Foreign currency markets account for almost two trillion dollars in transactions per day. It is the world’s largest market, and unlike markets such as the New York Stock Exchange, there is no central location. Traders can dealer with a number of brokers, since there is no need to funnel all trades through a seat on the exchange floor.
Foreign currency markets are extremely liquid. Trades can be made within minutes, depending on the currency and the rules of the broker. The high volume and frequent trades, along with the lack of centralization, mean that brokers can compete for clients through fee and commission structures.
There are basically five elements involved in foreign currency markets. Commercial banks comprise the bulk of foreign currency trading, and act not only for themselves but also their customers. Central banks function as regulators, whose interests lie in protecting the currency of their country. Corporations trade currency to make payments for international operations and to guard against the depreciation of currency. Global funds are seeking a profit for the accounts they manage. Individuals are also very active in the market, since the Internet has made it possible to trade quickly and easily for decent rates.
Trading in foreign currency markets is predicated on the changing values between the currencies of two nations. When the value of one member of the pair changes, so does the other. For each member, a bid price and an ask price will be established. The bid is the price the trader can sell at, and the ask is the price he can buy. The difference between the two is the spread, which is also how much the trader must earn to reach the break even point.
Foreign currency markets have been impacted dramatically by the advent of the Internet. Prior to the widespread use of computers and the Internet, foreign currency markets accounted for less than one billion dollars per day. Currently, foreign currency markets are almost two trillion dollars per day.
Analysis of foreign currency markets is usually based on one of two methods. The first is a statistical analysis of a currency’s past performance to predict future changes. The history is charted, graphed, and studied, and traders then use this information to make decisions. The second method is a broad analysis of not only a currency’s past performance but also the other economic indicators of the country, coupled with any business or political news that might affect the value of the currency.
There is no single center for foreign currency markets, but the most influential market is the one located in London. Most often, the rates quoted for a currency will be the price on the London market. There are also important market centers in Tokyo, Singapore, Hong Kong, and New York.
Many factors within a country can affect its performance in the foreign currency markets. For example, if the nation has a budget deficit, is experiencing inflation, or has a negative balance of trade, the currency may be devalued.