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Foreign exchange market.
The foreign exchange market (Forex, FX, or Financial market) is a global decentralized or over-the-counter market for the trading of currencies. This includes all aspects of buying, selling and exchanging currencies at current or determined prices. In terms of trading volume, it is by far the largest market in the world, followed by the Credit market.
The main participants in this market are the larger international banks. Financial centers around the world function as anchors of trading between a wide range of multiple types of buyers and sellers around the clock, with the exception of weekends. Since currencies are always traded in pairs, the forex market does not set a currency's absolute value but rather determines its relative value by setting the market price of one currency in another currency. Ex: 1 USD is worth X CAD, or CHF, or JPY, etc..
The foreign exchange market works through financial institutions, and operates on several levels. Behind the scenes, banks turn to a smaller number of financial firms known as "dealers", who are involved in large quantities of forex trading. Most foreign exchange dealers are banks, so this behind-the-scenes market is sometimes called the "interbank market" (although a few insurance companies and other kinds of financial firms are involved). Trades between forex dealers can be very large, involving hundreds of millions of dollars. Because of the sovereignty issue when involving two currencies, Forex has little (if any) supervisory entity, regulating its actions.
The foreign exchange market assists international trade and investments by enabling currency conversion. For example, it permits a business in the United States to import goods from European Union member states, especially Eurozone members, and pay Euros, even though its income is in United States dollars. It also supports direct profiteering for the cost of currencies, and profiteering for the difference interest rates of two currencies.
In a typical forex transaction, a party purchases some quantity of one currency by paying with some quantity of another currency.
The modern foreign exchange market began forming during the 1970s. This followed thirty years of government restrictions on forex transactions under the Bretton Woods system of monetary management, who set out the rules for commercial and financial relations among the world's major industrial states after World War II. Countries gradually switched to floating exchange rates from the previous exchange rate regime, which remained fixed per the Bretton Woods system.
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 22:00 GMT on Sunday (Sydney) until 22:00 GMT Friday (New York);
the variety of factors that affect exchange rates;
the low margins of relative profit compared with other markets of fixed income;
the use credit monies to enhance a profit and loss.
As such, it has been referred to as the market closest to the ideal of perfect competition, notwithstanding financial intervention by central banks.
According to the Bank for International Settlements, the preliminary global results from the 2016 Triennial Central Bank Survey of Foreign Exchange and OTC Derivatives Markets Activity show that trading in forex markets averaged $5.09 trillion per day in April 2016, this below $5.4 trillion in April 2013 but above $4.0 trillion in April 2010. Measured by value, foreign exchange swaps were traded more than any other instrument in April 2016, at $2.4 trillion per day, followed by spot trading at $1.7 trillion.
Financial trading and exchange first occurred in ancient times. Moneychangers (people helping others to change money and also taking a commission or charging a fee) were living in the Holy Land in the times of the Talmudic writings (Biblical times). These people (sometimes called "kollybistẻs") used city stalls, and at feast times the Temple's Court of the Gentiles instead. Moneychangers were also the silversmiths and/or goldsmiths of more recent ancient times.
During the 4th century AD, the Byzantine government kept a monopoly on the of currency exchange.
Papyri PCZ I 59021 (c.259/8 BC), shows the occurrences of exchange of coinage in Ancient Egypt.
Currency and exchange were important elements of trade in the ancient world, enabling people to buy and sell items like food, pottery and raw materials. If a Greek coin held more gold than an Egyptian coin due to its size or content, then a merchant could barter fewer Greek gold coins for more Egyptian ones, or for more material goods. This is why, at some point in their history, most world currencies in circulation today had a value fixed to a specific quantity of a recognized standard like silver and gold.
Medieval and later.
During the 15th century, the Medici family were required to open banks at foreign locations in order to exchange currencies to act on behalf of textile merchants. To facilitate trade, the bank created the nostro (from Italian, this translates to "ours") account book which contained two columned entries showing amounts of foreign and local currencies and information pertaining to the keeping of an account with a foreign bank. During the 17th (or 18th) century, Amsterdam maintained an active Forex market. In 1704, foreign exchange took place between agents acting in the interests of the Kingdom of England and the County of Holland.
