Jan 23: The World Makes the Forex Market Go Round

by David Jenyns on January 23, 2007

You may wonder if it’s possible to day trade currencies along with trading stocks. Yes, it is possible to day trade currencies as well as trading stocks. In case you have ever wondered how the foreign exchange market, or Forex, works, here is an overview of some of the markets basic features.

First and foremost there are the foreign exchange rates, which is the proportional value of two currencies. To be more specific, it’s the required quantity of one particular currency to sell or buy a unit of another currency. There are two methods used to express a foreign exchange rate. The most common method would express the amount of foreign currency that is needed to buy one U.S. dollar. For instance, if a foreign exchange quote expressed as USD/CND at 1.4300, this means that one U.S. dollar can be exchanged for 1.43 Canadian dollars, and vise versa.

The second method is when the foreign exchange rate is expressed under the terms that the USD amount can be exchanged for one unit of a foreign currency. For instance, if a quote of CND/USD at 0.6700 means that one Canadian dollar can be exchanged for the same 0.6700 USD. When the USD is not used to convey an exchange rate, then the “cross rate” term is used to convey the proportional values between the two currencies. For instance, if the quote is DEM/SFR at .7000, this means that on German Mark can be exchanged for only .7 Swiss Francs.

Basis points are normally when the foreign exchange rate is expressed by a whole number followed by four decimal points. For example, 0.0001 is called a basis point. Therefore, if an exchange rate rises from 1.4550 to 1.4590, then the currency is said to have changed by 40 basis points.

The forex market is used to invest in other countries or even to buy foreign products. Sometimes individuals or firms who wish to buy foreign currencies or products, may need to get hold of some of the currency, beforehand, from the country in which they wish to do business with. Also, the exporters may require payment for services or goods in their own currency, or in USD, which is accepted throughout the world.

In the Forex market, a majority of selling and buying of foreign currencies throughout the world is taken place, mostly by the large commercial banks, who are the major traders in the forex market. With five major institutions based throughout the world in New York, London, Frankfurt, Zurich and Tokyo, the forex market is considered the largest financial market in the world by far, with the multitude of trading volumes exceeding 1.5 trillion USD on most days.

Consisting primarily of world wide network interbank traders who are connected together by computers and telephone lines, forex traders are incessantly negotiating prices among one another. These artful negotiations normally ensue in a market bid, or asking price, for a specific currency which is then introduce continuously into computers to be displayed on official quote screens. When the forex exchange rates are quoted between banks, this is called “Interbank Rates.”

The foreign exchange spreads are when the exchange rates in the forex market are cited as a two tier “bid” or “ask” rate. For instance, when a USD and a DEM is cited as 1.6000/15, the forex trader who cites this exchange rate is agreeing to buy the DEM’s at 1.6000 and sell them at 1.6015. The “spread” is the actual difference between cites of purchase and cites of sale and also illustrates the profit expected from the transaction for the forex trader. The “spread” may vary comprehensively on any specific currency, all depending on the currency’s strength or weakness, and even it’s past history or prospective volatility.

Many individuals may not be able to get hold of some foreign currencies at forex rates unless they become licensed traders through forex. Instead, those individuals may be able to come across foreign currency through a commercial bank, which may charge the individuals with either a commission or a higher spread than those reigning in the forex market. Sometimes these commercial banks will even charge individuals both commission and higher spread as to enable the bank to make a reasonable profit from the transaction.

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