The Foreign Exchange Market was established in 1971 with the abolishment of
fixed currency exchanges. Currencies became valued at 'floating' rates
determined by supply and demand. The FOREX grew steadily throughout the
1970's, but with the technological advances of the 80's FOREX grew from
trading levels of $70 billion a day to the current level of $1.5 trillion.
The FOREX is made up of about 5000 trading institutions such as
international banks, central government banks (such as the US Federal
Reserve), and commercial companies and brokers for all types of foreign
currency exchange. There is no centralized location of FOREX major trading
centers are located in New York, Tokyo, London, Hong Kong, Singapore, Paris,
and Frankfurt, and all trading is by telephone or over the Internet.
Businesses use the market to buy and sell products in other countries, but
most of the activity on the FOREX is from currency traders who use it to
generate profits from small movements in the market.
Even though there are many huge players in FOREX, it is accessible to the
small investor thanks to recent changes in the regulations. Previously,
there was a minimum transaction size and traders were required to meet
strict financial requirements. With the advent of Internet trading,
regulations have been changed to allow large interbank units to be broken
down into smaller lots. Each lot is worth about $100,000 and is accessible
to the individual investor through 'leverage' loans extended for trading.
Typically, lots can be controlled with a leverage of 100:1 meaning that
US$1,000 will allow you to control a $100,000 currency exchange.
There are two reasons to buy and sell currencies. About 5% of daily turnover
is from companies and governments that buy or sell products and services in
a foreign country or must convert profits made in foreign currencies into
their domestic currency.
The other 95% is trading for profit, or what you call speculation. Investors
frequently trade on information they believe to be superior and relevant,
when in fact it is not and is fully discounted by the market.
Unlike the futures and stock markets, trading of currencies is not
centralized on an exchange. Forex literally follows the sun around the
world. Trading moves from major banking centers of the U.S. to Australia and
New Zealand, to the Far East, to Europe and finally back to the U.S.
Advantages of Forex
A 24-hour market - A trader may take advantage of all profitable market conditions at any time. There is no waiting for the opening bell.
High liquidity - The Forex market with an average trading volume of over $1.3 trillion per day. It is the most liquid market in the world. It means that a trader can enter or exit the market at will in almost any market condition minimal execution marries or risk and no daily limit.
Low transaction cost - The retail transaction cost (the bid/ask spread) is typically less than 0.1% (10 pips or points) under normal market conditions. At larger dealers, the spread could be smaller.
Uncorrelated to the stock market - A trader in the Forex market involves selling or buying one currency against another. Thus, there is no correlation between the foreign currency market and the stock market. Bull market or a bear market for a currency is defined in terms of the outlook for its relative value against other currencies. If the outlook is positive, we have a bull market in which a trader profits by buying the currency against other currencies. Conversely, if the outlook is pessimistic, we have a bull market for other currencies and traders take profits by selling the currency against other currencies. In either case, there is always a good market trading opportunity for a trader.
Inter-bank market - The backbone of the Forex market consists of a global network of dealers. They are mainly major commercial banks that communicate and trade with one another and with their clients through electronic networks and telephones. There are no organized exchanges to serves a central location to facilitate transactions the way the New York Stock Exchange serves the equity markets. The Forex market operates in a manner similar to the way the NASDAQ market in the United States operates, thus it is also referred to as an over the counter ( OTC ) market.
No one can corner the market - The Forex market is so vast and has so many participants that no single entity, not even a central bank, can control the market price for an extended period of time. Even interventions by mighty central banks are becoming increasingly ineffectual and short lived. Thus central banks are becoming less and less inclined to intervene to manipulate market prices.
