By ForexPros.com – The forex, or foreign exchange, market is a worldwide market for currency trading. It is decentralized and over-the-counter: when a tourist in Tokyo buys with yen U.S. dollars, he makes a transaction in the forex market – as does a multinational corporation when it converts millions of euros into sterling. As such, the market is the largest in the world, with a trading volume that results in great liquidity; it is also open 24 hours a day, except on weekends.
Many market participants only seek to exchange a foreign currency for their own, such as firms that need to pay salaries in different countries from those in which they sell products. But a large proportion of the market is made up of retail currency traders, who speculate on movements in exchange rates – in a similar manner to those who trade on movements of stock prices.
Fluctuations in exchange rates are triggered by global macroeconomic conditions and events, and traders’ expectations ahead of them, as well as actual monetary flows. The market is appealing to private investors since its volatility offers opportunities for profits (as well as losses, of course), while standard instruments exist to manage risk exposure. Another attraction is that forex brokers allow investors to leverage their trades with low margin requirements.
In the forex market, currencies are traded against one another in “pairs,” which are the quotations of the relative value of one unit of a currency, the “base,” against another currency, the “counter.” These are generally written by linking together the international 3-letter codes of the currencies, with the base at the beginning; for example, EUR/USD denotes the relation of the euro against the U.S. dollar.
As in any market, there is a difference between the buying and selling price in forex, known as the bid/offer spread. This is noted in terms of pips, the smallest price change that a given exchange rate can make – which is usually 1/100 of a percent. On major currency crosses, the difference between the price at which a market-maker will buy (“bid”) from a customer and the price at which a market maker will sell (“offer” or “ask”) is often between one and three pips.
The market is divided into levels of access: at the top is the inter-bank market, which is made up of the largest commercial banks and securities dealers; these groups often receive razor-sharp spreads. Smaller banks and large multinational corporations are next, followed by hedge funds and investment management firms. Retail traders, who are next, participate indirectly through brokers or banks, and constitute a growing segment of the market due to the relative ease with which the Internet enables them to trade.
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