Foreign Exchange Market

A market is a place where people buy and sell goods and similarly the foreign exchange market is a place the currency of different countries are bought and sold. Due to the nature of this market it is classified as a financial market that is big in terms of the size of sales and purchase. Also in economic terms it is a good example for a market with perfect competition. The foreign exchange market includes traders who deal in speculation of currencies, banks commercial and the central bank, companies who are multinational, the government of the country and many other finance related organizations. There are some of the characteristics of this market that gives it a unique identity compared to the other financial markets in the world.

The main distinguishing characteristic is the large sales and purchase volumes which can go beyond billions. Another feature of the market is the fact that the market is working round the clock. The reason for this is so that they make it convenient for the traders all over the world. Other characteristics include the diversity of the market in relation to the differences in the geographical boundaries. It is this characteristic that encourages people from all parts of the world can take part in the trading activities. This factor is also encouraged by the advantage of using the internet in the trading and that is what invites people from all over.

Another main feature is the liquidity feature of the market and he reason is quite obvious because it involves the exchange of currencies of all the countries in the world. Also the innumerable varieties and the number of traders in the foreign exchange market make it unique. Another feature of the foreign exchange market is that there is no one single or particular place where trade happens and where the exchange of the currency happens. The entire trade happens in a policy called “Over the counter”. The arena is highly volatile and at the same time versatile. Now the trade takes place the world over, with fresh entrants and older players rubbing shoulders for maximum profitability. Online resources dedicated to the endeavor offer free tips and suggestions to help you grope with changing market times.

Functioning of the foreign exchange market

The price at which the currency is traded depends greatly on the type of exchange and the type of instrument that is being traded. Therefore is one type of instrument is being exchanged then the rates would differ completely if another type of instrument is being traded. Also the rates differ if a particular instrument is being bought rather than when it is being sold. There are some currencies that are traded more than the others and some of the more popular ones include USD or United States Dollar, BGBP or British Pound Sterling, EUR or Eurozone Euro, JPY or Japanese Yen and CHF or Swiss Franc. The rates of the currency are mentioned always in comparison to another currency. This comparison is usually done with another currency that is traded either in equal or more volumes and also a currency that is more constant and stable. One example is the rates of the Indian Rupee that is compared to the US dollar.

Factors that cause the rates to fluctuate

The main factor that causes changes in the rates of the currencies is the demand for and supply of the currency in the foreign exchange market. Though this is the main factor that causes the change there are other factors like the political and economic situations in the economy. If the political condition of the economy is stable then it will definitely improve the rates of the currency of the currency. If the economy is growing and there is considerable development in the economy then the currency is definitely going to be on a rise. By the economic condition it means that there are no budget deficits and the balance of trade is in surplus.

Other factors that can also influence the currency rates are the price levels of the goods and services in the economy that is termed as the inflation rates. Another factor that also affects the foreign exchange rates is the expectations and the hopes that are prevalent in the foreign exchange market. It is also affected by the vulnerability that exists in the market. If the market is prone to be influenced by rumors and expectations then there can be a lot of volatility in the market. Nevertheless, the foreign exchange marketplace is a highly competent arena. It is now home to some of the biggest players who study the market and even guide the newcomers in the field. There is a study involved and a very scientific approach in special situations, like inflation, economic recession and boom-time.

Today, the foreign exchange business is being run in real time as well as online. This has brought together investors from different parts of the world on a single international rostrum. However, like in the case of any undertaking, it is imperative to study the market and understand its implications prior to making investment. In the stock market every trader is classified in the same manner. However in the foreign exchange market there is there are different levels at which the market functions. There is the higher level which includes the large commercial banks and the dealers of security. This level is called the inter-bank market. What happens within this level is classified information and therefore information from this level is not passed on to the other levels. The crucial information includes price differenced between the bidding and the asking prices.

According to the change in the trading volumes of the currencies the difference between the bidding and asking price will increase. If the dealer bidding the price is capable of bringing in a greater number of trading opportunities then a small amount of difference between the two prices can be asked for. This small difference is termed as a better spread. The total amount of money that is being traded is a major factor that determines the level of accessing the foreign exchange market.

Components of the Foreign exchange market

More than half of all the buying and selling in the market is accounted for by the top level or the inter-bank transactions. It is only after this that the other small banks come. After the banks come the MNCs or the Multi National Corporations that are large in size. These organizations have to make payments to employees who are in different countries and therefore need hedge risk. Then you have the large hedge funds and at times even the Foreign exchange markets related to the metal markets that function only on a retail basis. People like Galati and Melwin are of the opinion that since the 2000s areas like the insurance companies, funds for pension and mutual funds are being stronger and are having a bigger say in the foreign exchange market. He has also stated that in terms of the number of trades and the amount of sales the hedge funds are raising beyond everyone’s expectations since the year 2001.