Alex. Brown & Sons traded foreign currencies around in 1850 and was a leading financial trader in the USA. In 1880, J.M. do Espírito Santo de Silva (Banco Espírito Santo) applied for and was given permission to engage in a foreign exchange trading business.
The year 1880 is considered by at least one source to be the beginning of modern forex: the gold standard began in that year.
Prior to the First World War, there was a much more limited control of international trade. Motivated by the onset of war, countries abandoned the gold standard monetary system.
Modern to post-modern.
From 1899 to 1913, holdings of countries' foreign exchange increased at an annual rate of 10.8%, while holdings of gold increased at an annual rate of 6.3% between 1903 and 1913.
At the end of 1913, nearly half of the world's forex was conducted using the pound sterling. The number of foreign banks operating within the boundaries of London increased from 3 in 1860, to 71 in 1913. In 1902, there were just two London foreign exchange brokers. At the start of the 20th century, trades in currencies was most active in Paris, New York City and Berlin; Britain remained largely uninvolved until 1914. Between 1919 and 1922, the number of forex brokers in London increased to 17; and in 1924, there were 40 firms operating for the purposes of exchange.
During the 1920s, the Kleinwort family were known as the leaders of the foreign exchange market, while Japheth, Montagu & Co. and Seligman still warrant recognition as significant FX traders. The trade in London began to resemble its modern manifestation. By 1928, Forex trade was integral to the financial functioning of the city. Continental exchange controls, plus other factors in Europe and Latin America, hampered any attempts prosperity from wholesale trade with London in the 1930s.
After World War II.
In 1944, the Bretton Woods Accord was signed, allowing currencies to fluctuate within a range of ±1% from the currency's par exchange rate. In Japan, the Foreign Exchange Bank Law was introduced in 1954. As a result, the Bank of Tokyo became the center of forex by September 1954. Between 1954 and 1959, Japanese law was changed to allow foreign exchange dealings in many more Western currencies.
U.S. President, Richard Nixon is credited with ending the Bretton Woods Accord and fixed rates of exchange, eventually resulting in a free-floating financial system. After the Accord ended in 1971, the Smithsonian Agreement allowed rates to fluctuate by up to ±2%. In 1961–62, the volume of foreign operations by the U.S. Federal Reserve was relatively low. Those involved in controlling exchange rates found the boundaries of the Agreement were not realistic and so ceased this in March 1973, when sometimes afterward none of the major currencies were maintained with a capacity for conversion to gold, organizations relied instead on reserves of currency. From 1970 to 1973, the volume of trading in the market increased three-fold. At some time (according to Gandolfo during February–March 1973) some of the markets were "split", and a two-tier financial market was subsequently introduced, with dual currency rates. This was abolished in March 1974.
Reuters introduced computer monitors during June 1973, replacing the telephones and telex used previously for trading quotes.
Closing of the markets.
Due to the ultimate ineffectiveness of the Bretton Woods Accord and the European Joint Float Agreement, the forex markets were forced to close sometime during 1972 and March 1973. The largest purchase of US dollars in the history of 1976 was when the West German government realized acquisition nearly $ 3 billion, this event indicated the impossibility of balancing the exchange stabilities by the control measures used at the time and the monetary system and the forex markets in West Germany and other countries within Europe closed for two weeks.
In developed nations, the state control of the foreign exchange trading ended in 1973 when complete floating and relatively free market conditions of modern times began. Other sources claim that the first time a currency pair was traded by U.S. retail customers was during 1982, with additional currency pairs becoming available by the next year.
On 1 January 1981, as part of changes beginning during 1978, the People's Bank of China allowed certain domestic "enterprises" to participate in forex trading. Sometime during 1981, the South Korean government ended Forex controls and allowed free trade to occur for the first time. During 1988, the country's government accepted the IMF quota for international trade.
Intervention by European banks (especially the Bundesbank) influenced the Forex market on 27 February 1985. The greatest proportion of all trades worldwide during 1987 were within the United Kingdom (slightly over one quarter). The United States had the second amount of places involved in trading.
