Foreign Currency Trading

by David Jenyns on July 30, 2011

Foreign currency trading is accomplished in a foreign exchange market in which one type of currency is exchanged or traded for another kind of currency. Currency trading is considered as the biggest financial market in the entire world. Players taking part in currency trading within a FOREX market are the big banks like Citibank and Deutsche bank, nationalized and government banks, multinational firms, monetary institutions and investment companies. The daily volume of the present global forex market is around US $3 trillion. Given the huge size and high liquidity of the markets worldwide, little players can’t easily do trading in a FOREX market. 

Trading within a market is carried out in levels, where a player in a level doesn’t have accessibility to other levels. The top level will be the inter-bank market comprised of big banks like Deutsche bank, Citibank, Union bank of Switzerland along with other banks around the world. The top 10 players sweep off 70% of the total business done in the FOREX trading. In the top level, the distinction between the bid and ask cost known as Spread is really minute and is not available to other circles outside. As the levels descend, the distinction increases mainly due to the volumes traded. Level of access for a player is determined by the ‘line’, the money with which one is trading. Currency trading has nearly doubled these days since 2001 mainly because of the recongnition of FOREX trading as an investment and asset class and also an increase in the fund management assets of pension funds and hedge funds. 

Commercial businesses do currency trading primarily to pay their customers for their good or services and trade in little amounts compared to large banks. Investment management businesses do trading to manage the pension or endowment or investment portfolio of their customers and are usually in large amounts, because they have to invest in foreign equities for which they need to exchange currency to purchase those equities.
Let us see the common characteristics of a FOREX currency trading. Because of the over-the-counter nature, the currency markets doesn’t trade in a single dollar or a euro rate, but instead a different number of rate applicable only to that specific market. There is no central house or hub or exchange or clearing house as traders deal directly with each due to this OTC nature.  Usually these rates are close to each other; or else special traders known as arbitrageurs take advantage of the difference in the rates and make huge profits from it. Main trading centers around the globe are in London, New york, Tokyo and Singapore. As the time zones differ, trading is carried out almost 24 hours each day. Fluctuations in the rate occur due to changes in the inflation, interest rates of banks, GDP growth, trade deficits and surpluses, cross-border M&A deals, economic situations, financial health and a few other macro economic conditions. 

Currencies are traded for each other and every pair of currencies is a separate and unique product and usually denoted by XXX/YYY. During creation, the XXX is recognized as base currency is the strongest and YYY the weakest. Today the US dollar is in nearly 88% of the transactions followed by Euro (37%) and yen. The most traded pairs are Euro/US dollar, US dollar/Yen and GB pound/US dollar. 

Trading is done via various forms of instruments such as derivatives, spot transactions, forward transactions, options and futures, swaps and exchange-traded funds. Currency speculation is carried out by speculators who do an important job of transferring the risk from those who can’t bear to those who are able to bear it. Speculators always face controversies because of the risk they take up. Currency trading is affected by some factors such as economic and financial situations, political scenarios, along with other psychological issues related to the markets.

 

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