Introduction to The Foreign Exchange Market
The Foreign Exchange Market (Forex) is a global decentralized Financial market where currencies are traded one against the other. The Forex market is a vast financial market, the largest in the world, with daily volumes of more than $5 trillion.
What is the Forex Market?
Forex is an acronym for FOReign EXchange and it is a global market where currencies are traded one against the other, forming currency pairs (EUR/USD, USD/JPY, etc.). The Foreign Exchange market is not situated at a specific physical location, it is operating without a central service in the same way as the worldwide web. Forex transactions are placed and executed via the Electronic Network of Banks (ECN) through phone or via the Internet.
The Forex Currencies are traded in pairs and are divided into Majors, Minors, and Exotic Forex pairs. The Forex market is the largest and the most liquid financial market in the whole world. The daily turnover activity in the Forex market is estimated at more than 4 trillion USD.
Forex Market Participants
The Forex market includes many different types of participants like:
1) Banks (Central, Retail, or Investment banks)
2) Retail and Institutional investors
3) Day-Trade speculators
4) International and National Firms
5) Forex Brokers (ECN, STP, and Dealing-Desk Forex Brokers)
The Forex market operates like the World Wide Web (internet) does, as it is not centralized and gives access to anyone who has a PC terminal and can meet some basic requirements. Forex trading is conducted electronically OTC (over-the-counter), meaning that all trades are executed via computer networks between currency buyers and sellers. The Forex market is open five days a week, 24 hours a day. The world’s major Forex marketplaces include New York, London, Zurich, Tokyo, Frankfurt, Paris, Hong Kong, Sydney, and Singapore. This means that when Forex trading ends in one place starts in another.
Forex Trading Hours (EST)
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Australia Session: 5 p.m. – 1 a.m.
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Tokyo Session: 7 p.m. – 3 a.m.
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Hong Kong / Singapore Session: 9 p.m. – 5 a.m.
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Frankfurt Session: 2 a.m. – 10 a.m.
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London Session: 3 a.m. – 11 a.m.
The Forex market includes sessions that operate at the same time, this is called a Forex session overlap.
Forex Sessions Overlap
a) London and New York sessions overlap from 8 a.m. to 12 a.m. (EST time)
b) Tokyo and Sydney sessions overlap from 7 p.m. to 2 a.m.
c) Tokyo and London and Tokyo sessions from 3 a.m. to 4 a.m.
The Majors, Minors, and Exotic Currencies
In a currency pair (ie EUR/USD), the first currency is the base or the primary currency (EUR) and the second currency is the quote currency (USD). Forex currencies are divided into majors, minors, and exotic currencies. Majors are very popular and are offered in narrow spreads.
1) Major Currencies
- USD (US Dollar)
- EUR (European Euro)
- GBP (UK Pound Sterling)
- JPY (Japanese Yen)
- CHF (Swiss Franc)
The US Dollar involves about 85% of the total daily Forex market turnover. The Euro involves about 37% of the total daily Forex market turnover while the Japanese Yen involves about 17% and the Pound Sterling about 15% of the total Forex daily turnover. The Swiss Franc involves 7% of the total Forex trading turnover.
2) Minor Currencies
The minor currencies are mainly the currencies of countries rich in natural resources (gold, oil, etc).
- AUD (Australian Dollar)
- CAD (Canadian Dollar)
- NZD (New Zealand Dollar)
- SEK (Swedish Krona)
- NOK (Norwegian Krone)
- DKK (Danish Krone)
The Australian Dollar which is called also the Aussie involves about 6.5% of the total Forex market daily turnover. The Canadian Dollar involves 4.2% while the New Zealand Dollar which is called Kiwi involves 2% of the total Forex market daily turnover.
3) The Exotic Currencies
- HKD (Hong Kong Dollar)
- SGD (Singapore Dollar)
- RUB (Russian Federation Ruble)
- MXN (Mexican Peso)
- ZAR (South African Rand)
- KRW (South Korean Won)
- INR (Indian Rupee)
The Spot, Forwards, and Futures Markets
These are the three ways an institutional or a retail investor can participate in the Forex market and exchange currencies. Forex trading usually involves the spot market. The Futures & Forward Contracts are used mainly for hedging against unfavorable market risk. Forex example an importer of Mercedes based in Japan needs to hedge against future Euro unfavorable appreciation so he buys a Forward contract based on Euro against the Japanese Yen. The Futures contracts are bought and sold on organized financial exchanges. On the other hand, the Forward contracts are bought and sold in OTC marketplaces. Usually, banks are offering Forward contracts to large international firms.
