Foreign exchange market
The foreign exchange market (forex, FX, or currency market) is a global decentralized market for the trading of currencies. This includes all aspects of buying, selling and exchanging currencies at current or determined prices. In terms of volume of trading, it is by far the largest market in the world. The main participants in this market are the larger international banks. Financial centres around the world function as anchors of trading between a wide range of multiple types of buyers and sellers around the clock, with the exception of weekends. The foreign exchange market determines the relative values of different currencies.
The foreign exchange market works through financial institutions, and it operates on several levels. Behind the scenes banks turn to a smaller number of financial firms known as “dealers,” who are actively involved in large quantities of foreign exchange trading. Most foreign exchange dealers are banks, so this behind-the-scenes market is sometimes called the “interbank market”, although a few insurance companies and other kinds of financial firms are involved. Trades between foreign exchange dealers can be very large, involving hundreds of millions of dollars. Because of the sovereignty issue when involving two currencies, forex has little (if any) supervisory entity regulating its actions.
The foreign exchange market assists international trade and investments by enabling currency conversion. For example, it permits a business in the United States to import goods from European Union member states, especially Eurozone members, and pay Euros, even though its income is in United States dollars. It also supports direct speculation and evaluation relative to the value of currencies, and the carry trade, speculation based on the interest rate differential between two currencies.
In a typical foreign exchange transaction, a party purchases some quantity of one currency by paying with some quantity of another currency. The modern foreign exchange market began forming during the 1970s after three decades of government restrictions on foreign exchange transactions (the Bretton Woods system of monetary management established the rules for commercial and financial relations among the world's major industrial states after World War II), when countries gradually switched to floating exchange rates from the previous exchange rate regime, which remained fixed as per the Bretton Woods system.
The foreign exchange market is unique because of the following characteristics:
- its huge trading volume representing the largest asset class in the world leading to high liquidity;
- its geographical dispersion;
- its continuous operation: 24 hours a day except weekends, i.e., trading from 22:00 GMT on Sunday (Sydney) until 22:00 GMT Friday (New York);
- the variety of factors that affect exchange rates;
- the low margins of relative profit compared with other markets of fixed income; and
- the use of leverage to enhance profit and loss margins and with respect to account size.
According to the Bank for International Settlements, the preliminary global results from the 2013 Triennial Central Bank Survey of Foreign Exchange and OTC Derivatives Markets Activity show that trading in foreign exchange markets averaged $5.3 trillion per day in April 2013. This is up from $4.0 trillion in April 2010 and $3.3 trillion in April 2007. Foreign exchange swaps were the most actively traded instruments in April 2013, at $2.2 trillion per day, followed by spot trading at $2.0 trillion. According to the Bank for International Settlements, as of April 2010, average daily turnover in global foreign exchange markets is estimated at $3.98 trillion, a growth of approximately 20% over the $3.21 trillion daily volume as of April 2007. Some firms specializing on foreign exchange market had put the average daily turnover in excess of US$4 trillion. The $3.98 trillion break-down is as follows:
- $1.490 trillion in spot transactions
- $475 billion in outright forwards
- $1.765 trillion in foreign exchange swaps
- $43 billion currency swaps
- $207 billion in options and other products
- Ancient 1.1
- Medieval and later 1.2
- Early modern 1.3
Modern to post-modern 1.4
- After WWII 1.4.1
- Markets close 1.4.2
- After 1973 1.4.3
- Market size and liquidity 2
Market participants 3
- Commercial companies 3.1
- Central banks 3.2
- Foreign exchange fixing 3.3
- Hedge funds as speculators 3.4
- Investment management firms 3.5
- Retail foreign exchange traders 3.6
- Non-bank foreign exchange companies 3.7
- Money transfer/remittance companies and bureaux de change 3.8
- Trading characteristics 4
Determinants of exchange rates 5
- Economic factors 5.1
- Political conditions 5.2
- Market psychology 5.3
Financial instruments 6
- Spot 6.1
- Forward 6.2
- Swap 6.3
- Futures 6.4
- Option 6.5
- Speculation 7
- Risk aversion 8
- Carry trade 9
- Forex signals 10
- See also 11
- References 12
- External links 13
Currency trading and exchange first occurred in ancient times. Money-changing people, people helping others to change money and also taking a commission or charging a fee were living in the times of the Talmudic writings (Biblical times). These people (sometimes called "kollybistẻs") used city-stalls, at feast times the temples Court of the Gentiles instead. Money-changers were also in more recent ancient times silver-smiths and/or gold-smiths.
During the 4th century, the Byzantine government kept a monopoly on the exchange of currency.
Papyri PCZ I 59021 (c.259/8 BC), shows the occurrences of exchange of coinage within Ancient Egypt. 
Currency and exchange was also a vital and crucial element of trade during the ancient world so that people could buy and sell items like food, pottery and raw materials. If a Greek coin held more gold than an Egyptian coin due to its size or content, then a merchant could barter fewer Greek gold coins for more Egyptian ones, or for more material goods. This is why, at some point in their history, most world currencies in circulation today had a value fixed to a specific quantity of a recognized standard like silver and gold.
Medieval and later
During the 15th century, the Medici family were required to open banks at foreign locations in order to exchange currencies to act on behalf of textile merchants. To facilitate trade the bank created the nostro (from Italian translated – "ours") account book which contained two columned entries showing amounts of foreign and local currencies, information pertaining to the keeping of an account with a foreign bank. During the 17th (or 18th ) century, Amsterdam maintained an active forex market. In 1704, foreign exchange took place between agents acting in the interests of the Kingdom of England and the County of Holland.
