FOREX WORLD

Retail forex trading is a segment of the vast foreign exchange market. It has been speculated that it represents 2 percent of the whole forex market which amounts to $50-60 billion ^[1][2] in daily trading turnover. Due to the increasing tendency in the past years of the gradual shift from traditional intrabank 'paper' trading to the more advanced and accurate electronic trading, there has been spur in software development in this field. This change provided different types of trading platforms and tools intended for the use by banks, portfolio managers, retail brokers and retail traders.

One of the most important tools required to perform a forex transaction is the trading platform providing retail traders and brokers with accurate currency quotes.

History and new developments

Since 1996, when retail forex trading was introduced, several brokers who lacked the sufficient tools developed their own trading platforms tailored specifically to their needs. These platforms were good enough at the time but required constant investments in R&D and its development cost too much. This was the first wave.

The second wave was in the early 2000s: several software companies entered the retail forex trading market by launching their own versions of trading platforms. Typically these versions were cumbersome for both front-end users (retail traders) and back-end users (retail brokers) due to the misunderstanding of the developers about the forex market and also because of the insufficient programming tools/languages at the time. Simultaneously most of the retail brokers kept using and developing their own systems as they waited for better platforms which were yet to be developed.

There are currently few to no brokers which were part of the first wave trading systems. By now most of the first wave brokers have either vanished, merged or progressed to the second wave trading platforms – the most common example of which is Metaquotes.

It is only in the last couple of years that the advanced trading platforms started to emerge. These platforms put much stronger emphasis on the user interface (GUI) making it more accessible to the retail traders while making trading on it very simple and intuitive. Moreover a very strong emphasis was put on the back-end which allowed the retail brokers better control over their operations, better reporting and accurate system and ways to manage marketing campaigns. Gradually this wave is replacing the previous second wave with a major shift now to the friendlier and more intuitive systems of the third wave which according to Aite Group are necessary in order to maintain growth.

Nowadays, banks have also jumped on the retail forex trading platform bandwagon and have started offering those services to individual traders and money mangers, expanding the forex trading appeal. DBFX and Citibank are some of the banks that are currently offering this service.

A currency future, also FX future or foreign exchange future, is a futures contract to exchange one currency for another at a specified date in the future at a price (exchange rate) that is fixed on the purchase date. Typically, one of the currencies is the US dollar. The price of a future is then in terms of US dollars per unit of other currency. This can be different from the standard way of quoting in the spot foreign exchange markets. The trade unit of each contract is then a certain amount of other currency, for instance €125,000. Most contracts have physical delivery, so for those held at the end of the last trading day, actual payments are made in each currency. However, most contracts are closed out before that. Investors can close out the contract at any time prior to the contract's delivery date.

History

Currency futures were first created at the Chicago Mercantile Exchange (CME) in 1972, less than one year after the system of fixed exchange rates was abandoned along with the gold standard. Some commodity traders at the CME did not have access to the inter-bank exchange markets in the early 1970s, when they believed that significant changes were about to take place in the currency market. They established the International Monetary Market (IMM) and launched trading in seven currency futures on May 16, 1972. Today, the IMM is a division of CME. In the second quarter of 2005, an average of 332,000 contracts with a notional value of $43 billion were traded every day. Currently most of these are traded electronically

A free floating exchange rate increases foreign exchange volatility. There are economists who think that this could cause serious problems, especially in emerging economies. These economies have a financial sector with one or more of following conditions:

• high liability dollarization
• financial fragility
• strong balance sheet effects

When liabilities are denominated in foreign currencies while assets are in the local currency, unexpected depreciations of the exchange rate deteriorate bank and corporate balance sheets and threaten the stability of the domestic financial system.

For this reason emerging countries appear to face greater fear of floating, as they have much smaller variations of the nominal exchange rate, yet face bigger shocks and interest rate and reserve movements.This is the consequence of frequent free floating countries' reaction to exchange rate movements with monetary policy and/or intervention in the foreign exchange market.

