If you’ve ever gone on holiday and exchanged say, pounds for euros, then you’ve participated in the forex market.
Forex, also known as foreign exchange, FX or the currency market, is the largest financial market in the world. On average over $5 trillion worth of transactions take place every day. That’s around 100 times more than the New York Stock Exchange (NYSE) – the world’s biggest stock exchange.
As well as being traded by individuals and businesses, Forex is also important for financial institutions, central banks, and governments. It facilitates international trade and investment by allowing companies that earn money in one currency to pay for goods and services in another.
Who trades currency markets?
Currency markets are important to a broad range of participants, from banks, brokers, hedge funds and investor traders who trade FX. Any company that operates or has customers overseas will need to trade currency.Central banks can also be active in currency markets, as they seek to keep the currency they are responsible for trading within a specific range.
What moves currency markets?
Economic data
This particularly affects critical areas of a country’s economy like inflation, unemployment numbers, foreign trade or payrolls.
Central banks
They can have a big influence over the performance of currencies, for example by changing interest rates or printing more money. Central banks can also buy and sell their own currency in order to keep it trading within a certain level.
Political factors
Increasingly, political uncertainty can drive currency markets. For example, the Swiss Franc has traditionally been seen as a safe haven currency. Something such as a speech by a finance minister can have a big impact on a currency.
Why do people trade forex?
Individuals and businesses participate in the forex market for two main reasons:
Speculation
The vast majority of forex transactions are made simply to make money. This means the person or institution making the trade has no plans to take delivery of the currency, they are just looking to turn a profit on movements in the market.
With major financial institutions always looking to profit from small changes in forex prices, many large trades can occur throughout the day. This activity means currency rates are some of the most consistently volatile financial markets in the world – which in turn provides more opportunity for traders to make money.
Purchasing goods or services in another currency
Every time a transaction is made between two entities in different regions, a foreign exchange transaction needs to take place to pay for the goods or services exchanged. Transactions such as this happen globally, every second of every day.
Despite the number of transactions, the amount of currency traded is often very small compared to trades made by large speculators. Therefore commercial trading tends not to have such a big effect on short-term market rates.