During 1991, Iran changed international agreements with some countries from oil-barter to foreign exchange.
Market size and liquidity.
The forex market is the most liquid financial market in the world. Financial traders is an governments and central banks, commercial banks, other institutional investors and financial institutions, financial speculators, other commercial corporations, and individuals. The average daily turnover in the global foreign exchange markets and related markets is continuously growing. According to the 2010 Triennial Central Bank Survey, coordinated by the Bank for International Settlements, average daily turnover was $3.98 trillion in April 2010 (compared to $1.7 trillion in 1998). Of this $3.98 trillion, $1.5 trillion was spot transactions and $2.5 trillion was traded in outright forwards, swaps, and other derivatives.
In April 2010, trading in the United Kingdom accounted for 36.7% of the total, making it by far the most important centre for forex trading in the world. Trading in the United States accounted for 17.9% and Japan accounted for 6.2%.
In the first time Singapore surpassed Japan in average daily foreign-exchange trading volume in April 2013 with $383 billion per day. So the trading volume became: United Kingdom (41%), United States (19%), Singapore (5.7%), Japan (5.6%) and Hong Kong (4.1%).
Turnover of traded foreign exchange futures and options has grown rapidly in recent years, reaching $166 billion in April 2010 (double the turnover recorded in April 2007). As of April 2016, exchange-traded currency derivatives represent 2% of OTC forex turnover. Foreign exchange futures contracts were introduced in 1972 at the Chicago Mercantile Exchange and are traded more than most other futures contracts.
Most developed countries permit the trading of derivative products (such as futures and options on futures) on their exchanges. All these developed countries already have fully convertible capital accounts. Some governments of emerging markets do not allow forex derivative products on their exchanges because they have capital controls. The use of derivatives is growing in many emerging economies. Countries such as South Korea, South Africa, and India have established currency futures exchanges, despite having some capital controls.
Foreign exchange trading increased by 20% between April 2007 and April 2010, and has more than doubled since 2004. The increase in turnover is due to a number of factors: the growing importance of foreign exchange as an asset class, the increased trading activity of high-frequency traders, and the emergence of retail investors as an important market segment. The growth of electronic execution and the diverse selection of execution venues has lowered transaction costs, increased market liquidity, and attracted greater participation from many customer types. In particular, electronic trading via online portals has made it easier for retail traders to trade in the foreign exchange market. By 2010, retail trading was estimated to account for up to 10% of spot turnover, or $150 billion per day.
Forex is traded in an over-the-counter market where brokers/dealers negotiate directly with one another, so there is no central exchange or clearing house. The biggest geographic trading center is the United Kingdom, primarily London. According to TheCityUK, it is estimated that London increased its share of global turnover in traditional transactions from 34.6% in April 2007 to 36.7% in April 2010. Due to London's dominance in the market, a particular currency's quoted price is usually the London market price. For instance, when the International Monetary Fund calculates the value of its special drawing rights every day, they use the London market prices at noon that day.
Unlike a stock market, the foreign exchange market is divided into levels of access. At the top is the interbank forex market, which is made up of the largest commercial banks and securities dealers. Within the interbank market, spreads, which are the difference between the bid and ask prices, are razor sharp and not known for players outside the inner circle. The difference between the bid and ask prices widens (for example from 0 to 1 pip to 1–2 pips for currencies such as the EUR) as you go down the levels of access. 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 foreign exchange market are determined by the size of the "line" (the amount of money with which they are trading). The top-tier interbank market accounts for 51% of all transactions. From there, smaller 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 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.
An important part of the forex 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 exchange rate. Some multinational corporations (MNCs) can have an unpredictable impact when very large positions are covered due to exposures that are not widely known by other market participants.
National central banks play an important role in the foreign exchange markets. They try to control the money supply, inflation, and/or interest rates and often have official or unofficial target rates for their currencies. They can use their often substantial forex reserves to stabilize the market. Nevertheless, the effectiveness of central bank "stabilizing speculation" is doubtful because central banks do not go bankrupt if they make large losses, like other traders would. There is also no convincing evidence that they actually make a profit from trading.