Alex. Brown & Sons traded foreign currencies exchange sometime about 1850 and was a leading participant in this within U.S.A. During 1880, J.M. do Espírito Santo de Silva (Banco Espírito Santo) applied for and was given permission to begin to engage in a foreign exchange trading business.
The year 1880 is considered by at least one source to be the beginning of modern foreign exchange, significant for the fact of the beginning of the gold standard during the year.
Prior to the first world war, there was a much more limited control of international trade. Motivated by the outset of war, countries abandoned the gold standard monetary system.
Modern to post-modern
From 1899 to 1913, holdings of countries' foreign exchange increased at an annual rate of 10.8%, while holdings of gold increased at an annual rate of 6.3% between 1903 and 1913.
At the time of the closing of the year 1913, nearly half of the world's foreign exchange was conducted using the Pound sterling. The number of foreign banks operating within the boundaries of London increased from 3 in 1860 to 71 in 1913. In 1902, there were altogether two London foreign exchange brokers. During the earliest years of the 20th century, trade was most active in Paris, New York and Berlin, while Britain remained largely uninvolved in trade until 1914. Between 1919 and 1922, the employment of foreign exchange brokers within London increased to 17, in 1924 there were 40 firms operating for the purposes of exchange. During the 1920s, the occurrence of trade in London resembled more the modern manifestation, by 1928 forex trade was integral to the financial functioning of the city. Continental exchange controls, plus other factors, in Europe and Latin America, hampered any attempt at wholesale prosperity from trade for those of 1930's London.
During the 1920s, the Kleinwort family were known to be the leaders of the foreign exchange market; while Japheth, Montagu & Co., and Seligman still warrant recognition as significant FX traders.
After WWII, the Bretton Woods Accord was signed allowing currencies to fluctuate within a range of 1% to the currencies par. In Japan, the law was changed during 1954 by the Foreign Exchange Bank Law, so, the Bank of Tokyo was to become, because of this, the centre of foreign exchange by September of that year. Between 1954 and 1959 Japanese law was made to allow the inclusion of many more Occidental currencies in Japanese forex.
- A user's guide to the Triennial Central Bank Survey of foreign exchange market activity, Bank for International Settlements
- London Foreign Exchange Committee with links (on right) to committees in NY, Tokyo, Canada, Australia, HK, Singapore
- United States Federal Reserve daily update of exchange rates
- Bank of Canada historical (10-year) currency converter and data download
- OECD Exchange rate statistics (monthly averages)
- National Futures Association (2010). Trading in the Retail Off-Exchange Foreign Currency Market. Chicago, Illinois.
- Record, Neil, Currency Overlay (Wiley Finance Series)
- The Economist – Guide to the Financial Markets (pdf)
- Global imbalances and destabilizing speculation (2007), UNCTAD Trade and development report 2007 (Chapter 1B).
- "Press release: Triennial Central Bank Survey of foreign exchange turnover in April 2013 - preliminary results released by the BIS". bis.org.
- "Report on global foreign exchange market activity in 2013" (PDF). Triennial Central Bank Survey.
- "What is Foreign Exchange?". Published by the International Business Times AU. Retrieved: 11 February 2011.
- CR Geisst – Encyclopedia of American Business History Infobase Publishing, 1 January 2009 Retrieved 14 July 2012 ISBN 1438109873
- GW Bromiley – International Standard Bible Encyclopedia: A–D Wm. B. Eerdmans Publishing, 13 February 1995 Retrieved 14 July 2012 ISBN 0802837816
- T Crump – The Phenomenon of Money (Routledge Revivals) Taylor & Francis US, 14 January 2011 Retrieved 14 July 2012 ISBN 0415611873
- J Hasebroek – Trade and Politics in Ancient Greece Biblo & Tannen Publishers, 1 March 1933 Retrieved 14 July 2012 ISBN 0819601500
- S von Reden (2007 Senior Lecturer in Ancient History and Classics at the University of Bristol, UK) - Money in Ptolemaic Egypt: From the Macedonian Conquest to the End of the Third Century BC (p.48) Cambridge University Press, 6 December 2007 ISBN 0521852641 [Retrieved 25 March 2015](ed. daing of papyri - c.f.46)
- Mark Cartwright. "Trade in Ancient Greece". Ancient History Encyclopedia.