A floating exchange rate or fluctuating exchange rate is a type of exchange rate regime wherein a currency's value is allowed to fluctuate according to the foreign exchange market. A currency that uses a floating exchange rate is known as a floating currency. It is not possible for a developing country to maintain the stability in the rate of exchange for its currency in the exchange market. There are two options open for them- Let the exchange rate be allowed to fluctuate in the open market according to the market conditions, or An equilibrium rate may be fixed to be adopted and attempts should be made to maintain it as far as possible. But, if there is a fundamental change in the circumstances, the rate should be changed accordingly. The rate of exchange under the first alternative is know as fluctuating rate of exchange and under second alternative, it is called flexible rate of exchange. In the modern economic conditions, the flexible rate of exchange system is more appropriate as it does not hamper the foreign trade. There are economists who think that, in most circumstances, floating exchange rates are preferable to fixed exchange rates. As floating exchange rates automatically adjust, they enable a country to dampen the impact of shocks and foreign business cycles, and to preempt the possibility of having a balance of payments crisis. However, in certain situations, fixed exchange rates may be preferable for their greater stability and certainty. This may not necessarily be true, considering the results of countries that attempt to keep the prices of their currency "strong" or "high" relative to others, such as the UK or the Southeast Asia countries before the Asian currency crisis. The debate of making a choice between fixed and floating exchange rate regimes is set forth by the Mundell-Fleming model, which argues that an economy cannot simultaneously maintain a fixed exchange rate, free capital movement, and an independent monetary policy. It can choose any two for control, and leave third to the market forces.

In cases of extreme appreciation or depreciation, a central bank will normally intervene to stabilize the currency. Thus, the exchange rate regimes of floating currencies may more technically be known as a managed float. A central bank might, for instance, allow a currency price to float freely between an upper and lower bound, a price "ceiling" and "floor". Management by the central bank may take the form of buying or selling large lots in order to provide price support or resistance, or, in the case of some national currencies, there may be legal penalties for trading outside these bounds.

A linked exchange rate system is a type of exchange rate regime to link the exchange rate of a currency to another. It is the exchange rate system implemented in Hong Kong to stabilise the exchange rate between the Hong Kong dollar (HKD) and the United States dollar (USD). The Macao pataca (MOP) is similarly linked to the Hong Kong dollar.

Unlike a fixed exchange rate system, the government or central bank does not actively interfere in the foreign exchange market by controlling supply and demand of the currency in order to influence the exchange rate. The exchange rate is stabilised by a mechanism.

History

As a response to the Black Saturday crisis in 1983, the linked exchange rate system was adopted in Hong Kong on October 17, 1983 through the currency board system. The redemption of certificates of indebtedness (for backing the banknotes) were sent out by note-issuing banks to peg the domestic currency against the US dollar at an internal fixed rate of HKD $7.80 = USD $1.

The Hong Kong Monetary Authority (HKMA), Hong Kong's de facto central bank, authorised note-issuing banks are to issue banknotes. These banks are required to have the same amount of USD to issue banknotes. The HKMA guarantees to exchange USD into HKD, or vice versa, at the rate of 7.80. When the market rate is below 7.80, the banks will convert USD for HKD from the HKMA, HKD supply will be increased, and the market rate will climb back to 7.80. The same mechanism also works when the market rate is above 7.80, and the banks will convert HKD for USD.

In practice, the HKMA also set a lower limit at 7.80 (7.85 as an upper limit and 7.75 as a lower limit since May 18, 2005) for the HKD to flow within. The HKMA will buy or sell HKD in the market when the exchange rate is at (or extremely close) the lower limit and upper limit respectively. The HKD is backed by one of the world's largest foreign exchange reserves, which is several times the amount of money supplied in circulation.

The currency band is a system of exchange rates by which a floating currency is backed by hard money.

A country selects a range, or "band", of values at which to set their currency, and returns to a fixed exchange rate if the value of their currency shifts outside this band. This allows for some revaluation, but tends to stabilize the currency's value within the band. In this sense, it is a compromise between a fixed (or "pegged") exchange rate and a floating exchange rate. For example, the exchange rate of the renminbi of the mainland of the People's Republic of China has recently been based upon a currency band; the European Economic Community's "snake in the tunnel" was a similar concept that failed, but ultimately led to the establishment of the European Exchange Rate Mechanism (ERM) and ultimately the Euro.

