Foreign exchange market

The foreign exchange market is unique because of

* its trading volume,
* the extreme liquidity of the market,
* the large number of, and variety of, traders in the market,
* its geographical dispersion,
* its long trading hours: 24 hours a day (except on weekends),
* the variety of factors that affect exchange rates.
* the low margins of profit compared with other markets of fixed income (but profits can be

high due to very large trading volumes)

According to the BIS,[1] average daily turnover in traditional foreign exchange markets is estimated

at $3,210 billion. Daily averages in April for different years, in billions of US dollars, are presented

on the chart below:

This $1.88 trillion in global foreign exchange market "traditional" turnover was broken down as

follows:

* $1,005 billion in spot transactions
* $362 billion in outright forwards
* $1,714 billion in forex swaps
* $129 billion estimated gaps in reporting

In addition to "traditional" turnover, $2.1 trillion was traded in derivatives.

Exchange-traded forex futures contracts were introduced in 1972 at the Chicago Mercantile

Exchange and are actively traded relative to most other futures contracts. Forex futures volume has

grown rapidly in recent years, and accounts for about 7% of the total foreign exchange market

volume, according to The Wall Street Journal Europe (5/5/06, p. 20).

Average daily global turnover in traditional foreign exchange market transactions totaled $2.7

trillion in April 2006 according to IFSL estimates based on semi-annual London, New York, Tokyo

and Singapore Foreign Exchange Committee data. Overall turnover, including non-traditional

foreign exchange derivatives and products traded on exchanges, averaged around $2.9 trillion a

day. This was more than ten times the size of the combined daily turnover on all the world’s equity

markets. Foreign exchange trading increased by 38% between April 2005 and April 2006 and has

more than doubled since 2001. This is largely due to the growing importance of foreign exchange

as an asset class and an increase in fund management assets, particularly of hedge funds and

pension funds. The diverse selection of execution venues such as internet trading platforms has also

made it easier for retail traders to trade in the foreign exchange market. [4]

Because foreign exchange is an OTC market where brokers/dealers negotiate directly with one

another, there is no central exchange or clearing house. The biggest geographic trading centre is

the UK, primarily London, which according to IFSL estimates has increased its share of global

turnover in traditional transactions from 31.3% in April 2004 to 32.4% in April 2006. RPP

The ten most active traders account for almost 73% of trading volume, according to The Wall

Street Journal Europe, (2/9/06 p. 20). These large international banks continually provide the

market with both bid (buy) and ask (sell) prices. The bid/ask spread is the difference between the

price at which a bank or market maker will sell ("ask", or "offer") and the price at which a market-

maker will buy ("bid") from a wholesale customer. This spread is minimal for actively traded pairs of

currencies, usually 0–3 pips. For example, the bid/ask quote of EUR/USD might be 1.2200/1.2203.

Minimum trading size for most deals is usually $100,000.

These spreads might not apply to retail customers at banks, which will routinely mark up the

difference to say 1.2100 / 1.2300 for transfers, or say 1.2000 / 1.2400 for banknotes or travelers'

checks. Spot prices at market makers vary, but on EUR/USD are usually no more than 3 pips wide

(i.e. 0.0003). Competition has greatly increased with pip spreads shrinking on the major pairs to as

little as 1 to 2 pips.

Market participants
Financial markets


Unlike a stock market, where all participants have access to the same prices, the forex market is

divided into levels of access. At the top is the inter-bank market, which is made up of the largest

investment banking firms. Within the inter-bank market, spreads, which are the difference between

the bid and ask prices, are razor sharp and usually unavailable, and not known to players outside

the inner circle. As you descend the levels of access, the difference between the bid and ask prices

widens (from 0-1 pip to 1-2 pips only for major currencies like the Euro). This is due to volume. If a

trader can guarantee large numbers of transactions for large amounts, they can demand a smaller

difference between the bid and ask price, which is referred to as a better spread. The levels of access

that make up the forex market are determined by the size of the “line” (the amount of money with

which they are trading). The top-tier inter-bank market accounts for 53% of all transactions. After

that there are usually smaller investment banks, followed by large multi-national corporations

(which need to hedge risk and pay employees in different countries), large hedge funds, and even

some of the retail forex market makers. According to Galati and Melvin, “Pension funds, insurance

companies, mutual funds, and other institutional investors have played an increasingly important

role in financial markets in general, and in FX markets in particular, since the early 2000s.” (2004) In

addition, he notes, “Hedge funds have grown markedly over the 2001–2004 period in terms of

both number and overall size” Central banks also participate in the forex market to align currencies

to their economic needs.

[edit] Banks

The interbank market caters for both the majority of commercial turnover and large amounts of

speculative trading every day. A large bank may trade billions of dollars daily. Some of this trading

is undertaken on behalf of customers, but much is conducted by proprietary desks, trading for the

bank's own account.

Until recently, foreign exchange brokers did large amounts of business, facilitating interbank

trading and matching anonymous counterparts for small fees. Today, however, much of this

business has moved on to more efficient electronic systems, such as EBS (now owned by ICAP),

Reuters Dealing 3000 Matching (D2), the Chicago Mercantile Exchange, Dukascopy - Swiss FX

Marketplace, FXMarketSpace, Bloomberg, and TradeBook(R). The broker squawk box lets traders

listen in on ongoing interbank trading and is heard in most trading rooms, but turnover is

noticeably smaller than just a few years ago.

[edit] Commercial companies

An important part of this market comes from the financial activities of companies seeking foreign

exchange to pay for goods or services. Commercial companies often trade fairly small amounts

compared to those of banks or speculators, and their trades often have little short term impact on

market rates. Nevertheless, trade flows are an important factor in the long-term direction of a

currency's exchange rate. Some multinational companies can have an unpredictable impact when

very large positions are covered due to exposures that are not widely known by other market

participants.