FOREX -
the foreign exchange market or currency market or Forex is the market where one
currency is traded for another. It is one of the largest markets in the world.
Some of the participants in
this market are simply seeking to exchange a foreign currency for their own,
like multinational corporations which must pay wages and other expenses in
different nations than they sell products in. However, a large part of the
market is made up of currency traders, who speculate on movements in exchange
rates, much like others would speculate on movements of stock prices. Currency
traders try to take advantage of even small fluctuations in exchange rates.
In the foreign exchange
market there is little or no 'inside information'. Exchange rate fluctuations
are usually caused by actual monetary flows as well as anticipations on global
macroeconomic conditions. Significant news is released publicly so, at least in
theory, everyone in the world receives the same news at the same time.
Currencies are traded
against one another. Each pair of currencies thus constitutes an individual
product and is traditionally noted XXX/YYY, where YYY is the ISO 4217
international three-letter code of the currency into which the price of one
unit of XXX currency is expressed. For instance, EUR/USD is the price of the
euro expressed in US dollars, as in 1 euro = 1.2045 dollar.
Unlike stocks and futures
exchange, foreign exchange is indeed an interbank, over-the-counter (OTC)
market which means there is no single universal exchange for specific currency
pair. The foreign exchange market operates 24 hours per day throughout the week
between individuals with forex brokers, brokers with banks, and banks with
banks. If the European session is ended the Asian session or US session will
start, so all world currencies can be continually in trade. Traders can react
to news when it breaks, rather than waiting for the market to open, as is the
case with most other markets.
Average daily international
foreign exchange trading volume was $1.9 trillion in April 2004 according to
the BIS study.
Like any market there is a bid/offer
spread (difference between buying price and selling price). On major currency
crosses, the difference between the price at which a market maker will sell
("ask", or "offer") to a wholesale customer and the price
at which the same market-maker will buy ("bid") from the same
wholesale customer is minimal, usually only 1 or 2 pips. In the EUR/USD price
of 1.4238 a pip would be the '8' at the end. So the bid/ask quote of EUR/USD
might be 1.4238/1.4239.
This, of course, does not
apply to retail customers. Most individual currency speculators will trade
using a broker which will typically have a spread marked up to say 3-20 pips
(so in our example 1.4237/1.4239 or 1.423/1.425). The broker will give their
clients often huge amounts of margin, thereby facilitating clients spending
more money on the bid/ask spread. The brokers are not regulated by the U.S.
Securities and Exchange Commission (since they do not sell securities), so they
are not bound by the same margin limits as stock brokerages. They do not
typically charge margin interest, however since currency trades must be settled
in 2 days, they will "resettle" open positions (again collecting the
bid/ask spread).
Individual currency
speculators can work during the day and trade in the evenings, taking advantage
of the market's 24 hours long trading day.
Compiled using Wikipedia
materials.