The Foreign Exchange Market

The foreign exchange (currency or forex or FX) is by far the largest financial market in the world, and includes trading between large banks, central banks, currency speculators, multinational corporations, governments, and other financial markets and institutions. The average daily trade in the global forex markets currently exceeds US$ 2 trillion.

Market size and liquidity

The foreign exchange market is unique because of:

•    Its trading volume
•    The extreme liquidity of the market
•    The large number of, and variety of, traders in the market
•    Its geographical dispersion
•    Its long trading hours - 24 hours a day (except on weekends)
•    The variety of factors that affect exchange rates

The forex market can be traded in one of two ways:

1.    At a retail brokerage firm that offers spot currency trading.

2.    On an exchange that offers currency futures and options products such as the Chicago Mercantile Exchange (CME) or the Philadelphia Stock Exchange. Some brokers offer both spot and futures trading.

How are forex rates quoted?

First, forex transactions are quoted in pairs such as EURUSD. In this example, the first half, EUR (Euro) is the “base” currency, and the second half, USD (US Dollar) is the “quote” or “counter” currency. Traders go long (buy) or go short (sell) the base currency against the quote (or counter) currency.

Second, pairs are quoted as “bid-ask” spreads or “sell-buy” quotes. In other words, a EURUSD spread of 1.3820/1.3825 offers the trader to sell a unit at 1.3820 or buy at 1.3825.

Some brokerage houses charge a commission for every trade while others widen the spread to compensate through volume.

Leverage

Spot currency trading, unlike equity trading, requires no cost for going long or short. As cash is only treated as margin to trade forex, leverage is controlled by the customer.

Leverage allows you to trade a large amount of currency for a small amount of margin (cash) requirement. The higher leverage you use, the larger your profit (or loss) will be on every incremental move by the currency pair.

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