Investment management firms.
Investment management firms (who typically manage large accounts on behalf of customers, such as pension funds and deposits) use the foreign exchange market to facilitate transactions in foreign securities. For example, an investment manager bearing an international equity portfolio needs to purchase and sell several pairs of foreign currencies to pay for foreign securities purchases.
Some investment management firms also have more speculative specialization in the operations with currency overlay, these companies manage clients' financial exposures with the aim of generating profits as well as limiting risk. While the number of this type of specialist firms is quite small, many have a large value of assets under management and can therefore generate large trades.
Retail foreign exchange traders.
With the advent of retail foreign exchange trading, individual retail speculative traders form a growing segment of this market, both in size and in relevance. Currently, they participate indirectly through brokers or banks. Retail brokers, while largely controlled and regulated in the United States by the Commodity Futures Trading Commission and the National Futures Association, have already been subject to periodic financial fraud. To deal with the issue, in 2010 the NFA required its members that deal in the Forex markets to register as such (I.e., Forex CTA instead of a CTA). Those NFA members that would traditionally be subject to minimum net capital requirements, FCMs and IBs, are subject to greater minimum net capital requirements if they deal in Forex. A number of the forex brokers operate from the UK under Financial Services Authority regulations where foreign exchange trading using margin is part of the wider over-the-counter derivatives trading industry that includes contracts for difference and financial spread betting.
There are two main types of retail FX brokers offering the opportunity for speculative financial trading: Brokers and dealers or market makers. Brokers serve as an agent of the customer in the broader FX market, by seeking the best price in the market for a retail order and dealing on behalf of the retail customer. They charge a commission or "mark-up" in addition to the price obtained in the market. Dealers or market makers, by contrast, typically act as principals in the transaction versus the retail customer, and quote a price they are willing to deal at.
Non-bank foreign exchange companies.
Non-bank foreign exchange companies offer currency exchange and international payments to private individuals and companies. These are also known as "forex brokers" but are distinct in that they do not offer speculative trading, but rather currency exchange with payments (i.e., there is usually a physical delivery of currency to a bank account). Purpose of these companies is usually that they will offer better exchange rates or cheaper payments than the customer's bank.
It is estimated that in the UK, 14% of financial transfers/payments are made via foreign exchange companies. The volume of transactions done through forex companies in India amounts to about USD 2 billion per day - this does not compete with a well-developed foreign exchange market of international reputation, but with the entry of online forex companies the market is steadily increasing. Around 25% of financial transfers/payments in India are made via non-bank foreign exchange companies. Most of these companies use the USP of better exchange rates than the banks. They are regulated by FEDAI and any transaction in forex is governed by the Foreign Exchange Management Act, 1999 (FEMA).
Companies on money transfer and the points of currency exchange.
Companies on money transfer perform high-volume low-value transfers generally by economic migrants back to their home country. In 2007, the Aite Group estimated that there were $369 billion of remittances (an increase of 8% on the previous year). The four largest markets (India, China, Mexico and the Philippines) receive $95 billion. The largest and best known provider is WesternUnion with 345,000 agents globally, followed by UAEexchange. Points of currency exchange provide low value foreign exchange services for travelers. These are typically located at airports and stations or at tourist locations and allow to be exchanged physical unit of one currency to another. They access to the foreign exchange markets via banks or non bank foreign exchange companies.
Fixing of the currencies exchange rate.
Fixing of the currencies exchange rate is the daily monetary exchange rate fixed by the national bank of each country. The idea is that central banks use the fixing time and exchange rate to evaluate the behavior of their currency. Fixing exchange rates reflect the real value of equilibrium in the market. Banks, dealers and traders use fixing rates as a market trend indicator.
The mere expectation or rumor of a central bank foreign exchange intervention might be enough to stabilize a currency. However, aggressive intervention might be used several times each year in countries with a dirty floating financial regime. Central banks do not always achieve their objectives. The combined resources of the market can easily overwhelm any central bank. Several scenarios of this nature were seen in the 1992–93 European Exchange Rate Mechanism collapse, and in more recent times in Asia.
