The foreign exchange market (forex, FX, or currency market) is a global decentralized market for the trading of currencies.
This includes all aspects of buying, selling and exchanging currencies
at current or determined prices. 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 does not determine
the relative values of different currencies, but sets the current market
price of the value of one currency as demanded against another.
The foreign exchange market works through financial institutions,
and it operates on several levels. Behind the scenes banks turn to a
smaller number of financial firms 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 financial firms 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 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 differential between two currencies.[2]
In a typical foreign exchange transaction, a party purchases some
quantity of one currency by paying with 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
financial relations among the world's major industrial states after World War II), when countries gradually switched to floating exchange rates from the previous exchange rate regime, which remained fixed as per the Bretton Woods system.
The foreign exchange market is unique because of the following characteristics:
- its huge trading volume representing the largest asset 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 variety of factors that affect exchange rates;
- the low margins of relative profit compared with other markets of fixed income; and
- the use of leverage to enhance profit 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,[3]
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,[4] 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 firms specializing on foreign exchange market had put
the average daily turnover in excess of US$4 trillion.[5] 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
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