The foreign exchange market, also known as the forex or FX, is a marketplace not unlike exchanges like the NYSE, which deals in types of national currency, wherin one currency is traded for an equal amount of another according to the current trading exchange rate. It is estimated that the forex market sees nearly 4 billion USD in trades every day, making it the biggest trading market on the planet.
Significance
The amount of money possessed by a national government will have an effect on the value of that national currency. When a government has more currency, that currency becomes more valuable, and vica versa. National trade levels and trends also effect national currency, with a trade deficit having a negative effect and vice versa. Inflation often devalues currency, though it sometimes raises the value of a currency when speculators expect that countries' central bank will lower interest rates.
Geopolitical conditions effect the value of currency. Social unrest will devalue a currency, where as the rise of a political party that is perceived as fiscally sound will increase that currencies' value.
Types
Spot Transactions are a direct exchange of two currencies in the market. This trade, which takes two days, is the shortest time frame of any action that can be taken on the forex market.
Forwards is a transaction in which currencies do not change hands until an agreed upon date. A buyer and seller agree to exchange currencies at an agreed upon date and do so at the agreed upon rate.
Forex Swaps, a currency swap, is the most common type of exchange on the forex market. Two parties exchange currencies and re-exchange the currencies later.
Option is a derivative in which the owner has the right to exchange money in one currency into another at a pre-agreed date and rate.
Exchange Traded Fund is an open ended investment company that can be traded on the forex market.
Identification
Large banks are regular participants in forex trading. Some of this trading is done for the benefit of the bank's customers, but the majority is done to augment the balance sheets of the bank itself, so that the banking institution itself will reap the rewards of the trade.
Commercial companies often must use foreign currencies to pay for needed goods or services.
Investment management firms often use the forex to facilitate trading of foreign assets. They also manage hedge funds, which often draw a portion of their trading action from the forex market.
Considerations
Besides geopolitical events, speculator perceptions and expectations can have a significant impact on activity within the forex market.
Often, at the onset of a sizable negative national or international event, many speculators will seek safer haven with their trades. The Swiss franc, for example, has historically been considered a safe currency.
Long term trends can also have an impact on trading. Though not as cyclical as commodities markets, speculators often follow pronounced trends when trading
Often, events that effect the forex market will make their impact upon the market before the event actually comes to pass. This is because many speculators anticipate the effect of the event sooner than it would otherwise occur. When enough speculators come to the same conclusion, the sheer number of trades will artificially spike the market, in effect creating the effect of the event before the event occurs. A common saying in forex trading is "buy the rumor, sell the fact."
Certain numerical economic indicators are widely regarded as having an effect on the market in and of themselves, for example numbers on money supply, trade balance figures and inflation numbers. Like an event, the anticipation of action within the market is enough to create the action itself, since so many speculators
Warning
As with any investment, trading on the foreign exchange market with the intent of making a profit is very risky. To the inexperienced investor, trading on the forex amounts to little more than gambling, a strategy that is unlikely to pay off in the long run. Even with the participation of a professionally managed fund, there is the possibility of losing money. It is an excellent investment strategy not to invest money that you can't afford to lose.
Expert Insight
Electronic trading, the trading of currencies over the forex market via a computer network instead of through a broker, is gaining popularity. Currently, about 25% of all forex trades are made online. One of the advantages of electronic trading (as well as electronic market watching) is that it can react to market conditions much faster than the traditional human trade, giving those who use electronic trading an edge when trading in the forex market. In addition, electronic trading makes possible the use of algorithmic trading, or trading using an automated system that will use a computer program with a predetermined set of parameters to make trades, making reaction to changing market conditions even faster.
