wholesale customer. This spread
is minimal for actively traded pairs of currencies, usually 0–3 pips.
For example, the bid/ask quote of EUR/USD might be 1.2200/1.2203 on a retail
broker. Minimum trading size for most deals is usually 100,000 units of currency,
which is a standard "lot".
Trading
Characteristics
There is no unified or centrally cleared market for the majority of FX trades,
and there is very little cross-border regulation. Due to the over-the-counter
(OTC) nature of currency markets, there are rather a number of interconnected
marketplaces, where different currency instruments are traded. This implies
that there is not a single dollar rate but rather a number of different rates
(prices), depending on what bank or market maker is trading. In practice the
rates are often very close, otherwise they could be exploited by arbitrageurs
instantaneously. A joint venture of the Chicago Mercantile Exchange and Reuters,
called FxMarketSpace opened in 2007 and aspires to the role of a central market
clearing mechanism.The main trading centers are in London,
New York, Tokyo, Hong Kong and Singapore, but banks throughout the world participate.
Currency trading happens continuously throughout the day; as the Asian trading
session ends, the European session begins, followed by the North American session
and then back to the Asian session, excluding weekends.
Market Participants
Unlike a stock market, where all participants have access to the same prices,
the forex market is divided into levels of access. At the top is the inter-bank
market, which is made up of the largest investment banking firms. Within the
inter-bank market, spreads, which are the difference between the bid and ask
prices, are razor sharp and usually unavailable, and not known to players outside
the inner circle. As you descend the levels of access, the difference between
the bid and ask prices widens (from 0-1 pip to 1-2 pips only for major currencies
like the Euro). This is due to volume. If a trader can guarantee large numbers
of transactions for large amounts, they can demand a smaller difference between
the bid and ask price, which is referred to as a better spread. The levels of
access that make up the forex market are determined by the size of the “line”
(the amount of money with which they are trading). The top-tier inter-bank market
accounts for 53% of all transactions. After that there are usually smaller investment
banks, followed by large multi-national corporations (which need to hedge risk
and pay employees in different countries), large hedge funds, and even some
of the retail forex market makers. According to Galati and Melvin, “Pension
funds, insurance companies, mutual funds, and other institutional investors
have played an increasingly important role in financial markets in general,
and in FX markets in particular, since the early 2000s.” (2004) In addition,
he notes, “Hedge funds have grown markedly over the 2001–2004 period
in terms of both number and overall size” Central banks also participate
in the forex market to align currencies to their economic needs.
Factors
Affecting Currency Trading
Although exchange rates are affected by many factors, in the end, currency prices
are a result of supply and demand forces. The world's currency markets can be
viewed as a huge melting pot: in a large and ever-changing mix of current events,
supply and demand factors are constantly shifting, and the price of one currency
in relation to another shifts accordingly. No other market encompasses (and
distills) as much of what is going on in the world at any given time as foreign
exchange.Supply and demand for any given currency, and thus its value, are not
influenced by any single element, but rather by several. These elements generally
fall into three categories: economic factors, political conditions and market
psychology.(1)
(1)
Source : Wikipedia