- RC Smith, I Walter, G DeLong – Global Banking Oxford University Press, 17 January 2012 Retrieved 13 July 2012 ISBN 0195335937
- (tertiary) – G Vasari – The Lives of the Artists Retrieved 13 July 2012 ISBN 019283410X
- (page 130 of ) RA De Roover – The Rise and Decline of the Medici Bank: 1397-1494 Beard Books, 1999 Retrieved 14 July 2012 ISBN 1893122328
- RA De Roover – The Medici Bank: its organization, management, operations and decline New York University Press, 1948 Retrieved 14 July 2012
- Cambridge dictionaries online – "nostro account"
- Oxford dictionaries online – "nostro account"
- S Homer, Richard E Sylla A History of Interest Rates John Wiley & Sons, 29 August 2005 Retrieved 14 July 2012 ISBN 0471732834
- T Southcliffe Ashton – An Economic History of England: The 18th Century, Volume 3 Taylor & Francis, 1955 Retrieved 13 July 2012
- (page 196 of) JW Markham A Financial History of the United States, Volumes 1–2 M.E. Sharpe, 2002 Retrieved 14 July 2012 ISBN 0765607301
- (page 847) of M Pohl, European Association for Banking History – Handbook on the History of European Banks Edward Elgar Publishing, 1994 Retrieved 14 July 2012
- (secondary) –  Retrieved 13 July 2012
- S Shamah – A Foreign Exchange Primer ["1880" is within 1.2 Value Terms] John Wiley & Sons, 22 November 2011 Retrieved 27 July 2102 ISBN 1119994896
- T Hong – Foreign Exchange Control in China: First Edition (Asia Business Law Series Volume 4) Kluwer Law International, 2004 ISBN 9041124268 Retrieved 12 January 2013
- P Mathias, S Pollard – The Cambridge Economic History of Europe: The industrial economies : the development of economic and social policies Cambridge University Press, 1989 Retrieved 13 July 2012 ISBN 0521225043
- S Misra, PK Yadav  – International Business: Text And Cases PHI Learning Pvt. Ltd. 2009 Retrieved 27 July 2012 ISBN 8120336526
- P. L. Cottrell – Centres and Peripheries in Banking: The Historical Development of Financial Markets Ashgate Publishing, Ltd., 2007 Retrieved 13 July 2012 ISBN 0754661210
- P. L. Cottrell (p.75)
- J Atkin – The Foreign Exchange Market Of London: Development Since 1900 Psychology Press, 2005 Retrieved 13 July 2012 ISBN 041534901X
- J Wake – Kleinwort, Benson: The History of Two Families in Banking Oxford University Press, 27 February 1997 Retrieved 13 July 2012 ISBN 0198282990
- Laurence S. Copeland – Exchange Rates and International Finance Pearson Education, 2008 Retrieved 15 July 2012 ISBN 0273710273
- M Sumiya – A History of Japanese Trade and Industry Policy Oxford University Press, 2000 Retrieved 13 July 2012 ISBN 0198292511
- RC Smith, I Walter, G DeLong (p.4)
- AH Meltzer – A History of the Federal Reserve, Volume 2, Book 1; Books 1951–1969 University of Chicago Press, 1 February 2010 Retrieved 14 July 2012 ISBN 0226520013
- (page 7 "fixed exchange rates" of) DF DeRosa –Options on Foreign Exchange Retrieved 15 July 2012
- K Butcher – Forex Made Simple: A Beginner's Guide to Foreign Exchange Success John Wiley and Sons, 18 February 2011 Retrieved 13 July 2012 ISBN 0730375250
- J Madura – International Financial Management Cengage Learning, 12 October 2011 Retrieved 14 July 2012 ISBN 0538482966
- N DraKoln – Forex for Small Speculators Enlightened Financial Press, 1 April 2004 Retrieved 13 July 2012 ISBN 0966624580
- (SFO Magazine, RR Wasendorf, Jr.) (INT) – Forex Trading PA Rosenstreich – The Evolution of FX and Emerging Markets Traders Press, 30 June 2009 Retrieved 13 July 2012 ISBN 1934354104
- J Jagerson, SW Hansen – All About Forex Trading McGraw-Hill Professional, 17 June 2011 Retrieved 13 July 2012 ISBN 007176822X
- Franz Pick Pick's currency yearbook 1977 – Retrieved 15 July 2012
- →Swobodapage 70 of
- G Gandolfo – International Finance and Open-Economy Macroeconomics Springer, 2002 Retrieved 15 July 2012 ISBN 3540434593
- City of London: The History Random House, 31 December 2011 Retrieved 15 July 2012 ISBN 1448114721
- C Robles – How To Profit From The Falling Dollar AuthorHouse, 2007 Retrieved 15 July 2012 ISBN 1434311023
- "Thursday was aborted by news of a record assault on the dollar that forced the closing of most foreign exchange markets." in The outlook: Volume 45, published by Standard and Poor's Corporation – 1972 – Retrieved 15 July 2012 → 
- H Giersch, K-H Paqué, H Schmieding – The Fading Miracle: Four Decades of Market Economy in Germany Cambridge University Press, 10 November 1994 Retrieved 15 July 2012 ISBN 0521358698
- International Center for Monetary and Banking Studies, AK Swoboda – Capital Movements and Their Control: Proceedings of the Second Conference of the International Center for Monetary and Banking Studies BRILL, 1976 Retrieved 15 July 2012 ISBN 902860295X
- ( -p. 332 of ) MR Brawley – Power, Money, And Trade: Decisions That Shape Global Economic Relations University of Toronto Press, 2005 Retrieved 15 July 2012 ISBN 1551116839
- "... forced to close for several days in mid-1972, ... The foreign exchange markets were closed again on two occasions at the beginning of 1973,.. " in H-J Rüstow New paths to full employment: the failure of orthodox economic theory Macmillan, 1991 Retrieved 15 July 2012 → 
- J Chen – Essentials of Foreign Exchange Trading John Wiley & Sons, 9 March 2009 Retrieved 13 July 2012 ISBN 0470390867
- (page 1 of) A Hicks – Managing Currency Risk Using Foreign Exchange Options Woodhead Publishing, 2000 Retrieved 14 July 2012 ISBN 1855734915
- (secondary) -GG Johnson Formulation of Exchange Rate Policies in Adjustment Programs International Monetary Fund, 15 August 1985 Retrieved 14 July 2012 ISBN 0939934507
- JA Dorn – China in the New Millennium: Market Reforms and Social Development Cato Institute, 1998 Retrieved 14 July 2012 ISBN 1882577612
- B Laurens, H Mehran, M Quintyn, T Nordman – Monetary and Exchange System Reforms in China: An Experiment in Gradualism International Monetary Fund, 26 September 1996 Retrieved 14 July 2012 ISBN 1452766126
- Y-I Chung – South Korea in the Fast Lane: Economic Development and Capital Formation Oxford University Press, 20 July 2007 Retrieved 14 July 2012 ISBN 0195325451
- KM Dominguez, JA Frankel – Does Foreign Exchange Intervention Work? Peterson Institute, 1993 Retrieved 14 July 2012 ISBN 0881321044
- (page 211 – [source BIS 2007]) H Van Den Berg – International Finance and Open-Economy Macroeconomics: Theory, History, and Policy World Scientific, 31 August 2010 Retrieved 14 July 2012 ISBN 9814293512
- PJ Quirk Issues in International Exchange and Payments Systems International Monetary Fund, 13 April 1995 Retrieved 14 July 2012 ISBN 1557754802
- BIS Triennial Central Bank Survey - Foreign exchange and derivatives market activity in April 2010, published in September 2010.
