The retail foreign exchange market is a global entity with the special feature of over-the-counter decentralization to the extent that it provides a platform for traders to carry out transaction on all weekdays on a 24-hour basis. Rates are fixed with relation to different currencies through this market.
Market Size and Liquidity
The retail forex market is not only the biggest but also most liquid money market in the world. Traders can be individuals but they could also be central banks, financial institutions and even governments. The everyday turnover of the foreign exchange market the world over is in trillions of dollars.
In terms of volumes of business, London occupies the first place at about 34% of the daily global turnover. This is followed by New York at 16% and Tokyo with 6%. The volume of the forex market increased by 38% between the years 2005 and 2006.
The foreign exchange market differs from the stock market in as much as there are different levels of access. At the apex of the structure are the huge international banks and securities dealers. As one moves down the ladder, other agencies and individuals are to be seen operating on various levels. The main participants are as follows:
- Central Banks: The central banks of countries are very instrumental in the dynamics of theforex market. Their main aim is to regulate money supply and usually have targets for their rates. As they have the resources to intervene and stabilize the rates, they usually have considerable success implementing their fiscal policies.
- Hedge Funds as Speculators: This form of trader occupies a major chunk of the foreign exchange transactions – up to 90%. The speculator usually does not intend to accept final delivery but only aims to move the currency from one point to another, earning some profit in the process.
- Investment Management Firms: These companies represent customers in the management of large accounts. The money of the clients of these investment management firms is invested in the foreign exchange market.
- Retail Foreign Exchange Brokers: This segment consists of individuals who offer an indirect participation in foreign exchange trading. In the recent past there have been a lot of changes in national and international regulations, which has resulted in making this sector more reliable.
- Non-Bank Foreign Exchange Companies: These are companies which offer foreign exchange trading to individuals. They are set apart from the rest in so much as there is no element of hedging and speculation here – the transactions culminate in delivery into the bank account. These companies differ from money transfer or remittance companies because the services offered are of higher value.
- Money Transfer/Remittance Companies: These companies deal in low-value transactions but the volume of transactions is high. These services are usually used by migrants who wish to send money to their native country.
Different currencies are traded with reference to each other, and there is a format to this. Trading is usually done in the form of “currency pairs”. Each currency has a designated three-character symbol, for example, USD denotes U. S. dollars and EUR denotes euros. The currency pairs would thus be in the form of XXX/YYY or USD/EUR and so on.
Determinants of Foreign Exchange Rates
There are several theories which attempt to explain the influencing factors of foreign exchange rates. These theories however do have their limitations, as each one is restricted to a set of conditions, which cannot be applied universally to the worldwide forex market. However it is possible to broadly classify the determinants of foreign exchange rates into the following three categories:
- Economic Factors: The fiscal and monetary policies of governments can push the cost of money up and down according to the difference in interest rates. Deficit and surplus in budgeting is another important factor. Level of imports and exports also has a major influence on the market. Other factors include inflation levels, productivity and the overall economic growth of countries.
- Political Conditions: The political climate of nations has an influence on the money markets too. A country under political upheaval will cause the forex market to have an adverse effect with relation its own currency. Also, the happenings in one nation or area can have an influence in the surrounding areas too.
- Market Psychology: This is by and large the most important consideration which an investor has to keep in mind. To understand the market psychology is to understand to waythe foreign exchange market works. For instance, suddenly the trend will be towards “safe havens” wherein there will be a major movement of different currencies to one particularly stable currency.
Another psychological factor in determining the foreign exchange rates is a phenomenon known as “buy the rumor, sell the fact”. In simple terms this means that a currency tends to reflect the impact prior to the occurrence of a particular action. The reaction when it eventually occurs is in the opposite direction, resulting in the market being “overbought” or “oversold”.
Therefore it becomes apparent by studying the various forces at work in the retail forex market, that there are several factors at play. A successful trader will take all these factors into consideration before making major investment decisions.