Typically, a government wanting to maintain a fixed exchange rate does so by either buying or selling its own currency on the open market. This is one reason governments maintain reserves of foreign currencies. If the exchange rate drifts too far below the desired rate, the government buys its own currency off the market using its reserves. This places greater demand on the market and pushes up the price of the currency. If the exchange rate drifts too far above the desired rate, the opposite measures are taken.

Another, less used means of maintaining a fixed exchange rate is by simply making it illegal to trade currency at any other rate. This is difficult to enforce and often leads to a black market in foreign currency. Nonetheless, some countries are highly successful at using this method due to government monopolies over all money conversion. This is the method employed by the Chinese government to maintain a currency peg or tightly banded float against the US dollar.Throughout the 1990s, China was highly successful at maintaining a currency peg using a government monopoly over all currency conversion between the yuan and other currencies

A fixed exchange rate, sometimes called a pegged exchange rate, is a type of exchange rate regime wherein a currency's value is matched to the value of another single currency or to a basket of other currencies, or to another measure of value, such as gold.

A fixed exchange rate is usually used to stabilize the value of a currency, against the currency it is pegged to. This makes trade and investments between the two countries easier and more predictable, and is especially useful for small economies where external trade forms a large part of their GDP.

It is also used as a means to control inflation. However, as the reference value rises and falls, so does the currency pegged to it. In addition, a fixed exchange rate prevents a government from using domestic monetary policy in order to achieve macroeconomic stability.

A former president of the Federal Reserve Bank of New York described fixed currencies as follows:

Float

Floating rates are the most common exchange rate regime today. For example, the dollar, euro, yen, and British pound all float. However, since central banks frequently intervene to avoid excessive appreciation or depreciation, these regimes are often called managed float or a dirty float.

Pegged float

Here, the currency is pegged to some band or value, either fixed or periodically adjusted. Pegged floats are:

• Crawling bands: the rate is allowed to fluctuate in a band around a central value, which is adjusted periodically. This is done at a preannounced rate or in a controlled way following economic indicators.
• Crawling pegs: Here, the rate itself is fixed, and adjusted as above.
• Pegged with horizontal bands: The currency is allowed to fluctuate in a fixed band (bigger than 1%) around a central rate.

Fixed

Fixed rates are those that have direct convertibility towards another currency. In case of a separate currency, also known as a currency board arrangement, the domestic currency is backed one to one by foreign reserves. A pegged currency with very small bands (< class="editsection">

The exchange rate regime is the way a country manages its currency in respect to foreign currencies and the foreign exchange market. It is closely related to monetary policy and the two are generally dependent on many of the same factors.

The basic types are a floating exchange rate, where the market dictates the movements of the exchange rate, a pegged float, where the central bank keeps the rate from deviating too far from a target band or value, and the fixed exchange rate, which ties the currency to another currency, mostly more widespread currencies such as the U.S. dollar or the euro.

In finance, a forex swap (or FX swap) is a simultaneous purchase and sale of identical amounts of one currency for another with two different value dates (normally spot to forward).

Structure

A forex swap consists of two legs:

• a spot foreign exchange transaction, and
• a forward foreign exchange transaction.

These two legs are executed simultaneously for the same quantity, and therefore offset each other.

It is also common to trade forward-forward, where both transactions are for (different) forward dates.

Uses

By far and away the most common use of FX swaps is for institutions to fund their foreign exchange balances.

Once a foreign exchange transaction settles, the holder is left with a positive (or long) position in one currency, and a negative (or short) position in another. In order to collect or pay any overnight interest due on these foreign balances, at the end of every day institutions will close out any foreign balances and re-institute them for the following day. To do this they typically use tom-next swaps, buying (selling) a foreign amount settling tomorrow, and selling (buying) it back settling the day after.

The interest collected or paid every night is referred to as the cost of carry. As currency traders know roughly how much holding a currency position will make or cost on a daily basis, specific trades are put on based on this; these are referred to as carry trades.

