Forex – The Biggest Market in the World
Forex, often abbreviated fx, is an acronym short for “foreign exchange” and is by far the
largest financial market in the entire world. The forex markets see roughly about 5 trillion US dollars of trade volume on a daily basis. Compare this to the stock market which sees roughly 20 billion US dollars of trade volume on any given day. Forex is the trading, or “exchanging” of different countries’ currencies. You will also commonly see various currencies exchanged for commodities or cryptocurrencies, and these exchanges are also included under the umbrella of the foreign exchange markets.
Many people participate in the forex markets without realizing it. When you travel to another country, you must exchange your native currency for the currency of the country you are visiting at the current exchange rate so that you may purchase goods and services while you are there. When you are ready to return home, you will then exchange the currencies back again (this time at a different exchange rate) so that you return with your native currency.
There are many participants in the foreign exchange markets, which here are the detailed participants below:
Individuals – We have already discussed an example of how regular, average people
participate in the forex markets throughout their lifetime. While many individuals only
exchange currencies when traveling, there are some who trade currencies to turn a profit. You will often hear these people referred to as “retail traders”. It is estimated that retail traders only account for a measly less than 5% of the overall trade volume in the foreign exchange markets.
Corporations – Large companies trade quite often in the foreign exchange markets! Their
participation has substantially increased over the previous years as we have seen a rise in
international business and a widespread adoption of more open, global economic policies. In fact, it’s not uncommon for a large corporation to reference and analyze the exchange rate for goods and services before carrying out transactions.
Banks – Average banks combine to account for more trading volume in the foreign exchange markets than any other entity. Most of these exchanges take place in the inter-bank market where banks conduct currency exchanges with one another electronically. There are many reasons why banks participate in the forex markets, but note that your bank does also trade your money in the forex market for financial gain!
Institutional Investors – Another significant source of transactions in the forex markets,
institutional investors such as hedge funds control substantial equity in the private sector and typically carry out a sizable portion of their portfolio’s positions in the forex markets.
Governments – Typically, governments participate and influence the foreign exchange markets via entities called central banks. Central banks have an incredible influence in the forex markets as they control a nation’s interest rates which directly impact supply & demand for a currency and, therefore, that currency’s exchange rate. These central bank entities also
employ impact economic tactics to stabilize their respective currencies between the
constant inflation – recession continuum.
So, as you can see there are quite a bit of participants in the foreign exchange markets and this is what contributes to the incredible amount of money being traded on any given day.
In the past, the forex markets wasn’t very accessible for average individual traders, however the world is changing and it’s changing fast. Globalization, technology advancements, economic and financial fundamental changes in society, and an overall shift in the way people are living their lives have opened up access to and increased the popularity of retail trading.
The foreign exchange market is comprised of many different participants. The major banks
are at the very top and control most of the trade volume. These major banks trade currency directly among one another via two special electronic networks at special pricing that aren’t available to the public (aka retail traders) via RD3-SM and EBS. All other banks come next in terms of trade volume, and then these smaller banks are followed by institutional investors, brokers, etc. Finally, at the very bottom of the totem pole, you have your retail traders.
Retail traders trade the foreign exchange markets through various trading platforms
accessible via their computers, smartphones, or tablets. These trading platforms are
connected to retail ECN’s (electronic communication networks) which are otherwise known as brokers. We will talk more about brokers and trading platforms at a later time. Take a look at the following diagram which depicts the various market participants and the overall volume of trading that they contribute. At the top, you will note that the major banks are responsible for the most trading volume in the forex markets. You will also see just how
small the contribution is from all of the retail traders in the world relatively.
Interestingly, the foreign exchange market never actually truly closes – it runs 24/7
worldwide. However, retail traders’ access to the foreign exchange markets is limited to
traditional business hours because that is when the retail brokers make trading available to clients. Thankfully, we don’t lose the full weekend because this is a worldwide calculation.
For example, let’s say you’re a trader in the United States. Business hours are typically M – F,
8 AM to 5 PM; however, the forex markets open up for you at 4 PM CST on Sunday because that’s equivalent to Monday morning at 8 AM in Sydney, Australia – one of the powerhouse trading market hubs in the world. Also interesting to note is the fact that, while the foreign exchange market may be tied to worldwide business hours, that does not necessarily mean that all markets are.
As an example, many retail brokers that offer the ability to trade cryptocurrency allow retail
client access to trade those assets 24/7. Another great example to note is the U.S. stock market which operates only MON – FRI, 8 AM to 5 PM EST regardless of the business hours in other time zones around the world.
Yes, the foreign exchange markets are almost always open for us to trade. No, that does not
mean that we should be trading these markets at all times. The foreign exchange market can
be broken down into 4 main sessions (listed here in CST):
European (London): 2 AM CST – 11 AM CST
United States (New York): 7 AM CST – 4 PM CST
Australian (Sydney): 3 PM CST – 12 AM CST
Asian (Tokyo): 5 PM CST – 2 AM CST
During the hours of 7 AM CST – 11 AM CST, for example, both the U.S. and European
sessions are active. This means that all of the banks, corporations, institutions, ECN brokers, retail traders, etc. of these two powerhouse economies are carrying out business, conducting currency exchanges, and reacting to fundamental factors that determine price valuation. All of this activity breeds significant opportunity to capitalize on a price movement. In contrast, the Asian and Australian sessions typically give rise to lower volatility and so you may see overall price consolidation across all major financial instruments during these hours especially relative to the sharp, substantial trends that often develop in the European and
United States sessions.
Using these same principles, you can also start to build an understanding of what market conditions and circumstances would present less than ideal trading conditions:
Holidays (Less financial transactions taking place – especially bank holidays.)
Market Open (Less financial transactions taking place – many market participants aren’t
conducting business yet because only part of the global market is open for business.)
Market Close (Less financial transactions taking place – many market participants aren’t
conducting business this late in the week because only a small portion of the global
market is still open for business.)
Understanding the overall structure of the forex financial markets will significantly help you as you learn technical analysis and begin trading. This element was designed to provide you with an introduction to forex and the necessary foundation to begin your trading journey.
There are two ways that you can make money trading:
1. BUYING – You believe the exchange rate for a certain currency pair is going to rise, so you go long on that pair. This means that you will simultaneously buy the base currency (1st listed asset of the pair) and sell the quote currency (2nd listed asset of the pair). When you go to close this trade, you will simultaneously sell the base currency back for the quote currency at a higher price than you originally bought it for and close out with an overall profit.
2. SELLING – You believe that the exchange rate for a certain currency pair is going to fall, so you go short on that pair. This means that you will simultaneously sell the base currency (1st listed asset of the pair) and buy the quote currency (2nd listed asset of the pair). When you go to close this trade, you will simultaneously buy the base currency back using your quote currency at a lower price than you sold it for originally and close out with an overall profit.
There are fundamental, universal laws in physics known as the conservation of matter and the conservation of energy, which state respectively that matter and energy cannot be created or destroyed – only transferred. This applies to the financial markets as well when it comes to money. For every winner, there must be a loser and vice versa. For any given market transaction, money is simply being transferred from one participant to another.