Foreign exchange market

Forex redirects here. For the football club, see FC

Forex Braov. For the U.S. FBI sting operation, see
Dominic Brooklier Bompensiero murder.

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 foreign exchange market (forex, FX, or currency

market) is a global decentralized market for the trading
of currencies. In terms of volume of trading, it is by
far the largest market in the world.[1] 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 dierent currencies.[2] The foreign exchange market works through nancial institutions, and it
operates on several levels. Behind the scenes banks turn
to a smaller number of nancial rms 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 nancial rms 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 the 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 dierential between two currencies.[3] In a typical foreign exchange transaction, a party purchases some
quantity of one currency by paying for 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 nancial
relations among the worlds major industrial states after World War II), when countries gradually switched to
oating exchange rates from the previous exchange rate
regime, which remained xed as per the Bretton Woods
system. The foreign exchange market is unique because
of the following characteristics:

the variety of factors that aect exchange rates;

the low margins of relative prot compared with
other markets of xed income; and
the use of leverage to enhance prot and loss margins and with respect to account size.
As such, it has been referred to as the market closest to the
ideal of perfect competition, notwithstanding currency
intervention by central banks. According to the Bank
for International Settlements,[4] 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,[5] 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 rms
specializing on foreign exchange market had put the average daily turnover in excess of US$4 trillion.[6] 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

1 History
1.1 Ancient

Currency trading and exchange rst occurred in ancient

its huge trading volume representing the largest asset times.[7] Money-changing people, people helping others
1

HISTORY

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
kollybists) used city-stalls, at feast times the temples
Court of the Gentiles instead.[8] Money-changers were
also in more recent ancient times silver-smiths and/or
gold-smiths.[9]

1.4 Modern to post-modern

During the fteenth century the Medici family were

required to open banks at foreign locations in order to exchange currencies to act on behalf of textile
merchants.[12][13] 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.[14][15][16][17] During the 17th (or 18th ) century
Amsterdam maintained an active forex market.[18] During 1704 foreign exchange took place between agents
acting in the interests of the nations of England and
Holland.[19]

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
signicant FX traders.[30]

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.[25]

At the time of the closing of the year 1913, nearly half

During the fourth century, the Byzantine government of the worlds foreign exchange was conducted using the
kept a monopoly on the exchange of currency.[10]
Pound sterling.[26] The number of foreign banks operCurrency and exchange was also a vital and crucial el- ating within the boundaries of London increased in the
were
ement of trade during the ancient world so that peo- years from 1860 to 1913 from 3 to 71. In 1902 there[27]
altogether
two
London
foreign
exchange
brokers.
In
ple could buy and sell items like food, pottery and raw
the
earliest
years
of
the
twentieth
century
trade
was
most
[11]
materials.
If a Greek coin held more gold than an
Egyptian coin due to its size or content, then a merchant active in Paris, New York and Berlin, while Britain recould barter fewer Greek gold coins for more Egyptian mained largely uninvolved in trade until 1914. Between
ones, or for more material goods. This is why, at some 1919 and 1922, the employment of foreign exchange browere
point in their history, most world currencies in circulation kers within London increased to 17, in 1924 there
[28]
40
rms
operating
for
the
purposes
of
exchange.
Durtoday had a value xed to a specic quantity of a recoging the 1920s the occurrence of trade in London resemnized standard like silver and gold.
bled more the modern manifestation, by 1928 forex trade
was integral to the nancial functioning of the city. Continental exchange controls, plus other factors, in Europe
and Latin America, hampered any attempt at wholesale
1.2 Medieval and later
prosperity from trade for those of 1930s London.[29]

1.3

Early modern

Alex. Brown & Sons traded foreign currencies exchange

sometime about 1850 and was a leading participant in this
within U.S.A.[20] During 1880, J.M. do Esprito Santo de
Silva (Banco Esprito Santo) applied for and was given
permission to begin to engage in a foreign exchange trading business.[21][22]
The year 1880 is considered by at least one source to be
the beginning of modern foreign exchange, signicant for
the fact of the beginning of the gold standard during the
year.[23]
Prior to the rst 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.[24]

