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FOREX DEFINITION - PART 1
Information in this section is fully provided by Wikipedia, free on-line encyclopedia.
Forex definition | Trading characteristics |
Major Factors
The foreign exchange (currency or forex or FX) market exists wherever one currency is traded for another. It is by far the largest financial
market in the world, and includes trading between large banks, central banks, currency speculators, multinational corporations,
governments, and other financial markets and institutions. The average daily trade in the global forex and related markets currently is
over US$ 3 trillion.
The foreign exchange market is unique because of
- its trading volumes
- the extreme liquidity of the market
- the large number of, and variety of, traders in the market
- its geographical dispersion
- its long trading hours: 24 hours a day (except on weekends)
- the variety of factors that affect exchange rates
- the low margins compared with other markets of fixed income (but profits/losses can be high due to very large trading volumes.)
As such, it has been referred to as the market closest to the ideal perfect competition. According to the BIS (Bank of International Settlements)
average daily turnover in traditional foreign exchange markets is estimated at $3.21 trillion.
Unlike a stock market, where all participants have access to the same prices, the forex market is divided into levels of access.
At the top is the inter-bank market, which is made up of the largest investment banking firms. Within the inter-bank market,
spreads, which are the difference between the bid and ask prices, are razor sharp and usually unavailable, and not known to
players outside the inner circle. As you descend the levels of access, the difference between the bid and ask prices widens
(from 0-1 pip to 1-2 pips for some currency's such as the EUR). This is due to volume. If a trader can guarantee large
numbers of transactions for large amounts, they can demand a smaller difference between the bid and ask price, which is
referred to as a better spread. The levels of access that make up the forex market are determined by the size of the “line”
(the amount of money with which they are trading). The top-tier inter-bank market accounts for 53% of all transactions. After
that there are usually smaller investment banks, followed by large multi-national corporations (which need to hedge risk and
pay employees in different countries), large hedge funds, and even some of the retail forex market makers. According to Galati
and Melvin, “Pension funds, insurance companies, mutual funds, and other institutional investors have played an increasingly
important role in financial markets in general, and in FX markets in particular, since the early 2000s.” (2004) In addition,
he notes, “Hedge funds have grown markedly over the 2001–2004 period in terms of both number and overall size” Central banks also
participate in the forex market to align currencies to their economic needs.
You may ask: how are the small investors classified in this business?
Retail forex brokers or market makers handle a minute fraction of the total volume of
the foreign exchange market. According to CNN, one retail broker
estimates retail volume at $25–50 billion daily, which is about 2% of the whole market.
Retail traders (individuals) are a small fraction of this market and may only participate indirectly through brokers or banks.
Forex definition | Trading characteristics |
Major Factors
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