Electronic trading is growing in the FX market, and algorithmic trading is becoming much more common. According to financial consultancy Celent estimates, by 2008 up to 25% of all trades by volume will be executed using algorithm, up from about 18% in 2005.^{[citation needed]}

Financial instruments

Spot

A spot transaction is a two-day delivery transaction (except in the case of trades between the US Dollar, Canadian Dollar, Turkish Lira and Russian Ruble, which settle the next business day), as opposed to the futures contracts, which are usually three months. This trade represents a “direct exchange” between two currencies, has the shortest time frame, involves cash rather than a contract; and interest is not included in the agreed-upon transaction. The data for this study come from the spot market. Spot transactions has the second largest turnover by volume after Swap transactions among all FX transactions in the Global FX market. NNM

Forward

One way to deal with the foreign exchange risk is to engage in a forward transaction. In this transaction, money does not actually change hands until some agreed upon future date. A buyer and seller agree on an exchange rate for any date in the future, and the transaction occurs on that date, regardless of what the market rates are then. The duration of the trade can be a one day, a few days, months or years. Usually the date is decided by both parties.

Future

Foreign currency futures are exchange traded forward transactions with standard contract sizes and maturity dates — for example, $1000 for next November at an agreed rate. Futures are standardized and are usually traded on an exchange created for this purpose. The average contract length is roughly 3 months. Futures contracts are usually inclusive of any interest amounts.

Swap

The most common type of forward transaction is the currency swap. In a swap, two parties exchange currencies for a certain length of time and agree to reverse the transaction at a later date. These are not standardized contracts and are not traded through an exchange.

Option

A foreign exchange option (commonly shortened to just FX option) is a derivative where the owner has the right but not the obligation to exchange money denominated in one currency into another currency at a pre-agreed exchange rate on a specified date. The FX options market is the deepest, largest and most liquid market for options of any kind in the world..

Exchange-Traded Fund

Exchange-traded funds (or ETFs) are open ended investment companies that can be traded at any time throughout the course of the day. Typically, ETFs try to replicate a stock market index such as the S&P 500 (e.g., SPY), but recently they are now replicating investments in the currency markets with the ETF increasing in value when the US Dollar weakens versus a specific currency, such as the Euro. Certain of these funds track the price movements of world currencies versus the US Dollar, and increase in value directly counter to the US Dollar, allowing for speculation in the US Dollar for US and US Dollar denominated investors and speculators.

Market psychology

Market psychology and trader perceptions influence the foreign exchange market in a variety of ways:

Flights to quality

Unsettling international events can lead to a "flight to quality," with investors seeking a "safe haven." There will be a greater demand, thus a higher price, for currencies perceived as stronger over their relatively weaker counterparts. The Swiss franc has been a traditional safe haven during times of political or economic uncertainty.

Long-term trends

Currency markets often move in visible long-term trends. Although currencies do not have an annual growing season like physical commodities, business cycles do make themselves felt. Cycle analysis looks at longer-term price trends that may rise from economic or political trends.

"Buy the rumor, sell the fact"

This market truism can apply to many currency situations. It is the tendency for the price of a currency to reflect the impact of a particular action before it occurs and, when the anticipated event comes to pass, react in exactly the opposite direction. This may also be referred to as a market being "oversold" or "overbought". To buy the rumor or sell the fact can also be an example of the cognitive bias known as anchoring, when investors focus too much on the relevance of outside events to currency prices.

Economic numbers

While economic numbers can certainly reflect economic policy, some reports and numbers take on a talisman-like effect: the number itself becomes important to market psychology and may have an immediate impact on short-term market moves. "What to watch" can change over time. In recent years, for example, money supply, employment, trade balance figures and inflation numbers have all taken turns in the spotlight.

Technical trading considerations

As in other markets, the accumulated price movements in a currency pair such as EUR/USD can form apparent patterns that traders may attempt to use. Many traders study price charts in order to identify such patterns.

Internal, regional, and international political conditions and events can have a profound effect on currency markets.

All exchange rates are susceptible to political instability and anticipations about the new ruling party. Political upheaval and instability can have a negative impact on a nation's economy. For example, destabilization of coalition governments in Pakistan and Thailand can negatively affect the value of their currencies. Similarly, in a country experiencing financial difficulties, the rise of a political faction that is perceived to be fiscally responsible can have the opposite effect. Also, events in one country in a region may spur positive or negative interest in a neighboring country and, in the process, affect its currency.

These include: (a)economic policy, disseminated by government agencies and central banks, (b)economic conditions, generally revealed through economic reports, and other economic indicators.

