Also: Foreign Exchange Market or FX
This is a decentralized, over-the-counter market which enables the trading of currencies. It is the market that determines the foreign exchange rates for every currency. This is the largest market by volume, eclipsing the credit market.
The FOREX is comprised most of large international banks. They trade currencies around the clock, except on weekends. All currencies are traded in pair. Therefore, there is no absolute rate on a currency, only a relative one as compared to the other end of the pair.
Financial institutions are the ones who facilitate the transactions. A small number of dealers make up the majority of the FOREX trading. These are typically banks although there are a few insurance companies and other kinds of financial firms involved. This is basically an interbank market since we are seeing mostly bank-on-bank relationships.
Transactions are very large, often getting into the hundreds of millions of dollars. This is mostly an unregulated market.
International trade and investments are assisted by the foreign exchange market. For example, it will allow companies in one country to pay in the currency of that in another country. A US based entity could pay in EURO even though it operates in USD. The FOREX enables this.
Speculators can also place trades based upon where they think things are going. They can do this via direct price movement or engage in a carry trade.
In the 1970s, the number of FOREX transactions took off as countries started to let the exchange rate on their currencies float. This was a reversal of the mindset under the Bretton Woods system where governments restricted the transactions.
Unique Characteristics
- its huge trading volume, representing the largest asset class in the world leading to high liquidity
- its geographical dispersion
- its continuous operation: 24 hours a day except for weekends
- the variety of factors that affect exchange rates
- the low margins of relative profit compared with other markets of fixed income
- the use of leverage to enhance profit and loss margins and with respect to account size
What really sets is apart is the size. While the US equity market is roughly $50 trillion, FOREX was estimated to be $2.4 quadrillion in 2019. There was $6.6 trillion traded daily at that time.