Forex Market: Overview

Welcome to Global Foreign Exchange Market (FX or Forex or Foreign Currency)!!!

The largest financial market in the world, measured by daily transaction turnover, with more than US $5 trillion traded per day—greater than the combined size of the world’s stock and bond markets. It is a decentralized market where currencies are traded between two or more parties globally.

The market has high liquidity due to the large number of traders (buyers and sellers) across the world. It also has a relatively small difference between bid and ask prices. Unlike other markets, forex trading, investing, and management activities continue to grow day by day.

Market Structure

There are two types of markets based on transaction mechanisms:

1. OTC (Over the Counter) – A market where transactions take place directly between two parties without a broker or any third party. It is known as the OTC market and is also referred to as a decentralized market, as there is no central authority governing transactions.

2. Exchange Market – A market where transactions take place between two or more parties through a broker or intermediary. It is known as a centralized market. Examples include stock markets and bond markets.

In the case of the forex market, most transactions occur directly in the OTC market, making it independent of centralized exchanges. Due to high liquidity and accessibility, the market experiences a large volume of transactions and participants.

Market Participants

In the forex market, there are various participants such as central banks, commercial banks, investment banks, hedge funds, retail investors, financial brokers, and mutual funds.

These participants have different objectives for trading. Some engage in transactions to stabilize their economies, some manage reserves for private entities, while others act as intermediaries facilitating trades.

Let's look at each of them and understand their objectives and roles.

Participants in FOREX MARKET

Commercial Banks

Commercial banks are major participants in the forex market. It can be said that central banks form the core of the foreign exchange system. Globally, around 100–200 central banks are involved. The key objectives include:

• Serving retail customers
• Serving corporate/bank customers
• Making international investments in financial assets requiring foreign exchange

Commercial banks operate in the forex market in two ways:

1. Retail Level: At the retail level, transactions occur with exporters, importers, and corporate clients.
2. Wholesale Level: At the wholesale level, banks operate in the interbank market, either directly or through specialized foreign exchange brokers.

Small Banks and Investors

These participants are also part of the foreign exchange market. Their transaction volumes are smaller compared to major participants, but they play an important role, especially in hedging activities.

Central Banks

Central banks are the monetary authorities of their respective countries and actively participate in forex markets.

They intervene in the forex market to maintain currency stability within desired ranges and to smooth excessive fluctuations.

Forex Brokers

Foreign exchange brokers act as intermediaries who facilitate trading between market participants. Unlike other participants, they do not trade for themselves but help match buyers and sellers.

MNCs

Multinational corporations (MNCs) use derivatives, particularly forward contracts, to manage foreign exchange risk. They exchange cash flows across international operations and hedge future exposures due to constant currency fluctuations.

MNCs are among the largest non-bank participants in the foreign exchange market.

Major Currencies and Trade System

In the forex market, there are numerous currencies and currency pairs, but a few major currencies account for the majority of global transactions.

Six major currencies include:

1. The US Dollar (USD)
2. The Euro (EUR)
3. The Japanese Yen (JPY)
4. The British Pound (GBP)
5. The Swiss Franc (CHF)
6. The Canadian Dollar (CAD)

There are various trading systems through which transactions occur in the forex market, but commonly, three types are:

1. Trading through brokers
2. Direct dealing
3. Matching systems

Market Analysis

There are different methods of market analysis depending on participants’ objectives, time horizons, and strategies. However, the three most commonly used types are:

1. Fundamental Analysis
2. Technical Analysis
3. Sentiment Analysis

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