- "Singapore Overtakes Japan as Asia’s Top Foreign-Exchange Hub". Bloomberg. 6 September 2013.
- "Derivatives in emerging markets", the Bank for International Settlements, 13 December 2010
- "The $4 trillion question: what explains FX growth since the 2007 survey?, the Bank for International Settlements, 13 December 2010
- Source: Euromoney FX survey 2015 results revealed 
- Gabriele Galati, Michael Melvin (December 2004). "Why has FX trading surged? Explaining the 2004 triennial survey" (PDF).
- Alan Greenspan, The Roots of the Mortgage Crisis: Bubbles cannot be safely defused by monetary policy before the speculative fever breaks on its own. , the Wall Street Journal, 12 December 2007
- McKay, Peter A. (26 July 2005). "Scammers Operating on Periphery Of CFTC's Domain Lure Little Guy With Fantastic Promises of Profits".
- Egan, Jack (19 June 2005). "Check the Currency Risk. Then Multiply by 100".
- The Sunday Times (London), 16 July 2006
- Andy Kollmorgen. "Overseas money transfers". choice.com.au.
- "World’s Most Traded Currencies By Value 2012". investopedia.com. Retrieved 10 June 2013.
- The total sum is 200% because each currency trade always involves a currency pair.
- The Microstructure Approach to Exchange Rates, Richard Lyons, MIT Press (pdf chapter 1)
- "To What Extent Does Productivity Drive the Dollar?". ssrn.com.
- "Safe Haven Currency". Financial Glossary (Reuters). Retrieved 22 April 2013.
- John J. Murphy, Technical Analysis of the Financial Markets (New York Institute of Finance, 1999), pp. 343–375.
- Sam Y. Cross, All About the Foreign Exchange Market in the United States, Federal Reserve Bank of New York (1998), chapter 11, pp. 113–115.
- Michael A. S. Guth, "Profitable Destabilizing Speculation," Chapter 1 in Michael A. S. Guth, Speculative behavior and the operation of competitive markets under uncertainty, Avebury Ashgate Publishing, Aldorshot, England (1994), ISBN 1-85628-985-0.
- What I Learned at the World Economic Crisis Joseph Stiglitz, The New Republic, 17 April 2000, reprinted at GlobalPolicy.org
- Summers LH and Summers VP (1989) 'When financial markets work too well: a Cautious case for a securities transaction tax' Journal of financial services
- "Anatomy of the Forex Market". Pepperstone. Retrieved 22 April 2013.
- Redburn, Tom (17 September 1992). "But Don't Rush Out to Buy Kronor: Sweden's 500% Gamble". The New York Times. Retrieved 18 April 2015.
- Gregory J. Millman, Around the World on a Trillion Dollars a Day, Bantam Press, New York, 1995.
- "Risk Averse".
- Moon, Angela (5 February 2010). "Global markets – US stocks rebound, dollar gains on risk aversion".
- Stewart, Heather (9 April 2008). "'"IMF says US crisis is 'largest financial shock since Great Depression.
Forex trade alerts, often referred to as "forex signals", are trade strategies provided by either experienced traders or market analysts. These signals which are often charged a premium fee for can then be copied or replicated by a trader to his own live account. Forex signal products are packaged as either alerts delivered to a user's inbox or SMS, or can be installed to a trader's trading platforms. Algorithmic trading, whereby foreign exchange users can programme (or buy ready made software) to place trades on their behalf, according to pre-determined rules has become very popular in recent years. This means that users can set their 'Algos' to trade on their behalf, thus reducing the need to sit and monitor the markets continuously, plus it can remove the element of human emotion around executing a trade.
Currency carry trade refers to the act of borrowing one currency that has a low interest rate in order to purchase another with a higher interest rate. A large difference in rates can be highly profitable for the trader, especially if high leverage is used. However, with all levered investments this is a double edged sword, and large exchange rate price fluctuations can suddenly swing trades into huge losses.
In the context of the foreign exchange market, traders liquidate their positions in various currencies to take up positions in safe-haven currencies, such as the US dollar. Sometimes, the choice of a safe haven currency is more of a choice based on prevailing sentiments rather than one of economic statistics. An example would be the Financial Crisis of 2008. The value of equities across the world fell while the US dollar strengthened (see Fig.1). This happened despite the strong focus of the crisis in the USA.
Risk aversion is a kind of trading behavior exhibited by the foreign exchange market when a potentially adverse event happens which may affect market conditions. This behavior is caused when risk averse traders liquidate their positions in risky assets and shift the funds to less risky assets due to uncertainty.
In this view, countries may develop unsustainable financial bubbles or otherwise mishandle their national economies, and foreign exchange speculators made the inevitable collapse happen sooner. A relatively quick collapse might even be preferable to continued economic mishandling, followed by an eventual, larger, collapse. Mahathir Mohamad and other critics of speculation are viewed as trying to deflect the blame from themselves for having caused the unsustainable economic conditions.
Gregory Millman reports on an opposing view, comparing speculators to "vigilantes" who simply help "enforce" international agreements and anticipate the effects of basic economic "laws" in order to profit.