1. Economic policy comprises government fiscal policy (budget/spending practices) and monetary policy (the means by which a government's central bank influences the supply and "cost" of money, which is reflected by the level of interest rates).
2. Economic conditions include:

   Government budget deficits or surpluses

   The market usually reacts negatively to widening government budget deficits, and positively to narrowing budget deficits. The impact is reflected in the value of a country's currency.

   Balance of trade levels and trends

   The trade flow between countries illustrates the demand for goods and services, which in turn indicates demand for a country's currency to conduct trade. Surpluses and deficits in trade of goods and services reflect the competitiveness of a nation's economy. For example, trade deficits may have a negative impact on a nation's currency.

   Inflation levels and trends

   Typically a currency will lose value if there is a high level of inflation in the country or if inflation levels are perceived to be rising [. This is because inflation erodes purchasing power, thus demand, for that particular currency. However, a currency may sometimes strengthen when inflation rises because of expectations that the central bank will raise short-term interest rates to combat rising inflation.

   Economic growth and health

   Reports such as GDP, employment levels, retail sales, capacity utilization and others, detail the levels of a country's economic growth and health. Generally, the more healthy and robust a country's economy, the better its currency will perform, and the more demand for it there will be.

   Productivity of an economy

   Increasing productivity in an economy should positively influence the value of its currency. Its effects are more prominent if the increase is in the traded sector

The following theories explain the fluctuations in FX rates in a floating exchange rate regime (In a fixed exchange rate regime, FX rates are decided by its government):

(a) International parity conditions viz; purchasing power parity, interest rate parity, Domestic Fisher effect, International Fisher effect. Though to some extent the above theories provide logical explanation for the fluctuations in exchange rates, yet these theories falter as they are based on challengeable assumptions [e.g., free flow of goods, services and capital] which seldom hold true in the real world.

(b) Balance of payments model (see exchange rate). This model, however, focuses largely on tradable goods and services, ignoring the increasing role of global capital flows. It failed to provide any explanation for continuous appreciation of dollar during 1980s and most part of 1990s in face of soaring US current account deficit.

(c) Asset market model (see exchange rate) views currencies as an important asset class for constructing investment portfolios. Assets prices are influenced mostly by people’s willingness to hold the existing quantities of assets, which in turn depends on their expectations on the future worth of these assets. The asset market model of exchange rate determination states that “the exchange rate between two currencies represents the price that just balances the relative supplies of, and demand for, assets denominated in those currencies.”

None of the models developed so far succeed to explain FX rates levels and volatility in the longer time frames. For shorter time frames (less than a few days) algorithm can be devised to predict prices. Large and small institutions and professional individual traders have made consistent profits from it. It is understood from above models that many macroeconomic factors affect the exchange rates and in the end currency prices are a result of dual forces of demand and supply. The world's currency markets can be viewed as a huge melting pot: in a large and ever-changing mix of current events, supply and demand factors are constantly shifting, and the price of one currency in relation to another shifts accordingly. No other market encompasses (and distills) as much of what is going on in the world at any given time as foreign exchange.

Supply and demand for any given currency, and thus its value, are not influenced by any single element, but rather by several. These elements generally fall into three categories: economic factors, political conditions and market psychology.

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Look, I’m not talking about the standard, everyday stuff you find in every forex trading book. Go through ANY book in the library, on Amazon.com, or local book store on Forex trading and you’ll find the following…

1. Basic introduction and glossary on the forex market.
2. Description of a dozen or more chart patterns.

The only problem with those trading techniques is that you have to recognize and interpret these “chart patterns”. Hardly a reliable approach. Then there are the system sellers…

There is no unified or centrally cleared market for the majority of FX trades, and there is very little cross-border regulation. Due to the over-the-counter (OTC) nature of currency markets, there are rather a number of interconnected marketplaces, where different currencies

