How the forex market works

Foreign exchange, often abbreviated as forex or simply FX, refers to the exchange of global currencies on a decentralized market place – also known as over the counter (OTC) currency exchange.

The foreign exchange market is the largest and most liquid market in the world, with an average day trading volume of approximately $5 trillion. There is a lot more forex trading than other forms of investing, including U.S stock market trades. The size of the global foreign exchange market - where the Swiss franc, British pound, the euro, US dollar are traded - dwarfs bond and equity markets where daily volumes are much lower.

Who trades the foreign exchange market?

Historically, the currency market was only accessible to large financial institutions and high net worth individuals, acting as currency speculators and hedgers of foreign exchange risk. However, technological innovations over the last two decades have enabled currency traders of all sizes to buy or sell currencies on the forex market from anywhere in the world, through the use of innovative online trading platforms. Forex trading is still done through the interbank foreign exchange market but technology has allowed greater access.

global forex currencies map

Some of the main participants in the foreign exchange market include:

Governments and Central Bank

Major national governments and their respective central banks including the Federal Reserve, the Bank of England and the European Central Bank are some of the largest players on the forex market, using currency exchange to manage money supply and make changes to monetary policy.

Major Banks

Some of the world’s largest banks such as Goldman Sachs, Deutsche Bank and Citibank trade immense volumes of currency on the forex market on a daily basis, both for themselves and their clients which include major corporations, government agencies and high net worth individuals.

Forex Brokers

Forex brokers provide access to the global currency markets to retail traders of all sizes. Through online trading platforms, a broker acts as a gateway for investors to trade currency from the comfort of their own homes.

Retail Traders

Almost one-third of the daily volume traded on the forex market is now supplied by retail traders. Retail traders traditionally access the forex market via the currency futures market but now the most popular is trading the spot forex market. This means individuals are trading approximately $1.5 trillion of currency on a daily basis, gaining access to the market through the trading platforms supplied by forex brokers.

How are currencies traded?

Currencies on the forex market are traded in pairs. It is the same thing you see for quote currencies when you go to the foreign exchange office before going on holiday. This means that, when a trader goes to buy or sell a currency, they are simultaneously selling or buying another. For example, if a trader wishes to buy EURUSD, they will be buying euros and selling dollars at the same time.

Three categories of Currency pairs

Major Forex Pairs

Involve the U.S. dollar paired with any other major currency. Examples of major pairs include EURUSD, GBPUSD, USDJPY and USDCAD.

Cross Currency Forex Pairs

Pairs not featuring the U.S dollar. Crosses between other major currencies are also referred to as minors. Examples of cross currency pairs include EURGBP, EURJPY, GBPJPY and NZDCAD.

Exotic Forex Pairs

Involve a major currency paired with one from an emerging economy. Examples of exotic pairs include USDHKD, CADMXN, EURSEK and JPYSGD.

 

FlowBank like all the best forex brokers offers a EUR/USD weekly forecast, GBP/USD weekly forecast and USD/JPY weekly forecast. Please enquire with your account manager to see if you qualify for daily free forex signals via email.

What is a pips in Forex?

Forex pairs are typically quoted to four significant figures. Forex example EUR/USD is 1.2051. Here the '1' is the pip. The pip in forex is normally the fourth number after the decimal point. An exception to the rule is USD/JPY where the forex pip is the second number after the decimal point, for example 105.21 where '1' is the pip.

Trading a nation’s currency is akin to investing in the fortunes of said nation. When the country is doing well and its economy is thriving, its currency strengthens. Conversely, when a nation is struggling, its currency will be worth less. As such, investors in the forex market are speculating that one country’s economy will outperform that of another.

For example, if a trader believes that the United Kingdom’s economy will outperform that of the United States, they would buy GBPUSD (buy the pound and sell the dollar). On the other hand, if the U.S. economy is likely to perform better than that of the UK, a trader would sell GBPUSD (sell the pound and buy the dollar). Currency can also be traded through currency futures markets where an investor can bet on the future performance of a currency but this market is smaller than FX and represents closer to $100 billion.

What Affects a Currency’s Exchange Rate?

When looking to buy or sell currencies on the forex market, an investor must be aware of the factors that affect exchange rates, so that they can adapt their strategies accordingly.

 

what effects a currencies exchange rate

 

Two of the main factors to watch out for include:

Macroeconomic Events

Macroeconomic news including announcements about important data points such as inflation, unemployment, interest rates and gross domestic product can have major effects on a currency’s exchange rate. Investors watch this data closely for hints on how the markets may move.

Geopolitical Events

Geopolitics also play a major role in the prices of currency. Factors including changes in government, new regulation, taxes, labour laws and trade tariffs can all cause volatility in the forex market, and significantly impact the value of national currencies.

Economic Data

It is important for investors to keep abreast of all upcoming events and announcements that may impact currency prices, so as not to be caught off-guard in the case of market volatility. There are numerous tools including economic calendars that can be used to monitor market-moving events, enabling traders to adapt their strategies when necessary.

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