The Foreign Exchange Market: The Basics

FOREX is an abbreviation for the Foreign Exchange Market. This is a virtual market place where corporations, banks, and individuals (usually speculators) buy and sell currencies. Every company that exports or imports products participates in the forex market. The forex market is easily the world's largest market, with several trillion dollars (with a “T” or twelve zeroes) traded each day.

 The forex market is a 24-hour market. The forex market follows the sun - trading begins in Asia with the banks in New Zealand, Australia, Japan and China. Then, at the end of the Asian day, the European market begins with banks and market participants in Germany, Switzerland, Paris and England opening. This European session accounts for about half of the volume in the forex market. As the European day comes to a close, the American market begins with trading in New York and Los Angeles. The forex market begins to quiet down after the close of the New York Stock Exchange. The forex market then starts again with a “new day” in Asia. Thus, the forex market is roughly open from Sunday 5:00 pm until Friday at 5:00 pm eastern standard time in New York.

 The forex market does not have a central market location where people trade currencies face to face. Instead the forex market is made up of a network of electronic exchanges all over the world, making forex a virtual exchange similar to the NASDAQ market in the United States.

 The forex market is larger than all of the world’s stock and bond markets combined. The size and liquidity of the forex market makes this market attractive to individual speculators, hedge funds and private investment groups.

 Currencies are traded in pairs such EUR/USD (Euro against the US Dollar) or AUD/USD (Australian Dollar against the US Dollar. An example may best illustrate how currencies are traded. The current price for the EUR/USD is 1.4150. This simply means that about 1.41 US Dollars are needed to buy one Euro. Likewise, the current price for the AUD/USD is 0.8310, and this indicates that about 83 US cents will buy one Australian dollar.

 Some of the more liquid currency pairs such as the euro/U.S. dollar (EUR/USD), British pound/U.S. dollar (GBP/USD), and U.S. dollar/Japanese yen (USD/JPY) account for most of the trading activity in the forex market. These actively traded currencies tend to fluctuate at least one cent or more per day. Currencies are traded in incremental amounts equal to 1/100 of a cent; each of these units is referred to as a PIP (or “price index point“).

 There are many factors that determine fluctuations in a currency pair. It may be helpful to think of an individual currency as a “stock” of a country, and currency pairs are “stocks” that compare countries. Thus, if a country is doing well economically and politically, we might expect this currency to be strong relative to the currency of another country that has economic or political problems. Economic factors that affect a country’s currency include gross domestic product (GDP), employment rate, interest rates, inflation, and gross national product. A simple example: in Canada the current unemployment number has decreased with the creation of more jobs. Thus, we may expect to see the Canadian dollar (CAD) strengthen against other currencies from countries with relatively worse unemployment numbers.

 The forex market offers volatile 24-hour trading, exceptional leverage and liquidity. Many traders have recently looked toward this market for profits. In the future I will look at different aspects of the forex market and related investments, including getting started with forex trading, finding a forex broker, forex charts, technical analysis to trade forex, trading strategies and psychology and habits of a good trader.

Ashkan Bolour
Foreign Exchange Advisors LLC
www.thefxadvisors.com

For informational purposes only – consult your financial professional before making any investment/financial

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