1.4.1 After WWII

After WWII, the Bretton Woods Accord was signed allowing currencies to uctuate within a range of 1% to the
currencies par.[31] 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.[32]
U.S. President Richard Nixon is credited with ending the
Bretton Woods Accord and xed rates of exchange, eventually bringing about a free-oating currency system. After the ceasing of the enactment of the Bretton Woods
Accord during 1971,[33] the Smithsonian Agreement allowed trading to range to 2%. During 196162, the
amount of foreign operations by the U.S. Federal Reserve
was relatively low.[34][35] Those involved in controlling
exchange rates found the boundaries of the Agreement
were not realistic and so ceased this in March 1973, when
sometime afterward none of the major currencies were
maintained with a capacity for conversion to gold, organisations relied instead on reserves of currency.[36][37] During 1970 to 1973 the amount of trades occurring in the
market increased three-fold.[38][39][40] At some time (according to Gandolfo during FebruaryMarch 1973) some

3
of the markets were split, so a two tier currency market
was subsequently introduced, with dual currency rates.
This was abolished during March 1974.[41][42][43]

2 Market size and liquidity

Reuters introduced during June 1973 computer monitors, replacing the telephones and telex used previously
for trading quotes.[44]
1.4.2

Markets close

Due to the ultimate ineectiveness of the Bretton Woods

Accord and the European Joint Float the forex markets
were forced to close sometime during 1972 and March
1973.[45][46] 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 gure 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,
Paqu, & 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).[47][48][49][50]

Main foreign exchange market turnover, 19882007, measured

in billions of USD.

The foreign exchange market is the most liquid nancial

market in the world. Traders include large banks, central banks, institutional investors, currency speculators,
corporations, governments, other nancial 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).[5] Of this
$3.98 trillion, $1.5 trillion was spot transactions and $2.5
1.4.3 After 1973
trillion was traded in outright forwards, swaps and other
The year 1973 marks the point to which nation-state, derivatives.
banking trade and controlled foreign exchange ended and In April 2010, trading in the United Kingdom accounted
complete oating, relatively free conditions of a market for 36.7% of the total, making it by far the most imporcharacteristic of the situation in contemporary times be- tant centre for foreign exchange trading. Trading in the
gan (according to one source),[51] although another states United States accounted for 17.9% and Japan accounted
the rst time a currency pair were given as an option for for 6.2%.[60]
U.S.A. traders to purchase was during 1982, with addi- In April 2013, for the rst time, Singapore surpassed
tional currencies available by the next year.[52][53]
Japan in average daily foreign-exchange trading volume
On 1 January 1981, as part of changes beginning during 1978, the Peoples Bank of China allowed certain
domestic enterprises to participate in foreign exchange
trading.[54][55] Sometime during the months of 1981 the
South Korean government ended forex controls and allowed free trade to occur for the rst time. During 1988
the countries government accepted the IMF quota for international trade.[56]

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%).[61]

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
Intervention by European banks especially the exchange futures contracts were introduced in 1972 at the
Bundesbank inuenced the forex market, on February Chicago Mercantile Exchange and are actively traded relthe 27th 1985 particularly.[57] The greatest proportion ative to most other futures contracts.
of all trades world-wide during 1987 were within the Most developed countries permit the trading of derivaUnited Kingdom, slightly over one quarter, with the tive products (like futures and options on futures) on their
U.S. of America the nation with the second most places exchanges. All these developed countries already have
involved in trading.[58]
fully convertible capital accounts. Some governments
During 1991 the republic of Iran changed international of emerging economies do not allow foreign exchange
agreements with some countries from oil-barter to foreign derivative products on their exchanges because they have
capital controls. The use of derivatives is growing in
exchange.[59]

3 MARKET PARTICIPANTS

many emerging economies.[62] Countries such as Korea, tions (which need to hedge risk and pay employees in difSouth Africa, and India have established currency futures ferent countries), large hedge funds, and even some of the
exchanges, despite having some capital controls.
retail market makers. According to Galati and Melvin,
Foreign exchange trading increased by 20% between Pension funds, insurance companies, mutual funds, and
April 2007 and April 2010 and has more than doubled other institutional investors have played an increasingly
since 2004.[63] The increase in turnover is due to a num- important role in nancial markets in general, and in FX
ber of factors: the growing importance of foreign ex- markets in particular, since the early 2000s. (2004) In
change as an asset class, the increased trading activity addition, he notes, Hedge funds have grown markedly
over the 20012004 period in terms of both number and
of high-frequency traders, and the emergence of retail
[65]
investors as an important market segment. The growth overall size. Central banks also participate in the foreign exchange market to align currencies to their ecoof electronic execution and the diverse selection of execution venues has lowered transaction costs, increased nomic needs.
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).

