Not many know that the stock market isn’t the biggest financial market in the world. It is in fact the currency market or the foreign exchange market that surpasses the stock market in terms of the volume traded every day. The fx market conducts its operations through a digital site where currencies are exchanged. New traders may be intrigued by the features of this market.
What is Forex?
At large, there are a few key functions that the forex market carries out:
- Currency liquidation (internationally)
- Determine exchange rate
- Set auctions for international trades and reserves
Trillions of dollars are exchanged on the forex market every day. The largest and also the most liquid financial market in existence does not operate from a central location. Instead, it conducts day-to-day functions through a digital network of participants that includes banks, brokers, institutions, and retail traders who carry out their trades through forex brokers or banks.
How Big Is the Foreign Exchange Market?
Even though general awareness about stock and bond markets may be more, when it comes to liquidity, the foreign exchange market is far ahead of these two financial markets. The Bank of International Settlements (BIS) conducted a survey recently and found that foreign exchange market trades accounted for a daily average of a whopping $6.6 trillion in 2019. Compare this to the U.S equity market which was valued at $393 billion in December 2021.
London, Tokyo, Singapore, New York, Hong Kong, and Tokyo are popular forex trading hubs.
Who Trades Forex?
Forex trading is done by several investors who may be involved at an individual level or at an organizational level. Let’s look at them in some detail:
Commercial & Investment Banks
The interbank market allows banks of all scales to conduct trade with each other. They exchange currencies among themselves through electronic networks and their trade sizes are monumental. Big banks in particular make for a huge chunk of the actual volume of trades. Banks may even act as forex brokers and allow their clients access to the forex market. They could even have their own trading desks to process speculative trades on behalf of their clients.
If your bank is also your forex dealer, you are likely to come across a term called bid-ask spread which would indicate the profit the bank will earn on each trade. The main goal for currency trades based on speculation is to make the most of the price fluctuations and thus earn more profit.
It would be utterly foolish to undermine the role of central banks in the forex market. Central banks usually represent a country’s government and can greatly influence currency rates through their open market operations and interest rate policies. A country’s central bank freezes the price of its currency on the forex market and the currency then is traded in the market on the basis of this exchange rate.
Central banks could also intervene in order to appreciate or depreciate the value of their currencies. Their main goal is to stabilize the national economy.
Investment Managers and Hedge Funds
Second, only to banks and central banks, portfolio managers, pooled funds, and hedge funds together account for a considerable volume of forex trades conducted in the market. Some traders hire investment managers who use their expertise to trade forex for accounts like pension funds, foundations, and endowments. If an investment manager wants to trade foreign securities and they have an international portfolio, they would have to buy or sell currencies. While some investment managers would engage in speculative forex trades, there may be certain hedge funds that do so as part of their investment strategies.
The forex market has recently opened its doors for retail investors. Hence, even though forex trading is becoming popular among individual investors, they still do not account for a great volume of daily trades in forex. Retail investors use an amalgamation of fundamental and technical indicators for their forex trading decisions.
How Forex Trading Shapes Business
Since there is such diversity in the kind of players that operate in the forex market, it adds up to make it a liquid, global market that can dramatically affect businesses internationally. Every country can be impacted by exchange rates as it plays a big role in inflation rates, corporate earnings (globally), and the balance of payments.
Take carry trade strategies as an example. These go on to show exchange rates are influenced by those who are an active part of the forex market and the impact this influence can have on the international economy. Banks, hedge funds, investment managers, and individual investors use carry trades to borrow currencies that yield less with currencies that have high value. Their goal is to earn profits through yield differences. Say the Euro has a low yield so it would be sold for a currency that’s doing better.
How Does Foreign Exchange Differ From Other Markets?
In terms of regulations, the forex market remains fairly decentralized in comparison to the stock or commodities market. There is no central authority that supervises the forex market which is both a good and bad thing. Since there are no regulations in the market, the investors may be exposed to risks but low regulation also implies that there is greater liquidity. Traditional exchanges may charge commissions or fees per trade but that’s not the case in forex. Also, the forex market operates for 24 hours, Monday-Friday without any cut-off time which ensures flexibility.
The Bottom Line
The forex market can be very empowering for all its participants right from banks to individual investors. In order to trade and hedge currencies, numerous strategies can be put to use such as carry trades which also go on to show how forex players can influence the global economy. There can be more than one reason to engage in forex broker trading. Banks, financial institutions, and individuals usually trade forex for profit while central banks engage so they can put a monetary policy in action or set the exchange rate regime. Large corporations tend to trade forex for their international businesses and to hedge the risks involved.