Exists wherever one currency is traded for another. It is by far the largest market in the world, in terms of cash value traded, and includes trading between large banks, central banks, currency speculators, multinational corporations, governments, and other financial markets and institutions. Retail traders are a small part of this market.

Market size and liquidity

The foreign exchange market is unique because of its trading volume, the extreme liquidity of the market, the large number of, and variety of, traders in the market,

its geographical dispersion and its long trading hours - 24 hours a day

Average international foreign exchange trading is in the range of US$2 trillion daily

Out of which $600 billion spot and $1,300billion in derivatives.

Exchange-traded forex futures were introduced in 1972 at the Chicago Mercantile Exchange and are actively traded relative to most other futures contracts. Forex futures volume has grown rapidly in recent years.

The ten most active traders account for almost 73% of trading volume. These large international banks continually provide the market with trading prices. The bid / ask spread is the difference between the price at which a bank will sell to and the price at which it will buy from a wholesale customer. This spread is minimal but as the volunme is huge the returns are also impressive. Minimum trading size for most deals is usually $1,000,000.

There is no single unified foreign exchange market. Due to the OTC nature of currency markets, there are rather a number of interconnected marketplaces, where different currency instruments are traded.

Most traded currencies are the US$, the Euro, the Yen, the Pound Sterling, the Swiss Franc and the Australian $.

Main trading centers are London, New York, and Tokyo, but banks throughout the world participate.

Exchange rate fluctuations are usually caused by actual monetary flows as well as by expectations of changes in monetary flows caused by changes in GDP growth, inflation, interest rates, budget and trade deficits or surpluses, and other macroeconomic conditions. While these data are open large banks have an important advantage, as they can see their customers order flow.

Currencies are traded against one another. Each pair of currencies thus constitutes an individual product. For instance, EUR/USD is the price of the Euro expressed in US$, as in 1 Euro = 1.2045 dollar.

Although trading in the Euro has grown considerably since the currency's creation in January 1999, the foreign exchange market is still dollar-centered. For instance, trading the euro versus a non-European currency will usually involve two trades: EUR/USD and USD/ A currency. The only exception to this is EUR/JPY, which is an established traded currency pair in the interbank spot market.

Market participants

While 53% of transactions are strictly interbank, 33% involve a dealer and a fund manager or some other non-bank financial institution. Only 14% are between a dealer and a non-financial company.

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 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 electronic systems, such as EBS or Reuters, the Chicago Mercantile Exchange, Bloomberg and TradeBook. 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 trade fairly small amounts compared to those of banks or speculators, but trade flows are still an important factor in the long-term direction of a currency's exchange rate.

Central Banks

play an important role. 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 foreign exchange reserves, to stabilize the market.

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, however. The combined resources of the market can easily overwhelm any central bank.

Investment Management firms

Typically manage large accounts on behalf of customers such as pension funds, or endowments etc utilise the Foreign exchange market to facilitate transactions in foreign securities.

An investment manager with an international equity portfolio will need to buy and sell foreign currencies in the 'spot' market in order to pay for, and redeem, purchases and sales of foreign equities.

Some investment management firms also possess specialist currency overlay units, which have the specific objective of managing clients' currency exposures with the aim of generating profits whilst limiting risk. Whilst the number of dedicated currency managers is quite small, the size of their AuM can be significant, which can lead to large trades.

Hedge Funds

They have gained a reputation for aggressive currency speculation since 1990. 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.

Retail Forex Brokers

Retail forex brokers handle according to estimates not more than $25-50 billion daily, which comes just to 2% of the whole market.

Speculation

Controversy about currency speculators and their effect on currency devaluations and national economies recurs regularly. Nevertheless, many economists argue that speculators perform the important function of providing a market for hedgers and transferring risk from those people who don't wish to bear it, to those who do. Other economists however, may consider this argument to be based more on politics and a free market philosophy than on economics.

Large hedge funds and other well capitalized "position traders" are the main professional speculators.

Currency speculation is considered a highly suspect activity in many countries. For many it is simply gambling, that often interferes with economic policy. For example, in 1992, currency speculation forced the Central Bank of Sweden to raise interest rates for a few days to 150% per annum, and later to devalue the krona. Former Malaysian Prime Minister Mahathir Mohamad is one well known proponent of this view. He blamed the devaluation of the Malaysian ringgit in 1997 on pure speculation.

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