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 nature of financial markets, there are rather a number of interconnected marketplaces, where different currencies instruments are traded. This implies, that there is not of single exchange rate, but there is 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 Electronic Broking Services (EBS) and Thomson Reuters Dealing, while major banks also offer trading systems. A joint venture of the Chicago Mercantile Exchange and Reuters, called Fxmarketspace opened in 2007 and aspired but failed to the role of a central market clearing mechanism.
The main trading centers are London and New York City, though Tokyo, Hong Kong and Singapore are all important centers as well. Banks participate around the world. Financial 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.
Fluctuations in exchange rates are usually caused by actual monetary flows as well as by expectations of changes in monetary flows. These are caused by changes in gross domestic product (GDP) growth, inflation (purchasing power parity theory), interest rates (interest rate parity, Domestic Fisher effect, International Fisher effect), budget and trade deficits or surpluses, large cross-border M&A deals and other macroeconomic conditions. Major news is released publicly, often on scheduled dates, so many people have access to the same news at the same time. However, the large banks have an important advantage; they can see their customers' order flow.
Currencies are traded against one another in pairs. Each currency pair thus constitutes an individual trading product and is traditionally noted XXXYYY or XXX/YYY, where XXX and YYY are the ISO 4217 international three-letter code of the currencies involved. The first currency (XXX) is the base currency that is quoted relative to the second currency (YYY), called the counter currency (or quote currency). For instance, the quotation EURUSD (EUR/USD) 1.5465 is the price of the Euro expressed in US dollars, meaning 1 euro = 1.5465 dollars. The market convention is to quote most exchange rates against the USD with the US dollar as the base currency (e.g. USDJPY, USDCAD, USDCHF). The exceptions are the British pound (GBP), Australian dollar (AUD), the New Zealand dollar (NZD) and the euro (EUR) where the USD is the counter currency (e.g. GBPUSD, AUDUSD, NZDUSD, EURUSD).
The factors affecting XXX will affect both XXXYYY and XXXZZZ. This causes positive currency correlation between XXXYYY and XXXZZZ.
On the spot market, according to the 2016 Triennial Survey, the most heavily traded bilateral currency pairs were:
GBPUSD (also called cable): 9.2%
The U.S. currency was involved in 87.6% of transactions, followed by the euro (31.3%), the yen (21.6%), and sterling (12.8%). Volume percentages for all individual currencies should add up to 200%, as each transaction involves two currencies.
Trading in the euro has grown considerably since the currency's creation in January 1999, and how long the forex market will remain dollar-centered this is open to debate. Until recently, trading the euro versus a non-European currency ZZZ would have usually involved two trades: EURUSD and USDZZZ. The exception to this is EURJPY, which is an established traded currency pair in the interbank spot market.
Factors determining exchange rates.
The following theories explain the fluctuations in exchange rates in a floating exchange rate regime (In a fixed exchange rate regime, rates are decided by its government):
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 suppositions, which rarely have a meaning in the real world.
Balance of payments model: This model, however, focuses largely on tradable goods and services, ignoring the increasing role of global capital flows, this model failed to provide any explanation for the continuous appreciation of the US dollar during the 1980s and most of the 1990s, despite the soaring US current account deficit.
The model of the asset market: 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 model of the asset market for 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.”
None of the models developed so far succeed to explain exchange rates and volatility in the longer time frames. For shorter time frames (less than a few days), algorithms can be devised to predict prices. It is understood from the above models that many macroeconomic factors affect the exchange rates and in the end currency prices are a result of dual forces of demand and supply. The world's financial markets can be viewed as a huge melting pot: in a large and ever-changing mix of current events, supply and demand factors are constantly shifting, and the price of one currency in relation to another shifts accordingly. No other market encompasses (and distills) as much of what is going on in the world at any given time with foreign exchange market.
Demand and supply for any currency is affected by several factors, not by any single factor. These factors are generally divided into three categories: economic factors, political conditions, and market psychology.
These include: (a) economic policy, disseminated by government agencies and central banks, (b) economic conditions, generally revealed through economic reports, and other economic indicators.
