This post is part of the free Forex beginners course
The Foreign Exchange Market (also known as currency market) is a decentralized global market used for the trading and speculating of the world’s currencies. The average daily turnover in this currency market has reached over $5.3 trillion in 2014, up from $4 trillion in 2010.
The Forex market is open five (5) days a week and for twenty-four (24) hours during each of those days. New York, Hong Kong, London, Singapore, Sydney, Frankfurt, Zurich and Tokyo are the most prominent world trading centers.
Unlike the stock exchanges such as the NYSE, there is no central marketplace for the currency market. On the contrary, trading is said to be done Over-the-Counter (OTC) between parties. This means transactions are done directly between the parties without the supervision of some exchange. In the foreign exchange currency market, currencies are quoted by the major banks. It is not uncommon for these banks to have the different quotes for any particular currency. Market Maker brokers take these quotes from the banks and create approximate averages. The brokers in turn sells/buys a currency pair to you. They do not buy that pair from some other trader somewhere else in the world. The broker is basically creating the ‘market’ for you by carrying out the trade and taking the other side of it. However, since all traders using the same brokers are buying and selling, the broker essentially makes money from the spread between the bid and the ask price. (More on this in a later lesson.) Also worth nothing is that since most traders lose money, the market maker brokers wins. However, ECN brokers operate differently. They channel your order to buy/sell to their 3rd party liquidity providers and make money via commissions. (this will also be discussed in a later section)
What you will learn in this article
- The History of the Forex Market;
- Who Trades Forex and why;
- The difference between trading stocks and forex,
History of currency trading and the Forex Market
Currency exchange is not new, it actually can be traced to the money-changers who were responsible in ancient times for the trading of currency. These money-changers would charge a small fee in order to help people change their currencies. Since most of history, money was referred to as gold and silver, and consequently goldsmiths were primarily the currency exchange dealers. This was necessary back then in order to facilitate trade.
Goldsmiths were also responsible for storing people’s gold, which eventually they created deposit recipients for the gold they stored to their owners. These receipts were the early days of “paper money” or currency. Naturally, many goldsmiths became bankers due to gold being money and their ability to control gold. During a gold standard, all paper currencies are backed by a physical store of gold, and currency was pegged to the price of an ounce of gold. Currency could be converted into gold at the fixed rate. In the US during the 19th century the rate was 20.67 USD / ounce of gold. In Britain it was set at 4.3474 GBP / ounce of gold. This gold standard imposed a limit on the expansion of the money supply. Countries were restricted on how much money can be created by the amount of gold was held in reserves.
Between 1914 and 1944, countries went in and out of the gold standard and currencies were permitted to fluctuate in terms of gold and each other. During World War II most currencies suspended their convertibility into gold. This was done primarily because military spending forced a drastic increase in the printing of currencies to help pay for the war.
Then in 1944 there was an important meeting held in New Hampshire in the United States in a little resort town called Bretton Woods. This meeting was the foundation for a new global monetary system, known as the ‘Bretton Woods System’. This meeting established the IMF (International Monetary Fund) and the dollar-based international monetary system. Under this structure, the price of gold was fixed, and the U.S. agreed to buy and sell it at the established price. Other countries in turn pegged their currencies to the US Dollar (USD). By means of the USD, all currencies were pegged to gold. The ‘Bretton Woods System’ was brought to an end on August 15, 1971 when President Nixon officially suspended all purchases and sales of gold by the U.S. Treasury.
The demise of the ‘Bretton Woods System’ unofficially marked beginning of the modern foreign currency exchange market. Within a couple of years, supply and demand were controlling the exchange rate between currencies. An increase in price volatility, volume and speed all led to the deregulation of the market, new financial instruments and open trade. It wasn’t until around the mid-nineties that the Forex became widely traded electronically.
Who Trades Forex?
Although there are many people who trade Forex around the world, some do it for specific purposes while others do it for pure speculation and profit. In this blog, we teach that the Agents of the Fed are the primary market movers and the most important traders to watch for. Here is the general list of everyone in the market ranked in order of importance.
Central Banks: Central banks of nations are the pivotal player in the foreign currency exchange. In an attempt to control money supply, inflation, and interest rates, these ‘banks’ hold substantial positions in the market. A central bank’s position can cause an increase/decrease in the value of their country’s currency. The US Federal Reserve (the “Fed”) is one of the most important central banks in the world. When the chairman of the Fed speaks, watch how the market swings and changes violently based on this speech. Intervention in the Forex market by central banks are carried out to serve elite and government agendas. Such as debasing a nations currency to create inflation and boost exports at the expense of the saver. In the advanced members course we will further learn how and why central banks intervene in the market to manipulate currencies.
Banks: The top ten currency traders, as of February 2014, are large international banks. This is primarily due to the interbank market for the foreign currency exchange. Within this network, the spreads between bid and ask prices are less than it is for those further down the chain. The banks’ better spread is directly related to the large volume in which they trade. The banks can trade on behalf of clients, but most of the volume is due to trading on their own account by their own proprietary traders. The top banks around the world usually act as the trading desk for the central banks monetary polices. These are the Agents of the Fed, traders who move the market.
Hedge Funds: Usually aggressively managed investment portfolios with a goal of high returns, account for billions of dollars worth of trades daily. Their aggressiveness translates into aggressive speculative positions being taken in the market.
Commercial Companies: Companies seeking to diversify currency holdings in order to facilitate trade and pay for goods and services. In comparison to the large banks, companies trade in smaller amounts. However, large multinationals can still have a big effect on the market when large positions are taken.
Retail Traders: Individual traders (such as you and I) are a growing part of the currency exchange market. Presently, retail traders participate indirectly either through banks or brokers. Brokers and Dealers are the two main types of Forex brokers providing us with the opportunity to speculate on the market. Brokers are simply agents working on our behalf that try to find the best price for us in the market for a currency pair. In exchange for this service, they charge a small commission fee. Dealers on the other hand, create the market for us. They quote a price that they are willing to accept exchange at. Their fee is hidden in the spread between the buy and sell price of the currency pair.
Why do I Prefer the Forex Market Over Any Other Market?
- There is extreme liquidity in the currency market. With daily volumes exceeding 5 trillion dollars, getting in and out of positions is relatively easy.
- Unlike the stock markets, the Forex market is open 24 hours a day during the week. Trading starts at around 5PM EST on Sunday and ends around 4PM EST on Friday.
- It is very easily accessible. Trading can be done online through a broker with very limited initial funding, all the while enjoying high levels of leverage.
- Instead of trying to follow an immeasurable amount of stocks worldwide, there are in turn only a few currency pairs.
- With all the technology present today, trading can be done from almost anywhere in the world through the use of a laptop, a tablet or even a cellular phone.
- Generally lower transaction costs and fees than that of trading stocks and commodities.
- There is an equal opportunity for traders to profit in both rising and falling markets. The volatility of the market allows for profits to be made very readily.
While these advantages are important, it is ever more crucial to be aware of and remember the risks involved with currency trading. Your savings/investment can be lost all too quickly if you are not careful. My advice to you would be to pick a strategy and stick to it. Don’t just trade on a whim, or because you like a currency pair and because you think it will go up! Remember, with great reward comes great risk. Strategies are used to mitigate some of this risk.