Currency distribution of reported FX market turnover

Rank	Currency	ISO 4217 code (Symbol)	% daily share (April 2007)
1	United States dollar	USD ($)	86.3%
2	Euro	EUR (€)	37.0%
3	Japanese yen	JPY (¥)	17.0%
4	Pound sterling	GBP (£)	15.0%
5	Swiss franc	CHF (Fr)	6.8%
6	Australian dollar	AUD ($)	6.7%
7	Canadian dollar	CAD ($)	4.2%
8-9	Swedish krona	SEK (kr)	2.8%
8-9	Hong Kong dollar	HKD ($)	2.8%
10	Norwegian krone	NOK (kr)	2.2%
11	New Zealand dollar	NZD ($)	1.9%
12	Mexican peso	MXN ($)	1.3%
13	Singapore dollar	SGD ($)	1.2%
14	South Korean won	KRW (₩)	1.1%
Other			14.5%
Total			200%

Instruments are traded. This implies that there is not a single exchange rate but rather a number of different rates (prices), depending on what bank or market maker is trading, and where it is. In practice the rates are often very close, otherwise they could be exploited by arbitrageurs instantaneously. Due to London's dominance in the market, a particular currency's quoted price is usually the London market price. A joint venture of the Chicago Mercantile Exchange and Reuters, called Fxmarketspace opened in 2007 and aspired but failed to the role of a central market clearing mechanism.

The main trading center is London, but New York, Tokyo, Hong Kong and Singapore are all important centers as well. Banks throughout the world participate. Currency trading happens continuously throughout the day; as the Asian trading session ends, the European session begins, followed by the North American session and then back to the Asian session, excluding weekends.

Fluctuations in exchange rates are usually caused by actual monetary flows as well as by expectations of changes in monetary flows caused by changes in gross domestic product (GDP) growth, inflation (purchasing power parity theory), interest rates (interest rate parity, Domestic Fisher effect, International Fisher effect), budget and trade deficits or surpluses, large cross-border M&A deals and other macroeconomic conditions. Major news is released publicly, often on scheduled dates, so many people have access to the same news at the same time. However, the large banks have an important advantage; they can see their customers' order flow.

Currencies are traded against one another. Each pair of currencies thus constitutes an individual product and is traditionally noted XXXYYY or YYY/XXX, where YYY is the ISO 4217 international three-letter code of the currency into which the price of one unit of XXX is expressed (called base currency). For instance, EURUSD or USD/EUR is the price of the euro expressed in US dollars, as in 1 euro = 1.5465 dollar. Out of convention, the first currency in the pair, the "base" currency, was the stronger currency at the creation of the pair. The second currency, counter currency or "term" currency, was the weaker currency at the creation of the pair. Currencies are occasionally incorrectly quoted with the pairs inverted e.g. EUR/USD but this is incorrect. The "/" acts the same as the divide mathematical operator and derives the actual exchange rate. e.g. an amount of $140,000 equates to €100,000. $140,000/€100,000 = $/€ = USD/EUR = a rate of 1.4 hence EURUSD or USD/EUR. See Exchange_rate

The factors affecting XXX will affect both XXXYYY and XXXZZZ. This causes positive currency correlation between XXXYYY and XXXZZZ.

On the spot market, according to the BIS study, the most heavily traded products were:

• EURUSD: 27%
• USDJPY: 13%
• GBPUSD (also called cable): 12%

and the US currency was involved in 86.3% of transactions, followed by the euro (37.0%), the yen (17.0%), and sterling (15.0%) (see table). Volume percentages for all individual currencies should add up to 200%, as each transaction involves two currencies.

Trading in the euro has grown considerably since the currency's creation in January 1999, and how long the foreign exchange market will remain dollar-centered is open to debate. Until recently, trading the euro versus a non-European currency ZZZ would have usually involved two trades: EURUSD and USDZZZ. The exception to this is EURJPY, which is an established traded currency pair in the interbank spot market. As the dollar's value has eroded during 2008, interest in using the euro as reference currency for prices in commodities (such as oil), as well as a larger component of foreign reserves by banks, has increased dramatically. Transactions in the currencies of commodity-producing countries, such as AUD, NZD,

Banks

The interbank market caters for both the majority of commercial turnover and large amounts of speculative trading every day. A large bank may trade billions of dollars daily. Some of this trading is undertaken on behalf of customers, but much is conducted by proprietary desks, trading for the bank's own account. Until recently, foreign exchange brokers did large amounts of business, facilitating interbank trading and matching anonymous counterparts for small fees. Today, however, much of this business has moved on to more efficient electronic systems. The broker squawk box lets traders listen in on ongoing interbank trading and is heard in most trading rooms, but turnover is noticeably smaller than just a few years ago.