Economic policy comprises government fiscal policy (budget/spending practices) and monetary policy (the means by which a government's central bank influences the supply and "cost" of money, which is reflected by the level of interest rates).
Government budget deficits or surpluses: The market usually reacts negatively on widening government budget deficits, and reacts positively on narrowing budget deficits. The impact is reflected in the value of a country's currency.
Balance of trade levels and trends: The trade flow between countries illustrates the demand for goods and services, which in turn indicates demand for a country's currency to conduct trade. Surpluses and deficits in trade of goods and services reflect the competitiveness of a nation's economy. For example, trade deficits may have a negative impact on a nation's currency.
Inflation levels and trends: Typically a currency will lose value if there is a high level of inflation in the country or if inflation levels are perceived to be rising. This is because inflation erodes purchasing power, thus demand, for that particular currency. However, a currency may sometimes strengthen when inflation rises, because of expectations that the central bank will increase short-term interest rates to combat rising inflation.
Economic growth and health: Reports such as GDP, employment levels, retail sales, capacity utilization and others, detail the levels of a country's economic growth and health. Generally, than stronger and healthier a country's economy, the more will be performance its currency, and the more will be demand on its currency.
Productivity of an economy: Increasing productivity in an economy should positively influence the value of its currency. Its effects are more prominent if the increase is in the traded sector.
Internal, regional, and international political conditions and events can have a profound effect on financial markets.
All exchange rates are susceptible to political instability and anticipations about the new ruling party. Political upheaval and instability can have a negative impact on a nation's economy. For example, destabilization of coalition governments in Pakistan and Thailand can negatively affect the value of their currencies. Similarly, in a country experiencing financial difficulties, the rise of a political faction that is perceived to be fiscally responsible can have the opposite effect. Also, events in one country in a region may spur positive/negative influence on neighboring country and in this process affect on its currency.
Market psychology and trader perceptions influence the forex market in a variety of ways:
Transition to quality: Unsettling international events can lead to a "transition to quality", a type of capital flight whereby investors move their assets to a perceived "safe haven". There will be a greater demand and thus a higher price for currencies perceived as stronger over their relatively weaker counterparts. The US dollar, Swiss franc and gold have been traditional safe havens during times of political or economic uncertainty.
Long-term trends: Financial markets often move in visible long-term trends. Although currencies do not have specific temps of annual growth, but business cycles do make themselves felt. Cycle analysis looks at longer-term price trends that may rise from economic or political trends.
"Buy on rumors, sell on fact": This market truism can apply to many financial situations. It is the tendency, at which currency price reflect the impact of a particular action before it occur, and when comes to pass anticipated event, then currency price react in exactly the opposite direction. This may also to name as a "over-sold" or "over-bought" market. Buy on rumors and sell on fact can also be an example of the cognitive bias, known as anchoring, when investors focus too much on the relevance of outside events to currency prices.
Economic numbers: While economic numbers can certainly reflect economic policy, some reports and numbers take on a talisman-like effect: the number itself becomes important to market psychology and may have an immediate impact on short-term market moves. "What to watch" can change over time. In recent years, for example, in the spotlight has been money supply, employment, trade balance figures and inflation numbers.
Technical trading aspects: As in other markets, the accumulated price movements in a currency pair such as EUR/USD can form apparent patterns that traders may attempt to use. Many traders study price charts in order to identify such patterns.
A spot transaction is a transaction with two-day delivery (except in the case of trades between the US dollar, Canadian dollar, Turkish lira, euro and Russian ruble, which settle the next business day), as opposed to the futures contracts, which are delivered usually in three months. This trade represents a “direct exchange” between two currencies, has the shortest time frame, involves cash rather than a contract, and interest is not included in the agreed-upon transaction. Spot trading is one of the most common types forex trading. Often a forex broker charges a small commission from the client to prolongation the expiring transaction, for a continuation of trading. This prolongation fee is known as the "Swap" fee.