» The CBE Options & Futures Exchange | » The Future Markets at Reuters
In the US, the regulating authority of the futures market is NFA (National Futures Association). » NFA Futures
Breaking-Down Volume Activity
The highest daily market activity takes place in the UK (36%), followed by the U.S. (17%) and Japan (6%). The FOREX market operates 24 hours and 5 days a week, from Monday through Friday.
Chart: Forex Market Activity
The Forex Spot Market
The Forex Spot Market was introduced in 1971. Forex Spot or Cash Market means trading at whatever the price is at the moment. Payments for imports and exports of goods and services are made through the Foreign exchange market. This part of the market is called the consumer Forex market. The Forex market consists of many different participants including Central, Banks, Commercial Banks, Investment Companies, Brokers, Commercial Firms, Institutional and Retail Investors, etc.
The Retail Forex Market
The interbank retail Forex market for small speculators began in 1994. Later, in 1999 FXCM started to break down large interbank units into small units and gave birth to the retail Forex market as we know it today. For the first time, small individual traders had the opportunity to trade in the Foreign Exchange market.
History of the Foreign Exchange Market
This is a brief history of the Foreign Exchange market.
The Bretton Woods Accord in 1944
The establishment of the Bretton Woods Accord in 1944 is generally accepted as the beginning of the Forex market. It was established to stabilize the global economy after World War II. It not only created the concept of pegging currencies against one another but also led to the creation of the International Monetary Fund (IMF). Currencies from around the world were pegged against the US Dollar which was in turn pegged against the value of gold in an attempt to bring stability to global economic events. In 1971, the Bretton Woods Accord finally ended. However, it did manage to stabilize major economies.
Free-Floating Currencies after 1971
Late in 1971 and 1972, two more attempts were made to establish free-floating currencies against the US Dollar (namely the Smithsonian Agreement and the European Joint Float). The Smithsonian Agreement was a modification of the Bretton Woods Accord with allowances for greater currency fluctuations while the European Joint Float aimed to reduce the dependence of European currencies upon the US Dollar. After the failure of each of these agreements, nations were allowed to peg their currencies to freely float and were actually mandated to do so in 1978 by the IMF. The free-floating system managed to continue for several years after the mandate, yet many countries with weaker currency values failed against those countries with stronger currency values.
The European Monetary System in 1978
European currencies were among those that were affected the most by the strength of stronger currencies such as the US dollar and the British pound. In July of 1978, the European Monetary System was created to counter the dependency on the U.S. dollar. It became increasingly clear by 1993 that this attempt had failed. Shortly thereafter, retail currency trading opportunities, as we know them today, started to be enjoyed not only by those familiar with the Foreign Exchange Market but also by small investors willing to take similar risks like the banks and large financial institutions.
The Impact of Devaluation in 1997
By the late 1990s, stability issues increased in Europe as did major financial problems in Asia. In 1997, there was a major currency crisis in Southeast Asia. Many of the countries’ currencies were forced to float. The devaluation of currencies continued to plague the Asian currency markets. Confidence in trading the open Asian Forex markets was failing. Those currencies that had continued to be valued relatively higher remained unchanged and kept the concept of trading currencies out of those economically strong nations.
The Introduction of the Euro in 1999
Though Europeans were already very comfortable with the concept of Forex trading, this trading arena was still unfamiliar territory to the rest of the world. The establishment of the European Union later gave birth to the euro in 1999. The euro was the first single currency used as legal tender for the member states in the European Union. It became the first currency to rival the United States dollar. Euro created financial stability, something that Europe had long desired.
■ The Foreign Exchange Market History
TradingFibonacci.com (c)
Sources:
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TradingCenter.org
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Wikipedia.org
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Ten Keys to Successful Forex Trading {Jared Martinez}
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