What is Forex Trading ? – An Introduction to the World of Currency Trading

The foreign exchange market assists international trade and investment by enabling currency conversion. For example, it permits a business in the United States to import goods from the European Union member states especially Euro zone members and pay Euros, even though its income is in United States dollars. It also supports direct speculation in the value of currencies, and the carry trade, speculation based on the interest rate differential between two currencies. In a typical foreign exchange transaction, a party purchases some quantity of one currency by paying some quantity of another currency.

It involves transactions in which one party purchases a quantity of one currency by paying in a quantity of another currency. The Forex market is a global decentralized financial market for the exchange of currencies. Around the world various financial centers act as hubs for trading between a wide range of different types of buyers and sellers 24 hours a day, except weekends. It is the foreign exchange market that determines the value of one country’s currency relative to another.

Why this technique is used and for what ?

The primary reason the Forex market exists is to facilitate international trade and investment by giving businesses the ability to convert one currency into another. As an example, a U.S. business can import goods from Japan and pay in Japanese Yen, even though the business is based in America and operates in U.S. dollars. The Forex market also provides a medium for speculation which works to add deeper liquidity to the market, making exchange rates less volatile. The “carry-trade” is facilitated via the Forex market, this is a trade in which investors can buy high-yielding currencies against low-yielding currencies and profit from the higher yielding interest rate.

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 20:15 GMT on Sunday until 22:00 GMT Friday;
• 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.

What Benefits it provides to Traders ?

There is no unified or centrally cleared market for the majority of trades, and there is very little cross-border regulation. Due to the over-the-counter (OTC) nature of currency markets, there are rather a number of interconnected marketplaces, where different currencies instruments are traded. This implies that there is not a single exchange rate but rather a number of different rates (prices), depending on what bank or market maker is trading, and where it is. In practice the rates are quite close due to arbitrage. Due to London's dominance in the market, a particular currency's quoted price is usually the London market price. Major trading exchanges include EBS and Reuters, while major banks also offer trading systems. A joint venture of the Chicago Mercantile Exchange and Reuters, called Fx market space opened in 2007 and aspired but failed to the role of a central market clearing mechanism. The main trading centres are New York and London, though Tokyo, Hong Kong and Singapore are all important centres as well. Banks throughout the world participate. Currency trading happens continuously throughout the day; as the Asian trading session ends, the European session begins, followed by the North American session and then back to the Asian session, excluding weekends.

Some of the many benefits of trading the Forex market include the following:

• Trading can be done from anywhere in the world with only an internet connection and a computer needed.

• Huge trading volume, this leads to dense liquidity making it easier to get in and out of positions at the price you want.

• Flexible trading hours; continuous operation 24 hours a day 5.5 days a week.

• Greater availability of leverage to enhance profit margins relative to account size than compare to other markets.

• Fewer variables to consider as compared to stock or commodity trading.

• No inherent market bias like the bullish bias stocks, this means greater opportunities to profit from the volatility in both rising and falling markets.

• Ease of accessibility and low start-up costs.

Advantages like the ones listed above and others are the reason why the Forex market has been referred to as the market closest to the ideal of “perfect competition”. According to the Bank for International Settlements, average daily turnover in global foreign exchange markets is estimated at $3.98 trillion, as of April 2010 a growth of approximately 20% over the $3.21 trillion daily volume recorded in April 2007.

Top 10 currency traders % of overall volume, May 2012
Rank	Name	Market share
1	Deutsche Bank	14.57%
2	Citi	12.26%
3	Barclay's Investment Bank	10.95%
4	UBS AG	10.48%
5	HSBC	6.72%
6	JP Morgan	6.6%
7	Royal Bank of Scotland	5.86%
8	Credit Suisse	4.68%
9	Morgan Stanley	3.52%
10	Goldman Sachs	3.12%

This chart is taken from google and it shows the Top 10 currencies for currency traders to deal in as on May 2012. Deutsche bank is on the top of the list and Goldman Sachs holds 10th position but it hardly matters for middle level traders to know all the details about this but normally it shows good result.

Who Trades Forex?

• Large banks, central banks, and other financial institutions.
• Governments
• Currency speculators / Retail traders / brokers
• Institutional investors
• Corporations involved internationally
• Travelers / Tourists

Individual persons invest in this and earns according to their knowledge they have and can get more and more benefits according to their holdings and investment they have.

Most traded Forex pairs ?

These pairs are:

USD/CAD	EUR/JPY
EUR/USD	EUR/CHF
USD/CHF	EUR/GBP
GBP/USD	AUD/CAD
NZD/USD	GBP/CHF
AUD/USD	GBP/JPY
USD/JPY	CHF/JPY
EUR/CAD	AUD/JPY
EUR/AUD	AUD/NZD

The total amount of currency trading involving these 18 pairs represents the majority of the trading volume in the FX market. This manageable number of choices makes trading a lot less complicated compared to dealing with equities, which has thousands of possible choices to choose from. 

Most Traded currencies are ?

On the spot market, according to the 2010 Triennial Survey, the most heavily traded bilateral currency pairs were:

EURUSD: 28%

USDJPY: 14%

GBPUSD (also called cable): 9%

and the US currency was involved in 84.9% of transactions, followed by the euro (39.1%), the yen (19.0%), and sterling (12.9%) (see table). Volume percentages for all individual currencies should add up to 200%, as each transaction involves two currencies.

How Exchange Rates are Determined ?

• • Economic factors – These include: economic policy made by government agencies and central banks, and economic conditions as described by and through economic reports as well as various economic indicators.
• • Political conditions – International, national, and regional political conditions and events can have a large impact on the Forex currency markets.
• • Market Psychology – The psychology of market participants can influence the foreign exchange market in numerous ways. Ultimately all economic variables are expressed through the filter of the human brain / trader psychology
• • Trading Algorithms – Electronic trading based on algorithms (or computer / robot trading) is become more and more popular, as a result algorithmic trading is starting to have a large effect on Forex currency rates.

• International parity conditions: Relative Purchasing Power Parity, interest rate parity, Domestic Fisher effect, International Fisher effect. Though to some extent the above theories provide logical explanation for the fluctuations in exchange rates, yet these theories falter as they are based on challengeable assumptions [e.g., free flow of goods, services and capital] which seldom hold true in the real world.
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• Balance of payments model (see exchange rate): This model, however, focuses largely on tradable goods and services, ignoring the increasing role of global capital flows. It failed to provide any explanation for continuous appreciation of dollar during 1980s and most part of 1990s in face of soaring US current account deficit.
• Asset market model (see exchange rate): views currencies as an important asset class for constructing investment portfolios. Assets prices are influenced mostly by people's willingness to hold the existing quantities of assets, which in turn depends on their expectations on the future worth of these assets. The asset market model of exchange rate determination states that “the exchange rate between two currencies represents the price that just balances the relative supplies of, and demand for, assets denominated in those currencies.”

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