FOREX (the foreign exchange market, FX, or currency market) is a worldwide financial market for the trading of currencies and the largest financial market in the world. It is a unique market and has no physical location or any central exchange unlike other markets. It is a true 24-hour market with buyers and sellers conducting business with a daily average turnover of 1 trillion US dollars.
Forex is an ideal market for active traders who want to take advantage of economic, social and political fluctuations in the world and the inability of governments to control the direction of the market.
The foreign exchange market is also unique due to its geographical dispersion: Forex trading starts in Sydney, and as the business day begins in other financial centers, moves around the globe to Tokyo, London, New York.
In simple terms, Forex is about simultaneous purchase and sale of the currency or the exchange of one country’s currency for the one of another country. As you know, the world currencies are always fluctuating being traded in the currency pairs like, for example, Euro/Dollar, Dollar/Yen etc.
Now let us look at a typical Forex transaction, and try to work out how it all works. In a typical foreign exchange transaction, currencies are always priced in pairs: a party purchases a quantity of one currency by paying a quantity of another currency. The purpose of trading is to exchange one currency for another in the expectation that the price will change so that the currency you bought has increased its value if we compare it to the one you sold. The first currency in the pair is called the base currency, and the second currency is the quote or counter currency.
The foreign exchange market is divided into levels of access. The inter-bank market is made up of the largest commercial banks and securities dealers. Central banks are also active participants in the foreign exchange market, and try to control the money supply, inflation, and interest rates and usually have official or unofficial target rates for their currencies. Central banks control currency reserves and adjust the interest investment rate in the national currency. The national central banks attempt to bring some stability to the market by using available foreign exchange reserve currencies.
Commercial companies typically trade fairly small amounts compared to those of banks or speculators. However, some multinational companies can have a great impact in case very large positions are covered.
Retail traders have an increasing influence on foreign exchange market. At present, they participate indirectly through brokers or banks. There are two main types of retail brokers offering the opportunity for speculative currency trading: brokers and dealers or market makers.
Brokers serve as an agent of the customer in the broader Forex market. They look for the best price in the market for a retail order and deal on behalf of the retail customer. They charge a commission or mark-up in addition to the price obtained in the market.
Dealers or market makers normally act as principal in the transaction versus the retail customer, and quote a price they are willing to deal at, and the customer has the choice whether or not to trade at that price. The broker firms also have their fee by charging the percent out of the operation sum.
Forex market makers provide a platform for foreign currency exchange for the customer: they buy and sell to people who want to enter the market. Market makers know the current cost of investing in the market and stand ready, every second of the trading day with a firm bid and ask price. Therefore, they help customers to reduce the chances of losing money in the market. Normally, the Forex market maker is a bank or brokerage company, which ensures that the market is always functional and that the currencies in it will always fetch the market rate.
Forex trading includes a “bid” and “ask”. The “bid” is the price at which a market maker wants to buy the base currency in exchange for the counter currency. The “ask” is the price at which a market maker is willing to sell the base currency in exchange for the counter currency. The difference between the bid and the ask price is called the spread.
There are a number of different techniques market participants use to predict the changes and grasp the future course of a currency. About 70-to-90 percent of the foreign exchange transactions are speculative. The person or institution that bought or sold the currency is speculating on the movement of that particular currency.