3.1 Commercial companies

An important part of the foreign exchange market comes
from the nancial 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
ows are an important factor in the long-term direction
of a currencys 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.

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 Londons dominance in the market,
a particular currencys quoted price is usually the London
market price. For instance, when the International Mone- 3.2 Central banks
tary Fund calculates the value of its special drawing rights
every day, they use the London market prices at noon that National central banks play an important role in the foreign exchange markets. They try to control the money
day.
supply, ination, and/or interest rates and often have ofcial or unocial target rates for their currencies. They
can use their often substantial foreign exchange reserves
to stabilize the market. Nevertheless, the eectiveness
3 Market participants
of central bank stabilizing speculation is doubtful because central banks do not go bankrupt if they make large
See also: Forex scandal
losses, like other traders would, and there is no convincing evidence that they do make a prot trading.
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 3.3 Foreign exchange xing
and securities dealers. Within the interbank market,
spreads, which are the dierence between the bid and ask Foreign exchange xing is the daily monetary exchange
prices, are razor sharp and not known to players outside rate xed by the national bank of each country. The idea
the inner circle. The dierence between the bid and ask is that central banks use the xing time and exchange rate
prices widens (for example from 0 to 1 pip to 12 pips for to evaluate behavior of their currency. Fixing exchange
a currencies such as the EUR) as you go down the levels rates reects the real value of equilibrium in the market.
of access. This is due to volume. If a trader can guaran- Banks, dealers and traders use xing rates as a trend intee large numbers of transactions for large amounts, they dicator.
can demand a smaller dierence between the bid and ask The mere expectation or rumor of a central bank foreign
price, which is referred to as a better spread. The levels of exchange intervention might be enough to stabilize a curaccess that make up the foreign exchange market are de- rency, but aggressive intervention might be used several
termined by the size of the line (the amount of money times each year in countries with a dirty oat currency
with which they are trading). The top-tier interbank mar- regime. Central banks do not always achieve their obket accounts for 39% of all transactions.[60] From there, jectives. The combined resources of the market can eassmaller banks, followed by large multi-national corpora- ily overwhelm any central bank.[66] Several scenarios of

3.7

Non-bank foreign exchange companies

this nature were seen in the 199293 European Exchange that includes Contract for dierences and nancial spread
Rate Mechanism collapse, and in more recent times in betting.
Asia.
There are two main types of retail FX brokers oering
the opportunity for speculative currency trading: brokers
and dealers or market makers. Brokers serve as an agent
3.4 Hedge funds as speculators
of the customer in the broader FX market, by seeking the
best price in the market for a retail order and dealing on
About 70% to 90% of the foreign exchange transactions behalf of the retail customer. They charge a commission
conducted are speculative. This means the person or in- or mark-up in addition to the price obtained in the marstitution that bought or sold the currency has no plan to ket. Dealers or market makers, by contrast, typically act
actually take delivery of the currency in the end; rather, as principal in the transaction versus the retail customer,
they were solely speculating on the movement of that par- and quote a price they are willing to deal at.
ticular currency. Since 1996, Hedge funds have gained a
reputation for aggressive currency speculation. They control billions of dollars of equity and may borrow billions 3.7 Non-bank foreign exchange companies
more, and thus may overwhelm intervention by central
banks to support almost any currency, if the economic Non-bank foreign exchange companies oer currency exfundamentals are in the hedge funds favor.
change and international payments to private individuals and companies. These are also known as foreign exchange brokers but are distinct in that they do not of3.5 Investment management rms
fer speculative trading but rather currency exchange with
payments (i.e., there is usually a physical delivery of curInvestment management rms (who typically manage rency to a bank account).
large accounts on behalf of customers such as pension
It is estimated that in the UK, 14% of currency
funds and endowments) use the foreign exchange market
transfers/payments[69] are made via Foreign Exchange
to facilitate transactions in foreign securities. For examCompanies. These companies selling point is usually
ple, an investment manager bearing an international eqthat they will oer better exchange rates or cheaper payuity portfolio needs to purchase and sell several pairs of
ments than the customers bank.[70] These companies difforeign currencies to pay for foreign securities purchases.
fer from Money Transfer/Remittance Companies in that
Some investment management rms also have more spec- they generally oer higher-value services.
ulative specialist currency overlay operations, which manage clients currency exposures with the aim of generating
prots as well as limiting risk. While the number of this 3.8 Money transfer/remittance companies
type of specialist rms is quite small, many have a large
and bureaux de change
value of assets under management and, hence, can generate large trades.
Money transfer companies/remittance companies perform high-volume low-value transfers generally by economic migrants back to their home country. In 2007,
3.6 Retail foreign exchange traders
the Aite Group estimated that there were $369 billion
of remittances (an increase of 8% on the previous year).
Individual retail speculative traders constitute a growing The four largest markets (India, China, Mexico and the
segment of this market with the advent of retail foreign Philippines) receive $95 billion. The largest and best
exchange trading, both in size and importance. Currently, known provider is Western Union with 345,000 agents
they participate indirectly through brokers or banks. Re- globally followed by UAE Exchange
tail brokers, while largely controlled and regulated in the
Bureaux de change or currency transfer companies proUSA by the Commodity Futures Trading Commission
vide low value foreign exchange services for travelers.
and National Futures Association, have in the past been
These are typically located at airports and stations or at
[67][68]
To
subjected to periodic foreign exchange fraud.
tourist locations and allow physical notes to be exchanged
deal with the issue, in 2010 the NFA required its memfrom one currency to another. They access the foreign exbers that deal in the Forex markets to register as such (I.e.,
change markets via banks or non bank foreign exchange
Forex CTA instead of a CTA). Those NFA members that
companies.
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 4 Trading characteristics
the UK under Financial Services Authority regulations
where foreign exchange trading using margin is part of There is no unied or centrally cleared market for the
the wider over-the-counter derivatives trading industry majority of trades, and there is very little cross-border