Commercial companies

An important part of this market comes from the financial activities of companies seeking foreign exchange to pay for goods or services. Commercial companies often trade fairly small amounts compared to those of banks or speculators, and their trades often have little short term impact on market rates. Nevertheless, trade flows are an important factor in the long-term direction of a currency's exchange rate. Some multinational companies can have an unpredictable impact when very large positions are covered due to exposures that are not widely known by other market participants.

Central banks

National central banks play an important role in the foreign exchange markets. They try to control the money supply, inflation, and/or interest rates and often have official or unofficial target rates for their currencies. They can use their often substantial foreign exchange reserves to stabilize the market. Milton Friedman argued that the best stabilization strategy would be for central banks to buy when the exchange rate is too low, and to sell when the rate is too high—that is, to trade for a profit based on their more precise information. Nevertheless, the effectiveness of central bank "stabilizing speculation" is doubtful because central banks do not go bankrupt if they make large losses, like other traders would, and there is no convincing evidence that they do make a profit trading.

The mere expectation or rumor of central bank intervention might be enough to stabilize a currency, but aggressive intervention might be used several times each year in countries with a dirty float currency regime. Central banks do not always achieve their objectives. The combined resources of the market can easily overwhelm any central bank.^[7] Several scenarios of this nature were seen in the 1992–93 ERM collapse, and in more recent times in Southeast Asia.

Hedge funds as speculators

About 70% to 90%^{[citation needed]} of the foreign exchange transactions are speculative. In other words, the person or institution that bought or sold the currency has no plan to actually take delivery of the currency in the end; rather, they were solely speculating on the movement of that particular currency. Hedge funds have gained a reputation for aggressive currency speculation since 1996. They control billions of dollars of equity and may borrow billions more, and thus may overwhelm intervention by central banks to support almost any currency, if the economic fundamentals are in the hedge funds' favor.

Investment management firms

Investment management firms (who typically manage large accounts on behalf of customers such as pension funds and endowments) use the foreign exchange market to facilitate transactions in foreign securities. For example, an investment manager bearing an international equity portfolio needs to purchase and sell several pairs of foreign currencies to pay for foreign securities purchases.

Some investment management firms also have more speculative specialist currency overlay operations, which manage clients' currency exposures with the aim of generating profits as well as limiting risk. Whilst the number of this type of specialist firms is quite small, many have a large value of assets under management (AUM), and hence can generate large trades.

Retail foreign exchange brokers

There are two types of retail brokers offering the opportunity for speculative trading: retail foreign exchange brokers and market makers. Retail traders (individuals) are a small fraction of this market and may only participate indirectly through brokers or banks. Retail brokers, while largely controlled and regulated by the CFTC and NFA might be subject to foreign exchange scams.^[8][9] At present, the NFA and CFTC are imposing stricter requirements, particularly in relation to the amount of Net Capitalization required of its members. As a result many of the smaller, and perhaps questionable brokers are now gone. It is not widely understood that retail brokers and market makers typically trade against their clients and frequently take the other side of their trades. This can often create a potential conflict of interest and give rise to some of the unpleasant experiences some traders have had. A move toward NDD (No Dealing Desk) and STP (Straight Through Processing) has helped to resolve some of these concerns and restore trader confidence, but caution is still advised in ensuring that all is as it is presented.

Non-bank Foreign Exchange Companies

Non-bank foreign exchange companies offer currency exchange and international payments to private individuals and companies. These are also known as foreign exchange brokers but are distinct in that they do not offer speculative trading but currency exchange with payments. I.e., there is usually a physical delivery of currency to a bank account. Send Money Home offer an in-depth comparison into the services offered by all the major non-bank foreign exchange companies.

It is estimated that in the UK, 14% of currency transfers/payments are made via Foreign Exchange Companies. These companies' selling point is usually that they will offer better exchange rates or cheaper payments than the customer's bank. These companies differ from Money Transfer/Remittance Companies in that they generally offer higher-value services.