Currency speculation is considered a highly suspect activity in many countries. While investment in traditional financial instruments like bonds or stocks often is considered to contribute positively to economic growth by providing capital, currency speculation does not; according to this view, it is simply George Soros and other speculators.
Large hedge funds and other well capitalized "position traders" are the main professional speculators. According to some economists, individual traders could act as "noise traders" and have a more destabilizing role than larger and better informed actors. Also to be considered is the rise in foreign exchange autotrading; algorithmic, or automated, trading has increased from 2% in 2004 up to 45% in 2010.
Controversy about currency speculators and their effect on currency devaluations and national economies recurs regularly. Economists, such as Milton Friedman, have argued that speculators ultimately are a stabilizing influence on the market, and that stabilizing speculation performs the important function of providing a market for hedgers and transferring risk from those people who don't wish to bear it, to those who do. Other economists, such as Joseph Stiglitz, consider this argument to be based more on politics and a free market philosophy than on economics.
A foreign exchange option (commonly shortened to just FX option) is a derivative where the owner has the right but not the obligation to exchange money denominated in one currency into another currency at a pre-agreed exchange rate on a specified date. The FX options market is the deepest, largest and most liquid market for options of any kind in the world.
Currency futures contracts are contracts specifying a standard volume of a particular currency to be exchanged on a specific settlement date. Thus the currency futures contracts are similar to forward contracts in terms of their obligation, but differ from forward contracts in the way they are traded. They are commonly used by MNCs to hedge their currency positions. In addition they are traded by speculators who hope to capitalize on their expectations of exchange rate movements.
Futures are standardized forward contracts and are usually traded on an exchange created for this purpose. The average contract length is roughly 3 months. Futures contracts are usually inclusive of any interest amounts.
The most common type of forward transaction is the foreign exchange swap. In a swap, two parties exchange currencies for a certain length of time and agree to reverse the transaction at a later date. These are not standardized contracts and are not traded through an exchange. A deposit is often required in order to hold the position open until the transaction is completed.
One way to deal with the foreign exchange risk is to engage in a forward transaction. In this transaction, money does not actually change hands until some agreed upon future date. A buyer and seller agree on an exchange rate for any date in the future, and the transaction occurs on that date, regardless of what the market rates are then. The duration of the trade can be one day, a few days, months or years. Usually the date is decided by both parties. Then the forward contract is negotiated and agreed upon by both parties.
A spot transaction is a two-day delivery transaction (except in the case of trades between the US dollar, Canadian dollar, Turkish lira, euro and Russian ruble, which settle the next business day), as opposed to the futures contracts, which are usually three months. This trade represents a “direct exchange” between two currencies, has the shortest time frame, involves cash rather than a contract, and interest is not included in the agreed-upon transaction. Spot trading is one of the most common types of Forex Trading. Often, a forex broker will charge a small fee to the client to roll-over the expiring transaction into a new identical transaction for a continuum of the trade. This roll-over fee is known as the "Swap" fee.
- Flights to quality: Unsettling international events can lead to a "flight-to-quality", a type of capital flight whereby investors move their assets to a perceived "safe haven". There will be a greater demand, thus a higher price, for currencies perceived as stronger over their relatively weaker counterparts. The US dollar, Swiss franc and gold have been traditional safe havens during times of political or economic uncertainty.
- Long-term trends: Currency markets often move in visible long-term trends. Although currencies do not have an annual growing season like physical commodities, business cycles do make themselves felt. Cycle analysis looks at longer-term price trends that may rise from economic or political trends.
- "Buy the rumor, sell the fact": This market truism can apply to many currency situations. It is the tendency for the price of a currency to reflect the impact of a particular action before it occurs and, when the anticipated event comes to pass, react in exactly the opposite direction. This may also be referred to as a market being "oversold" or "overbought". To buy the rumor or sell the fact can also be an example of the cognitive bias known as anchoring, when investors focus too much on the relevance of outside events to currency prices.
- Economic numbers: While economic numbers can certainly reflect economic policy, some reports and numbers take on a talisman-like effect: the number itself becomes important to market psychology and may have an immediate impact on short-term market moves. "What to watch" can change over time. In recent years, for example, money supply, employment, trade balance figures and inflation numbers have all taken turns in the spotlight.
- Technical trading considerations: As in other markets, the accumulated price movements in a currency pair such as EUR/USD can form apparent patterns that traders may attempt to use. Many traders study price charts in order to identify such patterns.
Market psychology and trader perceptions influence the foreign exchange market in a variety of ways:
All exchange rates are susceptible to political instability and anticipations about the new ruling party. Political upheaval and instability can have a negative impact on a nation's economy. For example, destabilization of coalition governments in Pakistan and Thailand can negatively affect the value of their currencies. Similarly, in a country experiencing financial difficulties, the rise of a political faction that is perceived to be fiscally responsible can have the opposite effect. Also, events in one country in a region may spur positive/negative interest in a neighboring country and, in the process, affect its currency.
Internal, regional, and international political conditions and events can have a profound effect on currency markets.
- Economic policy comprises government fiscal policy (budget/spending practices) and monetary policy (the means by which a government's central bank influences the supply and "cost" of money, which is reflected by the level of interest rates).
- Government budget deficits or surpluses: The market usually reacts negatively to widening government budget deficits, and positively to narrowing budget deficits. The impact is reflected in the value of a country's currency.
- Balance of trade levels and trends: The trade flow between countries illustrates the demand for goods and services, which in turn indicates demand for a country's currency to conduct trade. Surpluses and deficits in trade of goods and services reflect the competitiveness of a nation's economy. For example, trade deficits may have a negative impact on a nation's currency.
