FOREX, Foreign Exchange: what it is – Dictionary of Economy

FOREX Concept, Foreign Exchange

The foreign exchange market (also known as Forex, abbreviation of the English term Foreign Exchange or FX) is a global and decentralized market in which currencies are traded. This market was born with the aim of facilitating the monetary flow derived from international trade. The daily volume of transactions that leads to moving around five billion dollars, operating in a day what Wall Street can move in a month.

The main trading venues are the London, New York and Tokyo Stock Exchanges. First the Asian markets open, then the European ones and finally the American markets open. The market opens on Sunday afternoon (US Eastern time) and closes on Friday at 4:00 pm Eastern time. This allows permanent access to the markets with the benefit of greater liquidity and a rapid response capacity to economic or political events that have an effect on it.

Forex Characteristics

– Among the implications of not being a centralized market is that there is not a single price for the currencies that are traded: it depends on the different agents that participate in the market.

– The foreign exchange market is a world market that, although it has 24-hour access, in practice is limited by the parenthesis of operations on the weekend. Even in those periods of interruption, traders can place buy or sell positions that will be invigorated when the market begins to fluctuate.

– Fluctuations in exchange rates are generally caused by actual monetary flows as well as by expectations of changes in them due to changes in economic variables such as GDP growth, inflation, interest rates, budget and trade deficit or surplus, among others.

– Important news is often published on scheduled dates, so investors have access to the same news at the same time. However, the big banks have an important advantage: they can see the order book of their clients.

– In the foreign exchange market, currencies are traded in crosses. Each currency cross constitutes an individual product and is traditionally noted as XXX/YYY, where YYY is the ISO 4217 three-letter international code in which the price of one unit of XXX is expressed. For example: it is the price of the Euro (EUR) expressed in US dollars (USD), understanding that 1 euro = 1.3272 US dollars (August 22, 2014)

According to the BIS study, the most traded currency crosses were:

1- – 24.1%

2- USD/JPY – 18.3%

3- GBP/USD – 8.8%

The US dollar was involved in 87% of transactions, followed by the euro (33.4%), the yen (23%) and the pound sterling (11.8%).

Major players in the Forex market

According to a 2004 BIS study:

– 53% of transactions were exclusively between banks

– 33% were between banks and other types of financial firm

– 14% were made between an intermediary and a non-financial company.

The main operators in the foreign exchange market are the following

1- Financial institutions: they can participate in the market in a speculative or hedging manner or acting on behalf of a client. Any international economic transaction, from a transfer to the purchase of foreign shares, implies the previous step through the foreign exchange market to carry out the purchase and sale of currencies necessary to carry out the main operation.

Until recently, forex traders were active in this business, making it easy for trading parties to effectively fill their orders for a limited fee. Today, however, much of this business has moved to more efficient electronic systems such as EBS, Reuters, the Chicago Stock Exchange, Bloomberg and TradeBook.

2- Commercial companies: companies in the non-financial sector that operate with international clients and suppliers are also involved in the market. Its impact on the market in the short term is small. However, trade flows are an important factor in the long-term behavior of a currency. In addition, the operations of some multinationals can have an unpredictable impact on the currency of small countries.

3- Central banks: they operate in foreign currency markets to control the money supply, inflation and/or interest rates of their country’s currency. They often dictate exchange rates and often even use their international reserves to stabilize the market. The expectation or rumor of a central bank intervention may be enough to alter the value of a currency. However, central banks do not always achieve their goals and in some cases the market can override a central bank. This happened in the 1992-93 debacle of the Exchange Rate Mechanism, and in more recent times in the Asia-Pacific.

4- Individual investors through intermediaries: thanks to this market, specialized companies have emerged that are responsible for providing management services for forex accounts, investment funds and automatic systems. Today it is believed that the foreign exchange market (FOREX or FX) is the financial market with the highest growth projection in the modern financial world.

One of its main differences compared to the stock market is that the foreign exchange market lacks a centralized location, it operates as a global electronic network of banks, financial institutions and individual traders, all dedicated to buying or selling currencies by virtue of their volatile relationship of change.

There are currently companies specializing in the participation and support of operators in this market that offer different types of services. In the first place, the “Brokers” or financial intermediaries offer the possibility of opening an account in a certain currency and through purchase and sale orders, issued through different channels, they allow the investor to try to obtain benefits by taking advantage of the fluctuations of the exchange rates of different currencies. These companies, given their importance in the financial system, are normally subject to various controls and audits; however, when talking about the financial intermediary or “broker”, it is recommended that before choosing one, its solidity and trajectory be investigated, as well as taking into account the legal framework by which it is governed.

For the individual trader, the main objective as an investor is to speculate on the future changes in the price of currencies and by buying and selling them according to fluctuations in exchange rates, you can make a profit or a loss.

5- Investment fund management companies: these companies act in the foreign exchange market to have access to the financial markets of other countries and thus be able to invest in bonds, shares, etc. on account of the participants of their funds.