Players in the foreign exchange market

The banks are major players in the foreign exchange market with the maximum turnover and large amount of trade in the market on a daily basis. In fact there is billions of dollars worth of trading that is conducted by some of the banks and that too on a daily basis. A major part of this is done for the customers who trade with the help of these banks and the other part consists of the trading done by the bank itself. Though most of the business is conducted with the help of the internet and other electronic medium however till a little before it used to be done in exchange for a small fees and there were brokers who made it possible. These days the traders have access to the trade that is happening in the interbank trade and it is available in the rooms for trading. But the effect is that the volume of the sales has reduced.

After the banks comes the commercial companies which need the foreign exchange to help them trade in goods and services. Apart from the fact the volume of trade is much less compared to the banks the trade also only lasts for a short period of time. However trade in foreign currency is still a very important factor for these companies. Next are the central or the national banks of a country. They need to trade in the foreign exchange market because the responsibility of maintaining the flow of money on the economy rest son them. They also need to keep a tab on the inflation and the interest rates prevalent in the economy.

Sometimes they need not actually enter the market or intervene, even if there is a rumor that they will intervene the market just seems to fall in place and there will be stability in the market. Apart from all the mentioned players in the foreign exchange market there is also the speculators who only buy the currencies but do not take its delivery because their intention is to sell it immediately when the price is right. These are called hedge fund speculators. Their method of trading is based on aggression and they also deal in billions of dollars by borrowing the sum from banks. Then the rest of the traders comprise of firms that deal with investment management and brokers dealing in foreign exchange on a retail basis.

The foreign exchange market is no different from any other business arena. It is just as challenging, if not more, and just as case sensitive. In reality there is no particular organization that has a control over the functions of the foreign exchange markets. Though the trade happens between countries there is no particular market that regulates the functioning of the foreign exchange market. The usual procedure for trading is OTC or over the counter, and therefore the trading of currencies happen in different markets all over the world as they are all connected to one another.

This means that there could be different rates that are prevailing in the market depending on the financial instrument that is being traded and the place in which it is being traded in. Though the rates are not fixed in all places they are usually pretty close to each other and this helps to prevent people who would try to arbitrate. Most of the time certain current rates are quoted according to the price of the London market and this is because London happens to be dominating the market.

Important foreign exchange centers

Though London is the dominating center, there are also players like Tokyo, New York, Singapore and Hong Kong are centers that are equally important. However even though these are the important centers banks all over the world are a part of the trading. Since trading happens all over the word there is trading happening at all times of the days. If trading stops in one place it runs into another place due to the difference in time and therefore there is no time of he day when there is no trading of foreign exchange happening. It therefore happens round the clock.

Factors leading to trade and investment

Most of the times the rates of the currencies, being traded, depends on the buying and the selling of a particular currency. The more the buying happens the more the rates increase and vice versa. It also depends on the psychological factor that plays on the minds of the traders. If there is an expectation of a good and favorable market condition then the rates will simply shoot up and if there is an expectation of fall in interest rates or a rise in inflation rates then the rates are bound to drop and the sales are bound to increase. The main factors that affect the rates are the Gross Domestic Product of the economy, the budget deficiency and surpluses.

People base their decision on the reports that are published for the benefit of all the people and based on that they decide whether to buy or sell a particular currency. However the banks have the facility of understanding the markets on a first hand basis because they can keep a tab on the inflows and outflows of the orders placed by the customers. Since one currency is traded in pairs the demand for one affects the rates of the other. There is something called the on the spot market and in this market the trade happens for a very short period of time. The major trading currencies in this market is Euro and US dollar which above 25 % of the trade, then comes the US dollar and Japanese yen and this constitutes almost 13 %.

The total volume if totaled will be 200 % and this is because it is the total of trade of twp currencies. There has been an increase in the trade of Euro from the time it was created but the foreign exchange market is still centered on the US dollar. Till the very recent times when Euro had to be exchanged for any other currency then it has to be first exchanged against the US dollar and then it had to be exchanged against that particular currency. But this has changed and modified because now a direct exchange between US dollar and Japanese Yen is possible. This pair of US dollar and JPY is now recognized by the spot market in interbank transactions.

After the fall in demand of the US dollar in the foreign exchange market people are now interested in getting their currencies exchanged against Euro instead of the US dollar. Along with the demand for Euro increasing there is also an increase in demand for other currencies around the world like the Australian dollar, Canadian dollar and the New Zealand dollar. Today, there are a number of online as well as real time resources that help you to understand and invest in the foreign exchange market. They make available all the tools you need to remain buoyant in this otherwise turbulent market as well as help you hone the acquired skills. It pays to research and bit and become adept at terminology and technique and then jump into the fray.