- Inflation levels and trends: Typically a currency will lose value if there is a high level of inflation in the country or if inflation levels are perceived to be rising. This is because inflation erodes purchasing power, thus demand, for that particular currency. However, a currency may sometimes strengthen when inflation rises because of expectations that the central bank will raise short-term interest rates to combat rising inflation.
- Economic growth and health: Reports such as GDP, employment levels, retail sales, capacity utilization and others, detail the levels of a country's economic growth and health. Generally, the more healthy and robust a country's economy, the better its currency will perform, and the more demand for it there will be.
- Productivity of an economy: Increasing productivity in an economy should positively influence the value of its currency. Its effects are more prominent if the increase is in the traded sector.
These include: (a) economic policy, disseminated by government agencies and central banks, (b) economic conditions, generally revealed through economic reports, and other economic indicators.
Supply and demand for any given currency, and thus its value, are not influenced by any single element, but rather by several. These elements generally fall into three categories: economic factors, political conditions and market psychology.
None of the models developed so far succeed to explain exchange rates and volatility in the longer time frames. For shorter time frames (less than a few days), algorithms can be devised to predict prices. It is understood from the above models that many macroeconomic factors affect the exchange rates and in the end currency prices are a result of dual forces of demand and supply. The world's currency markets can be viewed as a huge melting pot: in a large and ever-changing mix of current events, supply and demand factors are constantly shifting, and the price of one currency in relation to another shifts accordingly. No other market encompasses (and distills) as much of what is going on in the world at any given time as foreign exchange.
- International parity conditions: Relative purchasing power parity, interest rate parity, Domestic Fisher effect, International Fisher effect. Though to some extent the above theories provide logical explanation for the fluctuations in exchange rates, yet these theories falter as they are based on challengeable assumptions [e.g., free flow of goods, services and capital] which seldom hold true in the real world.
- Balance of payments model: This model, however, focuses largely on tradable goods and services, ignoring the increasing role of global capital flows. It failed to provide any explanation for continuous appreciation of dollar during the 1980s and most part of the 1990s in face of soaring US current account deficit.
- Asset market model: views currencies as an important asset class for constructing investment portfolios. Assets prices are influenced mostly by people's willingness to hold the existing quantities of assets, which in turn depends on their expectations on the future worth of these assets. The asset market model of exchange rate determination states that “the exchange rate between two currencies represents the price that just balances the relative supplies of, and demand for, assets denominated in those currencies.”
Determinants of exchange rates
Trading in the euro has grown considerably since the currency's creation in January 1999, and how long the foreign exchange market will remain dollar-centered is open to debate. Until recently, trading the euro versus a non-European currency ZZZ would have usually involved two trades: EURUSD and USDZZZ. The exception to this is EURJPY, which is an established traded currency pair in the interbank spot market.
and the US currency was involved in 87.0% of transactions, followed by the euro (33.4%), the yen (23.0%), and sterling (11.8%) (see table). Volume percentages for all individual currencies should add up to 200%, as each transaction involves two currencies.
- EURUSD: 24.1%
- USDJPY: 18.3%
- GBPUSD (also called cable): 8.8%
On the spot market, according to the 2013 Triennial Survey, the most heavily traded bilateral currency pairs were:
The factors affecting XXX will affect both XXXYYY and XXXZZZ. This causes positive currency correlation between XXXYYY and XXXZZZ.
Currencies are traded against one another in pairs. Each currency pair thus constitutes an individual trading product and is traditionally noted XXXYYY or XXX/YYY, where XXX and YYY are the ISO 4217 international three-letter code of the currencies involved. The first currency (XXX) is the base currency that is quoted relative to the second currency (YYY), called the counter currency (or quote currency). For instance, the quotation EURUSD (EUR/USD) 1.5465 is the price of the Euro expressed in US dollars, meaning 1 euro = 1.5465 dollars. The market convention is to quote most exchange rates against the USD with the US dollar as the base currency (e.g. USDJPY, USDCAD, USDCHF). The exceptions are the British pound (GBP), Australian dollar (AUD), the New Zealand dollar (NZD) and the euro (EUR) where the USD is the counter currency (e.g. GBPUSD, AUDUSD, NZDUSD, EURUSD).
Fluctuations in exchange rates are usually caused by actual monetary flows as well as by expectations of changes in monetary flows caused by changes in gross domestic product (GDP) growth, inflation (purchasing power parity theory), interest rates (interest rate parity, Domestic Fisher effect, International Fisher effect), budget and trade deficits or surpluses, large cross-border M&A deals and other macroeconomic conditions. Major news is released publicly, often on scheduled dates, so many people have access to the same news at the same time. However, the large banks have an important advantage; they can see their customers' order flow.
The main trading centers are London and New York City, though Tokyo, Hong Kong and Singapore are all important centers as well. Banks throughout the world participate. Currency trading happens continuously throughout the day; as the Asian trading session ends, the European session begins, followed by the North American session and then back to the Asian session, excluding weekends.
There is no unified or centrally cleared market for the majority of trades, and there is very little cross-border regulation. Due to the over-the-counter (OTC) nature of currency markets, there are rather a number of interconnected marketplaces, where different currencies instruments are traded. This implies that there is not a single exchange rate but rather a number of different rates (prices), depending on what bank or market maker is trading, and where it is. In practice the rates are quite close due to arbitrage. Due to London's dominance in the market, a particular currency's quoted price is usually the London market price. Major trading exchanges include Electronic Broking Services (EBS) and Thomson Reuters Dealing, while major banks also offer trading systems. A joint venture of the Chicago Mercantile Exchange and Reuters, called Fxmarketspace opened in 2007 and aspired but failed to the role of a central market clearing mechanism.