One way to deal with the foreign exchange risk is to engage in a forward transaction. In this transaction, money actually does not change owner until some agreed upon future date. A buyer and seller agree on an exchange rate for any date in the future, and the transaction occurs on that date, regardless of what the market rates will be at this time. The duration of the trade can be one day, a few days, months or years. Usually the date is decided by both parties. Then the forward contract is agreed and approved by both parties.
Non-deliverable forward contracts.
Forex banks, ECNs, and prime brokers offer NDF contracts, which are derivatives that have no real deliver-ability. NDFs are popular for currencies with restrictions such as the Argentinian peso. In fact, a Forex hedger can only hedge these risks with NDFs, since currencies such as the Argentine Peso can not be exchanged in open markets, unlike major currencies.
The most common type of forward transaction is swap. In a swap, two parties exchange currencies for a certain length of time and agree to complete the transaction at a later date. This is not standardized contracts and it is not traded via exchange. A deposit is often required in order to hold the position open until the transaction is completed.
Futures are standardized forward contracts and are usually traded on an exchange created for this purpose. The average contract length is roughly 3 months. Futures contracts are usually inclusive of any interest amounts.
Currency futures contracts are contracts specifying a standard volume of a particular currency to be exchanged on a specific settlement date. Thus the currency futures contracts are similar to forward contracts in terms of their obligation, but differ from forward contracts in the way they are traded. They are commonly used by multinational corporations (MNCs) to hedge their currency positions. In addition they are traded by speculators who hope to capitalize on their expectations of exchange rate movements.
Forex options is a derivative, where the owner has the right but not the obligation to exchange money denominated in one currency into another currency at a pre-agreed exchange rate on a specified date. The market of Forex options is the deepest, the largest and the most liquid market of options of any types in all the world.
Large hedge funds and other well capitalized "position traders" are the main professional speculators. According to some economists, individual traders could act as "noise traders" and have a more destabilizing role than larger and better informed participants. Also to be considered the rise of autotrading in foreign exchange - algorithmic (automated) trading has increased from 2% in 2004 up to 45% in 2010.
Financial speculation is considered a suspicious activity in many countries. Investments in traditional financial instruments such as bonds or shares are often considered positive for economic growth due to the providing capital, but financial speculation not have a positive effect, according to this view, and considered it as simply gambling that often interferes of economic policy. For example, in 1992, financial speculation forced the Swedish National Bank (the central bank of Sweden) to raise interest rates for a few days to 500% per annum, and later to devalue the krona. Mahathir Mohamad, one of the former Prime Ministers of Malaysia, is one well-known proponent of this view. He blamed in devaluation Malaysian ringgit in 1997 of George Soros and other speculators.
Gregory Millman reports on an opposing view, comparing speculators to "vigilantes" who simply help "enforce" international agreements and anticipate the effects of basic economic "laws" in order to profit. In this view, countries may develop unsustainable economic bubbles or otherwise mishandle their national economies, and financial speculators make the inevitable collapse happen faster. A relatively quick collapse might even be preferable to continued of wrong economic management, followed by an eventual, larger, collapse. Mahathir Mohamad and other critics of speculation are viewed this as trying to deflect the blame from themselves for having caused the unsustainable economic conditions.
Risk avoiding is a kind of trading behavior exhibited by the forex market when a potentially adverse event happens which may affect market conditions. This behavior is characterized by the fact that traders not want risk and liquidate their positions in risky assets and transfer the funds to less risky assets due to market uncertainty.
In the context of the foreign exchange market, traders liquidate their positions in different currencies in order to take positions in safe currency, such as the US dollar. Sometimes, choosing a safe haven for currency is more based on prevailing sentiments, not on economic statistics. One example would be the financial crisis of 2008. The value of the shares around the world fell as the US dollar strengthened. This happened despite the strong focus of the US crisis.
Trade of interest rates (Carry-Trade).
Trade of interest rates refers to the act of borrowing one currency that has a low interest rate in order to purchase another with a higher interest rate. A big difference in rates can be very profitable for the trader, especially if is used credit monies. However, with all credit monies, this is a two-way sword, and with the appearance of large instability of exchange rate, you can suddenly get a big loss.
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