A Brief Guide to Understanding Foreign Exchange Markets
Every day, the world’s many currencies are traded in Foreign Exchange Markets, sometimes referred to as “Forex” or “FX” Markets. The largest and most liquid of all financial markets, the amount of volume in trading on FX Markets daily is staggering – close to $4 trillion dollars U.S., one-third of which takes place in London.
Anyone who has ever changed money in a foreign country has gotten a taste of this system on its most basic level. Over the course of an extended visit in a foreign country, a traveler is sure to notice the rises and falls in the exchange rate.
A look through the financial section of any newspaper will offer further insight to any interested parties. In the exchange rate listings, readers will notice a “bid” price listed along with the “ask” price for the same currency. The ask price will be slightly higher than that which could be obtained by the average customer, as transaction fees are in effect included in these quotes. If the same customer wished to sell the currency back to a bank, the “bid’ price would be the one quoted, at a slightly lower rate. This difference – which always exists between the bid and ask quotes and is known as the “spread” – makes the FX Markets consistently lucrative for major banks.
Many different strategies are available to investors in the Forex Markets. While it is obvious that some currencies are devaluating or growing stronger in broader trends, the different fluctuations over a short period of time can be highly profitable for investors. At the same time, a long-term strategy may be a winning technique.
Because Forex Markets are profitable only when a tremendous amount of money is involved, the average stock market investor may see them as out of reach. The largest banks, which are also the ones setting the bid vs. ask price and getting access to these quotes, control the majority of transactions in the FX markets. Close to 80% of deals made everyday in the Forex Markets are transacted by one of the world’s 10 biggest banks. Companies like JP Morgan, Barclay’s and Deutsche Bank set the tone.
Speculation in the FX Markets is rampant. Hedge funds – known for the aggressive style of investment – have been a major force in FX since the mid-1990s. One of the advantages of such an aggressive style is the ability to counteract influence made on behalf of a currency by its government. While financial ministers may be able to control devaluation using a country’s central bank funds, investors can overwhelm a market with volume.
The factors which have an effect on a currency’s strength around the world are numerous: government budget deficits, as well as trade deficits, are key indicators, along with inflation levels, overall GDP movement, unemployment levels and government credit rating. In addition, political factors may also have an effect on the strength of a nation’s currency, as when a nation’s citizens begin to sell local currency off rapidly in favor of an international alternative.
An interesting feature of the FX is the fact that they never close between Monday and Friday. After the close of business in New York, traders can continue on in Europe and finally Asia before New York markets open once again in the morning.
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