ISO 4217 code
% daily share
|United States dollar||
|New Zealand dollar||
|Hong Kong dollar||
|South Korean won||
|South African rand||
Bureaux de change or currency transfer companies provide low value foreign exchange services for travelers. These are typically located at airports and stations or at tourist locations and allow physical notes to be exchanged from one currency to another. They access the foreign exchange markets via banks or non bank foreign exchange companies.
Money transfer companies/remittance companies perform high-volume low-value transfers generally by economic migrants back to their home country. In 2007, the Aite Group estimated that there were $369 billion of remittances (an increase of 8% on the previous year). The four largest markets (India, China, Mexico and the Philippines) receive $95 billion. The largest and best known provider is Western Union with 345,000 agents globally followed by UAE Exchange.
Money transfer/remittance companies and bureaux de change
It is estimated that in the UK, 14% of currency transfers/payments are made via Foreign Exchange Companies. These companies' selling point is usually that they will offer better exchange rates or cheaper payments than the customer's bank. These companies differ from Money Transfer/Remittance Companies in that they generally offer higher-value services.
Non-bank foreign exchange companies offer currency exchange and international payments to private individuals and companies. These are also known as foreign exchange brokers but are distinct in that they do not offer speculative trading but rather currency exchange with payments (i.e., there is usually a physical delivery of currency to a bank account).
Non-bank foreign exchange companies
There are two main types of retail FX 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 FX market, by seeking the best price in the market for a retail order and dealing 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, by contrast, typically act as principal in the transaction versus the retail customer, and quote a price they are willing to deal at.
Individual retail speculative traders constitute a growing segment of this market with the advent of retail foreign exchange trading, both in size and importance. Currently, they participate indirectly through brokers or banks. Retail brokers, while largely controlled and regulated in the USA by the Commodity Futures Trading Commission and National Futures Association, have in the past been subjected to periodic foreign exchange fraud. To deal with the issue, in 2010 the NFA required its members that deal in the Forex markets to register as such (I.e., Forex CTA instead of a CTA). Those NFA members that would traditionally be subject to minimum net capital requirements, FCMs and IBs, are subject to greater minimum net capital requirements if they deal in Forex. A number of the foreign exchange brokers operate from the UK under Financial Services Authority regulations where foreign exchange trading using margin is part of the wider over-the-counter derivatives trading industry that includes Contract for differences and financial spread betting.
Retail foreign exchange traders
Some investment management firms also have more speculative specialist currency overlay operations, which manage clients' currency exposures with the aim of generating profits as well as limiting risk. While the number of this type of specialist firms is quite small, many have a large value of assets under management and, hence, can generate large trades.
Investment management firms (who typically manage large accounts on behalf of customers such as pension funds and endowments) use the foreign exchange market to facilitate transactions in foreign securities. For example, an investment manager bearing an international equity portfolio needs to purchase and sell several pairs of foreign currencies to pay for foreign securities purchases.
Investment management firms
About 70% to 90% of the foreign exchange transactions conducted are speculative. This means the person or institution that bought or sold the currency has no plan to actually take delivery of the currency in the end; rather, they were solely speculating on the movement of that particular currency. Since 1996, hedge funds have gained a reputation for aggressive currency speculation. They control billions of dollars of equity and may borrow billions more, and thus may overwhelm intervention by central banks to support almost any currency, if the economic fundamentals are in the hedge funds' favor.
Hedge funds as speculators
The mere expectation or rumor of a central bank foreign exchange intervention might be enough to stabilize a currency, but aggressive intervention might be used several times each year in countries with a dirty float currency regime. Central banks do not always achieve their objectives. The combined resources of the market can easily overwhelm any central bank. Several scenarios of this nature were seen in the 1992–93 European Exchange Rate Mechanism collapse, and in more recent times in Asia.
Foreign exchange fixing is the daily monetary exchange rate fixed by the national bank of each country. The idea is that central banks use the fixing time and exchange rate to evaluate behavior of their currency. Fixing exchange rates reflects the real value of equilibrium in the market. Banks, dealers and traders use fixing rates as a trend indicator.
Foreign exchange fixing
National central banks play an important role in the foreign exchange markets. They try to control the money supply, inflation, and/or interest rates and often have official or unofficial target rates for their currencies. They can use their often substantial foreign exchange reserves to stabilize the market. Nevertheless, the effectiveness of central bank "stabilizing speculation" is doubtful because central banks do not go bankrupt if they make large losses, like other traders would, and there is no convincing evidence that they do make a profit trading.
An important part of the foreign exchange market comes from the financial activities of companies seeking foreign exchange to pay for goods or services. Commercial companies often trade fairly small amounts compared to those of banks or speculators, and their trades often have little short-term impact on market rates. Nevertheless, trade flows are an important factor in the long-term direction of a currency's exchange rate. Some multinational corporations (MNCs) can have an unpredictable impact when very large positions are covered due to exposures that are not widely known by other market participants.