6
regulation. Due to the over-the-counter (OTC) nature
of currency markets, there are rather a number of interconnected marketplaces, where dierent currencies
instruments are traded. This implies that there is not
a single exchange rate but rather a number of dierent
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 Londons dominance in the
market, a particular currencys quoted price is usually the
London market price. Major trading exchanges include
Electronic Broking Services (EBS) and Thomson Reuters
Dealing, while major banks also oer 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.
The main trading centers are New York City and London,
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.

DETERMINANTS OF EXCHANGE RATES

vey, the most heavily traded bilateral currency pairs were:

EURUSD: 24.1%
USDJPY: 18.3%
GBPUSD (also called cable): 8.8%
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.
Trading in the euro has grown considerably since the currencys 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 nonEuropean 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. As the dollars value has
eroded during 2008, interest in using the euro as reference currency for prices in commodities (such as oil), as
well as a larger component of foreign reserves by banks,
has increased dramatically. Transactions in the currencies of commodity-producing countries, such as AUD,
NZD, CAD, have also increased.

Fluctuations in exchange rates are usually caused by actual monetary ows as well as by expectations of changes
in monetary ows caused by changes in gross domestic
product (GDP) growth, ination (purchasing power parity theory), interest rates (interest rate parity, Domestic
Fisher eect, International Fisher eect), budget and
5 Determinants of exchange rates
trade decits or surpluses, large cross-border M&A deals
and other macroeconomic conditions. Major news is released publicly, often on scheduled dates, so many people Main article: Exchange rate
have access to the same news at the same time. However,
the large banks have an important advantage; they can see The following theories explain the uctuations in extheir customers order ow.
change rates in a oating exchange rate regime (In a xed
Currencies are traded against one another in pairs. Each exchange rate regime, rates are decided by its governcurrency pair thus constitutes an individual trading prod- ment):
uct and is traditionally noted XXXYYY or XXX/YYY,
1. International parity conditions: Relative purchasing
where XXX and YYY are the ISO 4217 international
power parity, interest rate parity, Domestic Fisher
three-letter code of the currencies involved. The rst cureect, International Fisher eect. Though to some
rency (XXX) is the base currency that is quoted relative to
extent the above theories provide logical explanathe second currency (YYY), called the counter currency
tion for the uctuations in exchange rates, yet these
(or quote currency). For instance, the quotation EURUSD
theories falter as they are based on challengeable as(EUR/USD) 1.5465 is the price of the Euro expressed in
sumptions [e.g., free ow of goods, services and capUS dollars, meaning 1 euro = 1.5465 dollars. The marital] which seldom hold true in the real world.
ket convention is to quote most exchange rates against
the USD with the US dollar as the base currency (e.g.
2. Balance of payments model: This model, however,
USDJPY, USDCAD, USDCHF). The exceptions are the
focuses largely on tradable goods and services, igBritish pound (GBP), Australian dollar (AUD), the New
noring the increasing role of global capital ows. It
Zealand dollar (NZD) and the euro (EUR) where the
failed to provide any explanation for continuous apUSD is the counter currency (e.g. GBPUSD, AUDUSD,
preciation of dollar during the 1980s and most part
NZDUSD, EURUSD).
of the 1990s in face of soaring US current account
The factors aecting XXX will aect both XXXYYY
decit.
and XXXZZZ. This causes positive currency correlation
3. Asset market model: views currencies as an imporbetween XXXYYY and XXXZZZ.
tant asset class for constructing investment portfoOn the spot market, according to the 2013 Triennial Surlios. Assets prices are inuenced mostly by peoples

