The foreign exchange market is the largest and most liquid financial market in the world, representing more than $1.2 trillion worth of transactions each day. Also known as forex or FX, currency trading involves the simultaneous purchase of one currency while selling another currency. Currencies are traded in pairs, such as U.S. dollar/Japanese yen (USD/JPY) or Euro/U.S. dollar (EUR/USD).
The FX interbank market is a global network of the world’s banks with no centralized location for trading. Much of the business is conducted over the-phone or electronically bank-to-bank. The FX market is a 24-hour-per-day market during the FX business week. The day starts in Asia, extends over to Europe and then into the U.S. daytime trading hours. Currencies are traded around the world, around the clock, from Monday morning (Sunday afternoon Chicago/New York time) in New Zealand/Asia to the close of the business week on Friday afternoon in Chicago/New York.
Speculators are active in the FX markets, as they are attracted to the opportunities that volatile and changing market conditions create. A multitude of economic forces impact the world’s currencies. Some of the forces at work include interest rate differentials, domestic money supply growth, comparative rates of inflation, central bank intervention and political stability. In times of global uncertainty, some currencies may benefit from perceived “flight-to-safety” status. Or, if one country’s economic outlook is perceived as strong by market forces, its currency may be firmer than another country’s currency, where economic or political conditions are viewed with caution.
FX traders include governments, corporations and fund managers doing business with foreign countries, that need to exchange one currency for another, and speculators who seek to profit from price movements in the markets.
The highly liquid and volatile currency markets offer opportunities for speculators every day. Most speculators tend to focus on the so-called “majors,” which are the most actively traded currencies and include the U.S. dollar, the euro, the Japanese yen, the British pound, the Swiss franc, the Australian dollar and the Canadian dollar.
Spot FX transactions are usually based on currency rates quoted for two-day settlement (U.S. dollar versus Canadian dollar is traded for one-day settlement), in order to transfer currency among the counterparties on the spot or value date. On the over-the-counter (OTC) market, FX traders also determine a forward exchange rate, such as for 30, 60 or 90 days in the future. A forward FX agreement specifies a currency exchange rate used for delivery at the stated time, or value date, in the future.
An exchange rate transaction is termed a cross rate when the home country currency is not a party in the trade. For example, for a trader in the U.S., a cross rate would be euro/yen, or the euro against the Japanese yen.