Unlike a stock market, the foreign exchange market is divided into levels of access. At the top is the interbank market, which is made up of the largest commercial banks and securities dealers. Within the interbank market, spreads, which are the difference between the bid and ask prices, are razor sharp and not known to players outside the inner circle. The difference between the bid and ask prices widens (for example from 0 to 1 pip to 1–2 pips for currencies such as the EUR) as you go down the levels of access. This is due to volume. If a trader can guarantee large numbers of transactions for large amounts, they can demand a smaller difference between the bid and ask price, which is referred to as a better spread. The levels of access that make up the foreign exchange market are determined by the size of the "line" (the amount of money with which they are trading). The top-tier interbank market accounts for 39% of all transactions. From there, smaller banks, followed by large multi-national corporations (which need to hedge risk and pay employees in different countries), large hedge funds, and even some of the retail market makers. According to Galati and Melvin, “Pension funds, insurance companies, mutual funds, and other institutional investors have played an increasingly important role in financial markets in general, and in FX markets in particular, since the early 2000s.” (2004) In addition, he notes, “Hedge funds have grown markedly over the 2001–2004 period in terms of both number and overall size”. Central banks also participate in the foreign exchange market to align currencies to their economic needs.
|3||Barclays Investment Bank||8.11%|
|6||Bank of America Merrill Lynch||6.22%|
|10||Royal Bank of Scotland||3.38%|
Foreign exchange is an over-the-counter market where brokers/dealers negotiate directly with one another, so there is no central exchange or clearing house. The biggest geographic trading center is the United Kingdom, primarily London, which according to TheCityUK estimates has increased its share of global turnover in traditional transactions from 34.6% in April 2007 to 36.7% in April 2010. Due to London's dominance in the market, a particular currency's quoted price is usually the London market price. For instance, when the International Monetary Fund calculates the value of its special drawing rights every day, they use the London market prices at noon that day.
Foreign exchange trading increased by 20% between April 2007 and April 2010 and has more than doubled since 2004. The increase in turnover is due to a number of factors: the growing importance of foreign exchange as an asset class, the increased trading activity of high-frequency traders, and the emergence of retail investors as an important market segment. The growth of electronic execution and the diverse selection of execution venues has lowered transaction costs, increased market liquidity, and attracted greater participation from many customer types. In particular, electronic trading via online portals has made it easier for retail traders to trade in the foreign exchange market. By 2010, retail trading is estimated to account for up to 10% of spot turnover, or $150 billion per day (see below: Retail foreign exchange traders).
Most developed countries permit the trading of derivative products (like futures and options on futures) on their exchanges. All these developed countries already have fully convertible capital accounts. Some governments of emerging markets do not allow foreign exchange derivative products on their exchanges because they have capital controls. The use of derivatives is growing in many emerging economies. Countries such as South Korea, South Africa, and India have established currency futures exchanges, despite having some capital controls.
Turnover of exchange-traded foreign exchange futures and options have grown rapidly in recent years, reaching $166 billion in April 2010 (double the turnover recorded in April 2007). Exchange-traded currency derivatives represent 4% of OTC foreign exchange turnover. Foreign exchange futures contracts were introduced in 1972 at the Chicago Mercantile Exchange and are actively traded relative to most other futures contracts.
In April 2013, for the first time, Singapore surpassed Japan in average daily foreign-exchange trading volume with $383 billion per day. So the rank became: the United Kingdom (41%), the United States (19%), Singapore (5.7)%, Japan (5.6%) and Hong Kong (4.1%).
In April 2010, trading in the United Kingdom accounted for 36.7% of the total, making it by far the most important centre for foreign exchange trading. Trading in the United States accounted for 17.9% and Japan accounted for 6.2%.
The foreign exchange market is the most liquid financial market in the world. Traders include large banks, central banks, institutional investors, currency speculators, corporations, governments, other financial institutions, and retail investors. The average daily turnover in the global foreign exchange and related markets is continuously growing. According to the 2010 Triennial Central Bank Survey, coordinated by the Bank for International Settlements, average daily turnover was US$3.98 trillion in April 2010 (vs $1.7 trillion in 1998). Of this $3.98 trillion, $1.5 trillion was spot transactions and $2.5 trillion was traded in outright forwards, swaps and other derivatives.
Market size and liquidity
During 1991, Iran changed international agreements with some countries from oil-barter to foreign exchange.
Intervention by European banks especially the Bundesbank influenced the forex market, on 27 February 1985 particularly. The greatest proportion of all trades world-wide during 1987 were within the United Kingdom, slightly over one quarter, with the United States being the nation with the second most places involved in trading.
On 1 January 1981, as part of changes beginning during 1978, the People's Bank of China allowed certain domestic "enterprises" to participate in foreign exchange trading. Sometime during 1981, the South Korean government ended forex controls and allowed free trade to occur for the first time. During 1988 the countries government accepted the IMF quota for international trade.
The year 1973 marks the point to which nation-state, banking trade and controlled foreign exchange ended and complete floating, relatively free conditions of a market characteristic of the situation in contemporary times began (according to one source), although another states the first time a currency pair were given as an option for U.S.A. traders to purchase was during 1982, with additional currencies available by the next year.
Due to the ultimate ineffectiveness of the Bretton Woods Accord and the European Joint Float the forex markets were forced to close sometime during 1972 and March 1973. The very largest of all purchases of dollars in the history of 1976 was when the West German government achieved an almost 3 billion dollar acquisition (a figure given as 2.75 billion in total by The Statesman: Volume 18 1974), this event indicated the impossibility of the balancing of exchange stabilities by the measures of control used at the time and the monetary system and the foreign exchange markets in "West" Germany and other countries within Europe closed for two weeks (during February and, or, March 1973. Giersch, Paqué, & Schmieding state closed after purchase of "7.5 million Dmarks" Brawley states "... Exchange markets had to be closed. When they re-opened ... March 1 " that is a large purchase occurred after the close).
Reuters introduced computer monitors during June 1973, replacing the telephones and telex used previously for trading quotes.
 during February–March 1973) some of the markets' were "split", so a two tier currency market was subsequently introduced, with dual currency rates. This was abolished during March 1974.Gandolfo At some time (according to  During 1970 to 1973 the amount of trades occurring in the market increased three-fold.