The foreign exchange market (Forex) is the market in which international currencies are traded. Every country has its own currency, except for the Eurozone. All members of the Eurozone have the same currency: the euro.
There is no centralised place where trading takes place, such as the New York Stock Exchange. Trading on Forex is decentralised and takes place everywhere in the world, making Forex unique. The average daily turnover on Forex amounts to 4.0 trillion USD.
Forex offers more advantages compared to other markets:
- Trading everywhere in the world;
- Huge trading volume that means more liquidity;
- 24 hours a day trading except Saturday and Sunday;
- Large movements of the exchange rates make larger profits possible;
- Possibility to use leverage to enhance the trading size of each transaction.
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Almost everyone has had some experience with currency trading. Every time you are on holiday abroad and change money, you are trading the currency indirectly. You buy one currency and sell another, which can influence the currency exchange rate. It is the same principle with Forex.
But, due to the huge trading volume, you cannot influence the currency exchange rate if only exchanging a few hundred or thousand. National banks, banks, market makers, export/import companies, investment and hedging companies, insurance companies, corporate investors, and intermediary companies offering individuals and legal entities access to the market all have far more influence on the exchange rate:
Central banks are the major market participants who do not impose any formal limitations on price development. Nevertheless, they act as regulating authorities determining the level of main interest rates. Banks operate on the open market, dealing with repurchases or selling securities, express their preferences to market participants and assess the situation. They may also reserve the right to effect direct currency interventions (purchase or sale of the national currency to prevent a subsequent fall or rise in its cost).
Market-makers are the banks individually quoting currency prices for other participants in the market. They have the right to determine price quotations on the basis of their agreement to adhere to international standards. Service stability, code of laws and rules developed by the regulating institutions (e.g., the FSA which is regulated by the Bank of England), plus the so-called ”honour code” established by market-makers, all secure continuous operation of the Forex market.
Export/import companies effecting currency exchange transactions in the market do not set out to gain direct profit from such transactions but apply international policies for currency exchange so that they can carry out their economic activities instead.
Investment funds, corporate and private investors
Investment funds, corporate and private investors aim to profit from the purchase and sale of currency due to price differences at various times. Intermediary companies gain them access (entry) to the market while receiving market quotations from market-makers i.e., these major participants effect exchange transactions with Forex.
Insurance companies are engaged in risk hedging (insuring transactions against the market risks) in the field of specialised transactions. For example, a company importing products from Germany carries a risk related to a possible increase in the cost of the European currency. It can offset such risks by buying euro in amounts assessed before for any other currencies.