Money Transfer/Remittance Companies

Money transfer companies/remittance companies perform high-volume low-value transfers generally by economic migrants back to their home country. In 2007, the Aite Group estimated that there were $369 billion of remittances (an increase of 8% on the previous year). The four largest markets (India, China, Mexico and the Philippines) receive $95 billion. The largest and best known provider is Western Union with 345,000 agents globally.

Send Money Home is an international money transfer price comparison site that allows consumers access to a range of alternative products and rates available when remitting (transferring) money worldwide.

Unlike a stock market, where all participants have access to the same prices, the foreign exchange market is divided into levels of access. At the top is the inter-bank market, which is made up of the largest commercial banks and securities dealers. Within the inter-bank market, spreads, which are the difference between the bid and ask prices, are razor sharp and usually unavailable, and not known to players outside the inner circle. The difference between the bid and ask prices widens (from 0-1 pip to 1-2 pips for some currencies such as the EUR). This is due to volume. If a trader can guarantee large numbers of transactions for large amounts, they can demand a smaller difference between the bid and ask price, which is referred to as a better spread. The levels of access that make up the foreign exchange market are determined by the size of the "line" (the amount of money with which they are trading). The top-tier inter-bank market accounts for 53% of all transactions. After that there are usually smaller banks, followed by large multi-national corporations (which need to hedge risk and pay employees in different countries), large hedge funds, and even some of the retail FX-metal market makers. According to Galati and Melvin, “Pension funds, insurance companies, mutual funds, and other institutional investors have played an increasingly important role in financial markets in general, and in FX markets in particular, since the early 2000s.” (2004) In addition, he notes, “Hedge funds have grown markedly over the 2001–2004 period in terms of both number and overall size” Central banks also participate in the foreign exchange market to align currencies to their economic needs.

The foreign exchange market is the largest and most liquid financial market in the world. Traders include large banks, central banks, currency speculators, corporations, governments, and other financial institutions. The average daily volume in the global foreign exchange and related markets is continuously growing. Daily turnover was reported to be over US$3.2 trillion in April 2007 by the Bank for International Settlements. Since then, the market has continued to grow. According to Euromoney's annual FX Poll, volumes grew a further 41% between 2007 and 2008.

Of the $3.98 trillion daily global turnover, trading in London accounted for around $1.36 trillion, or 34.1% of the total, making London by far the global center for foreign exchange. In second and third places respectively, trading in New York accounted for 16.6%, and Tokyo accounted for 6.0%. In addition to "traditional" turnover, $2.1 trillion was traded in derivatives.

Exchange-traded FX futures contracts were introduced in 1972 at the Chicago Mercantile Exchange and are actively traded relative to most other futures contracts.

The foreign exchange market (currency, forex, or FX) trades currencies. It lets banks and other institutions easily buy and sell currencies.

The purpose of the foreign exchange market is to help international trade and investment. A foreign exchange market helps businesses convert one currency to another. For example, it permits a U.S. business to import European goods and pay Euros, even though the business's income is in U.S. dollars.

In a typical foreign exchange transaction a party purchases a quantity of one currency by paying a quantity of another currency. The modern foreign exchange market started forming during the 1970s when countries gradually switched to floating exchange rates from the previous exchange rate regime, which remained fixed as per the Bretton Woods system.

The foreign exchange market is unique because of

• its trading volumes,
• the extreme liquidity of the market,
• its geographical dispersion,
• its long trading hours: 24 hours a day except on weekends (from 22:00 UTC on Sunday until 22:00 UTC Friday),
• the variety of factors that affect exchange rates.
• the low margins of profit compared with other markets of fixed income (but profits can be high due to very large trading volumes)
• the use of leverage

As such, it has been referred to as the market closest to the ideal perfect competition, notwithstanding market manipulation by central banks. According to the Bank for International Settlements,^[2] average daily turnover in global foreign exchange markets is estimated at $3.98 trillion. Trading in the world's main financial markets accounted for $3.21 trillion of this. This approximately $3.21 trillion in main foreign exchange market turnover was broken down as follows:

• $1.005 trillion in spot transactions
• $362 billion in outright forwards
• $1.714 trillion in foreign exchange swaps
• $129 billion estimated gaps in reporting