5.2

Political conditions

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.

Ination levels and trends: Typically a currency

will lose value if there is a high level of ination in the country or if ination levels are perceived to be rising. This is because ination erodes
purchasing power, thus demand, for that particular currency. However, a currency may sometimes
strengthen when ination rises because of expectations that the central bank will raise short-term interest rates to combat rising ination.

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 aect
the exchange rates and in the end currency prices are a
result of dual forces of demand and supply. The worlds
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.[73]

Economic growth and health: Reports such as GDP,

employment levels, retail sales, capacity utilization
and others, detail the levels of a countrys economic
growth and health. Generally, the more healthy and
robust a countrys 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 inuence the value
of its currency. Its eects are more prominent if the
increase is in the traded sector.[74]

5.2 Political conditions

Supply and demand for any given currency, and thus its
value, are not inuenced by any single element, but rather Internal, regional, and international political conditions
by several. These elements generally fall into three cate- and events can have a profound eect on currency margories: economic factors, political conditions and market kets.
psychology.
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 na5.1 Economic factors
tions economy. For example, destabilization of coalition
These include: (a) economic policy, disseminated by gov- governments in Pakistan and Thailand can negatively afernment agencies and central banks, (b) economic condi- fect the value of their currencies. Similarly, in a country
tions, generally revealed through economic reports, and experiencing nancial diculties, the rise of a political
faction that is perceived to be scally responsible can have
other economic indicators.
the opposite eect. Also, events in one country in a region may spur positive/negative interest in a neighboring
Economic policy comprises government scal pol- country and, in the process, aect its currency.
icy (budget/spending practices) and monetary policy (the means by which a governments central bank
inuences the supply and cost of money, which is 5.3 Market psychology
reected by the level of interest rates).
Market psychology and trader perceptions inuence the
Government budget decits or surpluses: The mar- foreign exchange market in a variety of ways:
ket usually reacts negatively to widening government
budget decits, and positively to narrowing budget
Flights to quality: Unsettling international events
decits. The impact is reected in the value of a
can lead to a "ight-to-quality", a type of capital
countrys currency.
ight whereby investors move their assets to a per Balance of trade levels and trends: The trade ow
between countries illustrates the demand for goods
and services, which in turn indicates demand for a
countrys currency to conduct trade. Surpluses and
decits in trade of goods and services reect the
competitiveness of a nations economy. For example, trade decits may have a negative impact on a
nations currency.

ceived "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.[75]
Long-term trends: Currency markets often move in
visible long-term trends. Although currencies do not

FINANCIAL INSTRUMENTS

have an annual growing season like physical com- 6.2 Forward

modities, business cycles do make themselves felt.
Cycle analysis looks at longer-term price trends that See also: Forward contract
may rise from economic or political trends.[76]
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 reect 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.[77] 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 reect economic policy, some reports and
numbers take on a talisman-like eect: 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 gures and ination numbers
have all taken turns in the spotlight.

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.

6.3 Swap
Main article: Foreign exchange swap
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.

Technical trading considerations: As in other mar6.4 Futures

kets, the accumulated price movements in a currency pair such as EUR/USD can form apparent
Main article: Currency future
patterns that traders may attempt to use. Many
traders study price charts in order to identify such
Futures are standardized forward contracts and are usupatterns.[78]
ally 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.

