Welcome to the World of Forex Trading
What is the Forex Market?
The Foreign Exchange Market is the hub of all money flow around the world. The Forex Market enables corporations, banks, financial institutions, governments and individual investors and speculators to trade just about anything in the currency of the asset they are wanting to trade. Without the Forex Market money couldn’t flow between countries. It is essentially the ‘glue’ or ‘hub’ that enables international trade and because of this it is the world’s largest financial market. Current estimates put daily turnover at USD5 Trillion for 2016, according to the Bank of International Settlements. Some predictions indicated that by 2020 it will reach USD10 Trillion.
What is the function of the Forex Market?
The Forex Market facilitates international trade where businesses and individuals need to transact in foreign currencies to their own.
An example of this would be Qantas, the Australian national airline wishes to buy an aircraft from Boeing the American aircraft manufacturer. Qantas operating currency is the Australian Dollar (AUD) and the operating currency of Boeing is the US Dollar (USD). Qantas needs to convert AUD into USD so it will contact its bank to facilitate this transaction and their bank will convert their AUD into USD in the forex marketplace to pay Boeing for their product.
This would be a similar transaction as an individual going from the UK to the USA on holiday, they will need to convert UK Pounds (GBP) to US Dollars (USD) to enable them to buy products and services whilst they are in the USA.
These two participants in the Forex market are an important part, however by far the largest proportion of the daily Forex Market turnover is what is known as Capital Market Transactions.
Capital Market Transactions
Capital Markets are what is generally known as the Financial Markets. They include such markets as Real Estate, Stocks (Equities), Treasury Bonds (Fixed Income), Commodities (Oil, Gold, Silver and Copper) and Derivatives. Explanations of these individual markets are explained in a later article. Markets such as Stocks.Equities are found in all countries that trade stocks so there are US Equities, European Equities to name a few. To enable investment managers to quickly sell lets say European Equities which are in Euros and buy US Equities they need to convert from EUR to USD to facilitate that change in asset allocation. This is achieved using what is known as the Spot Forex Market, which is in essence immediate exchange of currencies. There are other methods to allow you to ‘order your rate’ in advance and these are Currency Forwards, Futures and Options. These will be covered in a future article.
So as you can see money is continually moving around the world. It is this global money flow that makes the Forex Market so huge, and understanding the global money flow is critical to success in the Forex Market.
Who are the Forex Market Participants?
Those that use the Forex Market are very diverse from Institutions, Governments to Individual Investors such as retail traders. The Forex Market began to emerge in 1978 when the worldwide currencies were allowed to ‘float’ in accordance with ‘Supply and Demand’. Originally it was the sole domain of the banks and central banks, as various reforms, regulation and technological changes occurred over the years which eliminated the credit risk the forex market was opened up to literally anyone and hence the boom in the forex market in recent years. Whilst all transactions still go through the largest FX banks such as Citigroup, UBS and Deutsche Bank who are known as the ‘Sell Side’ ie they sell the fx financial products to the ‘Buy Side’ those participants that buy those FX products. It is these that we are interested in.
The buy side participants are (in no order of importance):
These are corporations such as Qantas as mentioned above transacting cross-border purchases.
Investment Managers and Bankers
These are institutional investors such as Pension Funds, Insurance Companies, Mutual Funds Exchange Traded Funds (ETF’s), Hedge Funds, Proprietary Trading Firms, Commodity Trading Advisors (CTA’s) and the Proprietary Traders at the banks.
Governments also need the FX Market to enable them to buy and sell such items as military equipment.
Whilst Central Banks do not commonly use the FX market they need access to it to enable them to manage and maintain Monetary Policy, they may intervene. Why are the Government and Central Banks in different categories? Central Banks are responsible for managing Monetary policy with any political interference, so they act alone from their government in implementing monetary policy.
So it can be seen from the above market players that the Forex Market is diverse and creates an extremely dynamic marketplace creating opportunities everyday for forex traders.
The latest survey by BIS was April 2016.
Forex Market Infrastructure?
Knowing who are the majority of the participants is key to understanding the movement in the forex market.
Non Centralised Market – Over The Counter
The Forex Market is a non-centralised market. Unlike Stocks that are bought and sold through a central exchange like the New York Stock Exchange where all trades are passed through, the Forex Market is an Over The Counter (OTC) market, that means is all transactions go through the major banks known as the Interbank. This also means there is no way to see the volume of trading happening at any one time. To be able to monitor the activities in the Forex Market the Bank of International Settlements undertake a survey every three years from participating central banks and report on the activity in the Forex Market.
Ever since the collapse of the Bretton Woods Agreement in 1974. The Forex Market has been essentially an unregulated market. It is now self regulated with the banks competeing in price with each other when servicing their clients.