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Foreign Exchange (Forex)
The foreign exchange (Forex or FX) market is one of the most liquid exchange markets in the world. Similarly based on buying and selling at a profit as other trading mechanisms, the FX market is one of the largest exchange markets in the world with a daily trading total of approximately $3.9 trillion (AUD). Noted as reference points, the American stock exchanges trade less than $160 billion (AUD) per day, and bond market traffic tallies slightly over $296 billion (AUD) daily.
The foreign exchange market was developed in the 1970s with the intent to encourage and assist international trade and investment. Lightly regulated, the over-the-counter (OTC) currency exchange has grown in scope and popularity primarily from the 1990s on.
Because all currency is available for OTC trading, the Forex market is global in nature. Over 5000 trading institutions around the world compose the market base. Trading brokerages, domestic national banks, and international banks monitor and trade currency 24 hours a day, Monday through Friday. There is no centralised location for the FX—no building or street address. Major trading centres, however, are Paris, Frankfort, London, Singapore, New York City, Hong Kong, and Tokyo—where the majority of Forex trading is conducted via the telephone or the Internet. However, anyone anywhere on the planet can engage in Forex trading.
Forex Cornerstone Organisations
As noted above, major traders in the foreign exchange market are generally larger financial institutions or commercial enterprises. Through brokers and brokerage houses individual investors can engage in currency trading, but bulk purchase influence is generally claimed by a core group forming the foundation of this high-volume market. Unlike stock exchanges, the Forex market is divided into levels of access. The largest group comprises the larger commercial banks and securities dealers engaging in interbank market.
Commercial banks, like private trading houses or brokerages, that trade on behalf of customers gain revenue by transaction fees, either per currency unit traded or by a set charge per transaction. In those instances the banks gain, regardless of whether their customers follow suit. Obviously, however, the banks trading offices prefer to maintain their trading customers and endeavour to keep those accounts in the black.
Additional Traditional Investors
Determining Currency Exchange Rates
Called Forex fixing, each nation's central or national bank, sets its country's exchange rate every weekday morning; that rate reflects the actual value of equilibrium of the country's currency and is often used to evaluate faith in the market. Foreign exchange traders use fixed rates as trend indicators and make investment decisions on those trends.
Several factors determine a nation's currency value. Ideally, a currency rests at its equilibrium—a stable currency balance. Every nation attempts to maintain a stable currency reserve. Those with trade deficits will spend more of its reserve to purchase needed goods and services. When the reserves drop, the currency value drops as well. Inflation rises as a result, and when inflation outstrips buying power, a country often prints more currency which may cause an additional drop in its exchange rate, however temporarily.
After an interim period expensive imports are forced to reduce which also reduces the amount of currency spent and which increases the nation's currency reserve. The country executes the import limitations in hopes of rebuilding its currency reserve, increasing its exchange value, and improving its equilibrium again.
Countries can gain what some consider an unfair advantage on the international market by deliberately undervaluing its currency. A low exchange rate reduces the cost of exports but raises the price of imports, requiring an increase in domestic spending.
All foreign exchange rates are based on two currencies—the base or home currency and the exchange currency of a different country. For example, the currency pair of American dollars to Australian dollars compose one currency pair. The Australian dollar to the Russian Ruble composes another currency pair. The British Pound and the Euro is yet another currency pair.
The difference in worth from one pair element to another composes the exchange rate between the two. On Monday, for example, the Australian dollar may be worth 1.2 American dollars or 5.6 Japanese yen, or 120 Mexican pesos. On Tuesday, the Australian dollar may be worth less or more against each other paired currency, depending on economy, interest rates, inflation, or any other aspect that influences exchange rate.
The currency pair is always rated in relation to only each other. The Australian dollar against the Japanese yen is not directly influenced by the Mexican peso against the Japanese yen.
Forex fixing by the central or national banks affect currency pairing exchanges, as noted above.
Foreign Exchange Options
A foreign exchange option is exactly that—a choice. The options holder holds the right to exchange currency at a contract rate at or by a designed time. The owner is by no means required to, however. If the option is activated, the terms have been predetermined and cannot be changed. Declining to activate the option has no directly assigned penalty.
Foreign Exchange Market Vocabulary
When researching and trading on the foreign exchange market, understanding the terminology is imperative. Some common terms and their definitions include:
Although there are several trading centres in the world, three are considered peak interest locations—Tokyo, New York City, and London.
The Forex market consistently experiences fluxes in currency values and in trading cycles. Typically, the primary flux periods are during business hours for each city, and liquidity against those currencies within that global region is greater during the peak activity times for each.
Because trading is conducted over-the-counter and around the clock, an investor may miss peak opportunities presented when not monitoring the FX market. Understanding limitations in trading times may help plot trading forecasts and strategies.
Forex Market Summary
Once basic principles and terminology are understood, practice investing and market trend observations enable quick learning and boost an investor's chances of successfully trading foreign currency. However, as with other investment tools, currency trading encompasses risk, whether investing only minimal amounts or millions of dollars.
Whether engaging in FX trading for one importation of goods transaction or as a speculative investment venture, careful consideration of timing, pricing, conditions, value, and volume all play their parts in determining whether foreign exchange trading is a viable possibility or not. It can be highly profitable, but hesitating even a moment too long can cause financial disaster if highly invested.
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