Financial instruments

Currency futures contracts are contracts specifying a

standard volume of a particular currency to be exchanged
on a specic settlement date. Thus the currency futures
6.1 Spot
contracts are similar to forward contracts in terms of their
obligation, but dier from forward contracts in the way
Main article: Foreign exchange spot
they are traded. They are commonly used by MNCs to
hedge their currency positions. In addition they are traded
A spot transaction is a two-day delivery transaction (ex- by speculators who hope to capitalize on their expectacept in the case of trades between the US dollar, Canadian tions of exchange rate movements.
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 repre- 6.5 Option
sents a direct exchange between two currencies, has the
shortest time frame, involves cash rather than a contract, Main article: Foreign exchange option
and interest is not included in the agreed-upon transaction. Spot trading is one of the most common types of A foreign exchange option (commonly shortened to just
Forex Trading. Often, a forex broker will charge a small FX option) is a derivative where the owner has the right
fee to the client to roll-over the expiring transaction into but not the obligation to exchange money denominated
a new identical transaction for a continuum of the trade. in one currency into another currency at a pre-agreed exchange rate on a specied date. The FX options market
This roll-over fee is known as the Swap fee.

9
is the deepest, largest and most liquid market for options
of any kind in the world.

8 Risk aversion
See also: Safe-haven currency
Risk aversion is a kind of trading behavior exhibited by

Speculation

Controversy about currency speculators and their eect

on currency devaluations and national economies recurs
regularly. Nevertheless, economists including Milton
Friedman have argued that speculators ultimately are a
stabilizing inuence on the market and perform 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.[79] Other economists, such as Joseph
Stiglitz, consider this argument to be based more on politics and a free market philosophy than on economics.[80]

Fig.1 Chart showing MSCI World Index of Equities fell while the
US dollar Index rose.

the foreign exchange market when a potentially adverse

event happens which may aect market conditions. This
behavior is caused when risk averse traders liquidate their
positions in risky assets and shift the funds to less risky
[85]
Large hedge funds and other well capitalized position assets due to uncertainty.
traders are the main professional speculators. According In the context of the foreign exchange market, traders liqto some economists, individual traders could act as "noise uidate their positions in various currencies to take up potraders" and have a more destabilizing role than larger sitions in safe-haven currencies, such as the US dollar.[86]
and better informed actors.[81] Also to be considered is Sometimes, the choice of a safe haven currency is more of
the rise in foreign exchange autotrading; algorithmic, or a choice based on prevailing sentiments rather than one of
automated, trading has increased from 2% in 2004 up to economic statistics. An example would be the Financial
45% in 2010.[82]
Crisis of 2008. The value of equities across the world fell
Currency speculation is considered a highly suspect ac- while the US dollar strengthened (see Fig.1). This hap[87]
tivity in many countries. While investment in traditional pened despite the strong focus of the crisis in the USA.
nancial instruments like bonds or stocks often is considered to contribute positively to economic growth by providing capital, currency speculation does not; according 9 Carry trade
to this view, it is simply gambling that often interferes
with economic policy. For example, in 1992, currency Main article: Carry trade
speculation forced the Central Bank of Sweden to raise
interest rates for a few days to 500% per annum, and later
to devalue the krona.[83] Mahathir Mohamad, one of the Currency carry trade refers to the act of borrowing one
former Prime Ministers of Malaysia, is one well-known currency that has a low interest rate in order to purchase
proponent of this view. He blamed the devaluation of another with a higher interest rate. A large dierence
the Malaysian ringgit in 1997 on George Soros and other in rates can be highly protable for the trader, especially
if high leverage is used. However, with all levered inspeculators.
vestments this is a double edged sword, and large exGregory Millman reports on an opposing view, compar- change rate uctuations can suddenly swing trades into
ing speculators to vigilantes who simply help enforce huge losses.
international agreements and anticipate the eects of basic economic laws in order to prot.[84]
In this view, countries may develop unsustainable nancial 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 deect the blame from themselves for
having caused the unsustainable economic conditions.

10 Forex signals
Main article: Forex signal
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

10

12

trader to his own live account. Forex signal products are

packaged as either alerts delivered to a users inbox or
SMS, or can be installed to a traders 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.

11

See also

12

References

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13

EXTERNAL LINKS

13 External links
Frankel, Jerey A. (2008). Foreign Exchange.
In David R. Henderson (ed.). Concise Encyclopedia of Economics (2nd ed.). Indianapolis: Library
of Economics and Liberty. ISBN 978-0865976658.
OCLC 237794267.
A users 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 O-Exchange Foreign Currency Market.
Chicago, Illinois.

13

14
14.1

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Text

Foreign exchange market Source: http://en.wikipedia.org/wiki/Foreign%20exchange%20market?oldid=640474250 Contributors: The

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