What Is The Foreign Exchange Market?

The definition of what the foreign exchange market is, goes something like this:

The foreign exchange market (Forex, FX, or currency market) is a global decentralized or over-the-counter (OTC) market for the trading of currencies. This market determines foreign exchange rates for every currency. It includes all aspects of buying, selling, and exchanging currencies at current or determined prices. In terms of trading volume, it is by far the largest market in the world, followed by the credit market.

Currencies have traditionally been the domain of businesses, institutional investors, and hedge funds. The invention and recent emergence of online forex trading has made it available to individual traders, most trading in their spare time and from the comfort of their own homes.

Currency is without a doubt the fastest moving and most liquid kind of trading in recent years, and really shot up after the 2008 financial crisis. By now it far surpasses the speed and volume of equities and the usual stock trading. The simplicity of the online platforms has lead millions of small-time traders into the market, and many of them are doing really well with it.

Online Forex Trading In Numbers

The overall forex market sees average daily volumes of more than $3.2 trillion.  This is four times more than all the equity and futures markets combined.

About 20% of those trades come from businesses that need to move money from one currency to another to conduct international business. Speculative traders, among these the online, private traders, make up a staggering 80%.

Basic Online Trading Timing

The online forex trading market has incredibly flexible hours as different markets around the globe open and close. Just look at these facts: New York opens at 1 pm GMT and closes at 10 pm. Sydney kicks off at 10 pm GMT and if you’re interested in Asia, Tokyo opens at midnight. For GBP London opens at 8 am GMT, just one hour before Tokyo closes and the cycle continues online day in and day out – 365 days a year.

The most active trading occurs when two markets overlap each others opening hours.
Example: London and New York overlap for four hours between 1-4 pm GMT. We can clearly see from analysis, that at this time the USD, EUR, GBP are the most actively traded currencies.

London and Tokyo only operate together for the last hour of Tokyo and the first of London trading. And the trading then shows the same with GBP, EUR, and JPY.

All trading strategies should include timing and opening and closing hours of the markets the online traders are interested in. Some traders choose the extra activity of multiple markets at the beginning and closing hours of the London or New York markets. Others prefer the calmer times when the markets are “open on their own”.

Why Do So Many Choose Online Forex Trading?

  • Many firms don’t charge commissions – you pay only the bid/ask spreads.
  • There’s 24 hour trading – you dictate when to trade and how to trade.
  • You can trade on leverage, but this can magnify potential gains and losses.
  • You can focus on picking from a few currencies rather than from 5000 stocks.
  • Forex is accessible – you don’t need a lot of money to get started.

How is Forex traded?

The mechanics of a trade are virtually identical to those in other markets. The only difference is that you’re buying one currency and selling another at the same time. That’s why currencies are quoted in pairs, like EUR/USD or USD/JPY. The exchange rate represents the purchase price between the two currencies.

Example:

The EUR/USD rate represents the number of USD one EUR can buy. If you think the Euro will increase in value against the US Dollar, you buy Euros with US Dollars. If the exchange rate rises, you sell the Euros back, and you cash in your profit. Please keep in mind that forex trading involves a high risk of loss.

Liquidity – Why Is it Important?

Liquidity refers to how active a market is. It is determined by how many traders are actively trading and the total volume they’re trading. One reason the foreign exchange market is so liquid is that it is tradable 24 hours a day during weekdays.

And What About Volatility?

Volatility is the measure of how drastically a market’s prices change. A market’s liquidity has a big impact on how volatile the market’s prices are. Lower liquidity usually results in a more volatile market and cause prices to change drastically; higher liquidity usually creates a less volatile market in which prices don’t fluctuate as drastically.

Liquid markets such as forex tend to move in smaller increments because of their high liquidity results in lower volatility.

News And World Events Affect Forex

Currency traders keep an ear tuned to all the latest news events. Government reports, politics, even a presidential tweet can twitch the market in minutes. The last 4 years have seen much of this in relation to the USD, but since it is a safe-haven currency it always rallies back and remains a favorite for traders.

One other example that comes to mind is from 15 January 2015:
That’s when the Swiss National Bank (SNB) suddenly decoupled the Swiss franc from the euro. This caused the Swiss franc (CHF) to rally 23% in a matter of moments. It bankrupted several currency trading firms and rocked the financial world.

This is why the news is so vital to traders. And it reminds traders how speculative and risky trading can be.

On the other hand, in currency markets, there is no such thing as ‘insider trading’. Any news is legal news. Hear a tip from your golf buddy who works in the central bank? You are free to use it. Traders who focus on news and fundamentals more often stick to a few currency pairs so they can keep up with all the information.

Leave a Reply

Your email address will not be published. Required fields are marked *