Fx Market Overview

by Warren Seah
forex market overview

Why Cash Is King?

Foreign exchange is the largest financial market in the world. It is estimated that $3.2 trillion[1] global average daily volume is traded across the world every day.

Decentralised Market

Unlike equity or futures market, forex market does not have a centralised exchange. Trading the forex market does not involve an exchange and is usually traded in over-the-counter market where buyers and sellers conduct currency transactions.

Around-the-Clock 24 Hr Market

Forex market is opened 24 hour a day (about 6 days a week) where people from different time zones can participate.

Instant Liquidity

Trading the forex market is most liquid throughout the day. In other words, you can buy and sell currencies almost instantly whenever you want to. This liquidity provides investors and traders minimal risk because they can exit their investments as and when they want to without the possibility of not finding a potential buyer or seller for their transactions.

Transactions Occurring in the Forex Market

Commercial Transactions

Building developers purchase raw material such as mineral ores from Australia and trading companies will import products from abroad and export out to other countries.

Both of these transactions require that the company first sell their currency in exchange for the foreign currency to purchase their products. Subsequently, exporting goods will mean that companies accept foreign currency in exchange for their goods. Thereafter, converting profits back to home currency.

These companies act as both buyers and sellers for foreign currencies.

Hedging

Companies with open currency exposures will frequently buy or sell their local currency against foreign currency to protect from a loss in value due to possible currency fluctuations.

Portfolio Investments

Fund managers and hedge fund managers will make foreign-based investments to participate in the growth of developing countries. Investments in foreign investments require money to be paid in their home currency. Hence, before investment can be made, money must first be converted to their currency.

Personal

Tourists, immigrants and emigrants making money remittance are the main transactions in this category.

Funding

Big banks and government central banks will often borrow large quantity of money from abroad by arranging the sale of securities (government treasury bonds or commercial loans). Money received in foreign currencies will be converted in the forex market.

Major Participants

Government and Central Banks

Central banks may regulate their country currency against US dollars by buying or selling US dollars to keep their currency within a certain band. This is also called dirty float.

We have witnessed many times that the Bank of Japan intervened in the forex market by selling Yen against US dollar to prevent Yen from appreciating too much against US dollars. This is because Japan is an exporting countries and prices of their product will become too expensive for its trading partners if Yen appreciate too much against US dollar.

Commercial Banks

They act as primary market dealers and provide liquidity to other participants in the forex market. Examples of these banks are Citibank, UBS and J.P Morgan.

Hedgers

These are usually multi national companies that hold large quantity of money in different currencies. They will take an opposite positions in anticipation of currency movements so as to minimise a lose in value.

Speculators

There are two groups of speculators. Hedge funds are the large speculators looking to profit from changes in major currency movements. The smaller group of speculator is the retail investors. Retail speculators have surged over the past 5 years due to the ability to trade electronically and from home.

The deregulation of the forex market allows retail investors to participate and profit from the forex market.  Low brokerage fees, low margin requirements and highly leveraged are reasons why more people decided to participate in forex trading for investment purposes.

Closing Remarks

Foreign exchange market is believed to be the fastest growing period of our time. As forex market does not operate through an exchange, costs of participating in this market are much lower compared to the equity market.

This information are written in the aim of educating people on the facts about forex and the key driving factors which make it one of the fastest growing market of our time. “Cash is king!” – This phrase will hold true for a long time.


[1] BIS Triennial Central Bank Survey of FX and Derivatives Market Activity in April 2007, published September and December 2007

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