The Foreign Exchange Market is the world’s largest market. The global currency markets have reached trading volumes in excess of $5 trillion a day, equating to at least 200 times the size of any individual exchange. The market is traded 24 hours a day, except on weekends.
The market is commonly referred to as the currency market, foreign exchange market, or abbreviated to Forex.
The currency market opens on Sunday at 22:00 GMT and closes on Friday at 22:00 GMT.
As the market operates 24 hours a day, and carries high liquidity, it is less likely to see a gap in prices that is commonly seen in equity markets. The market carries different levels of volatility as it follows the clock around the world. The market open starts in Sydney Australia, after two hours, Asian trading starts to weigh in as markets open in Tokyo. An hour after Sydney markets close, London traders start their day, often triggering a period of elevated volatility, while New York traders add to the volatility in what is commonly known as the overlap.
The period between 12:00 GMT and 17:00 GMT tends to carry the highest level of volatility because the last half of European trading overlaps with the first half of North American trading.
Why is the Forex Market Different from Other Markets?
The foreign exchange market offers leveraged trading, meaning only a portion of the trade size is required as a deposit to initiate a trade. Brokers commonly offer leverage of 1:50 or 1:100, translating to a deposit requirement of 2% or 1% (respectively) of the total trading size. In recent times, leverage has been seen as high as 1:1000, meaning a trade can be initiated with a mere 0.1% deposit.
Leverage is commonly referred to as a double-edged sword. It has the potential to make a trader realize gains rapidly, but also to incur losses rapidly.
The forex market is decentralized, carrying both advantages and disadvantages. A centralized exchange involves middlemen, often increasing costs for the trader, while costs in trading generally only involve the difference in the spread of a pair. A disadvantage is that quotes differ between brokers. It is possible to see currency pairs trading at slightly different prices between brokers, or even in some cases during volatile events, a major difference in prices. These divergences can lead to a frustrating experience if a trader was stopped out because of a price spike that did not occur with other brokers, and can also impact technical analysis, and indicators.
How to Trade the Forex Market?
In the currency market, trades are made in pairs. When one currency is sold, another currency is bought, meaning that a trader will always have exposure to two different currencies.
The eight most traded currencies in the world are the US Dollar, Euro, Japanese Yen, British Pound, Swiss Franc, Canadian Dollar, Australian Dollar, and New Zealand Dollar.
- As the US dollar is the highest traded currency in the world, the most common currency pairs in the Forex market are EUR/USD, USD/JPY, GBP/USD, USD/CHF, AUD/USD, NZD/USD, and USD/CAD. These seven currency pairs are referred to as the majors.
- In addition to the seven majors, there are 20 pairs derived from the remaining seven currencies. These pairs are referred to as cross rates, or alternatively referred to as cross-currency pairs, minor currency pairs, or simply minors.
- Aside from the majors, and cross rates, there are also exotics. These pairs include currencies from emerging markets or smaller economies. Generally, these currencies that are not as commonly traded.
The currencies can be paired with a major currency, or against another exotic currency. Common exotic currencies are the Swedish Krona, Norwegian Krona, South African Rand, Hong Kong Dollar, Indian Rupee, Singapore Dollar, Turkish Lira, and Mexican Peso. There are several more currencies, but as volumes tend to be low in exotic pairs, spreads or commissions tend to be high, making them less popular.
What Affects Forex Rates?
There are several factors that move the markets. Currencies are traded every day in tourism, international trade, investments, governments, and speculators to name a few. Supply and demand in these areas will move prices.
Monetary policy is a big driver to a currencies value due to sensitivity to interest rate fluctuations. Central banks play a big role in the market, and at times use currency intervention. A central bank may look to devalue its currency to help exports for example, or to combat low inflation. Political and economic instability also influence prices. And while rare, natural disasters also have an impact on currency values.
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