FOREX The foreign exchange market (currency, forex, or FX) trades currencies.

It lets banks and other institutions easily buy and sell currencies. The purpose of the foreign exchange market is to help international trade and investment. A foreign exchange market helps businesses convert one currency to another. For example, it permits a U.S. business to import European goods and pay Euros, even though the business's income is in U.S. dollars. The foreign exchange market is unique because of: its trading volumes, the extreme liquidity of the market, its geographical dispersion, its long trading hours: 24 hours a day except on weekends (from 22:00 UTC on Sunday until 22:00 UTC Friday), the variety of factors that affect exchange rates. the low margins of profit compared with other markets of fixed income (but profits can be high due to very large trading volumes) the use of leverage. There is no unified or centrally cleared market for the majority of FX trades, and there is very little cross-border regulation. Due to the over-the-counter (OTC) nature of currency markets, there are rather a number of interconnected marketplaces, where different currencies instruments are traded. This implies that there is not a single exchange rate but rather a number of different rates (prices), depending on what bank or market maker is trading, and where it is. In practice the rates are often very close, otherwise they could be exploited by arbitrageurs instantaneously. The main trading center is London, but New York, Tokyo, Hong Kong and Singapore are all important centers as well. Banks throughout the world participate. Currency trading happens continuously throughout the day; as the Asian trading session ends, the European session begins, followed by the North American session and then back to the Asian session, excluding weekends. Fluctuations in exchange rates are usually caused by actual monetary flows as well as by expectations of changes in monetary flows caused by changes in gross domestic product (GDP) growth, inflation (purchasing power parity theory), interest rates (interest rate parity, Domestic Fisher effect, International Fisher effect), budget and trade deficits or surpluses, large cross-border M&A (Mergers and Acquisitions) deals and other macroeconomic conditions. Major news is released publicly, often on scheduled dates, so many people have access to the same news at the same time. However, the large banks have an important advantage; they can see their customers' order flow. On the spot market, according to the BIS study, the most heavily traded products were:

EURUSD: 28%; USDJPY: 14%; GBPUSD (also called cable): 9%.

and the US currency was involved in 84.9% of transactions, followed by the euro (39.1%), the yen (19.0%), and sterling (12.9%) (see table). Volume percentages for all individual currencies should add up to 200%, as each transaction involves two currencies.

While forex has been trade since the beginning of financial markets, o s ed on-line retai trading ha only been il as n activ since abo 1996. From the 19 ve out F 970s, larger retail trad r ders could t trade FX co ontracts at the Chicago o Merc cantile Exch hange. By 1 1996 on-lin retail for ne rex trading became pr ractical. Int ternet-based market m d makers wou take the uld e oppo osite side of retail traders trades.T f These comp panies also created ret tail forex p platform th provided hat d a qu uick way for individuals to buy and sell on the forex spot m s d market. In online currency exchan nge, few or no transact tions actual lead to p lly physical delivery to th client; al he ll posit tions will ev ventually be closed. Th market m he makers offe high amo er ounts of leverage. Whi up to 4:1 ile 1 lever rage is avai ilable in equ uities and 20:1 in Futur res, it is com mmon to ha 100:1 lev ave verage in cu urrencies. In n the typical 100:1 scenario, the client absorbs all risks asso , l ociated with controlling a position worth 100 h g n 0 es al. time his capita ISO 4217 code e (Symbo ol) USD ($) EUR () JPY () daily %d sha are (Ap pril 201 10) 84.9% 39.1% 19.0% 12.9% 7.6% 6.4% 5.3% 2.4% 2.2% 1.6% 1.5% 1.4% 1.3% 1.3% 0.9% arket parti icipant Ma High Leverage he margin (leve erage) and f floating loss s Th idea of m is another im mportant tr rading conc cept and is s rhaps best understoo using a example od an e. per Mo retail Fo ost orex marke makers p et permit 100:1 1 lev verage, but a also, crucial require you to have lly, e a c certain amo ount of mon ney in your account to r o pro otect again nst a crit tical loss point. For r exa ample, if a $100,000 position is held in 0 n EU UR/USD on 100:1 lever rage, the tr rader has to o put up $1,000 to control the position However t 0 n. r, in the event of a dec t clining valu of your ue r sitions, Forex market m makers, mi indful of the e pos fas nature of forex p st price swing and the gs e am mplifying eff ffect of leve erage, typic cally do not allo their tra ow aders to go negative an make up nd p the difference at a later date. In ord to make e der e sur the trade does not lose more money than re er n is held in the account, f e forex mark ket makers s pically empl automat systems to close out loy tic typ pos sitions whe clients run out of m en margin (the e am mount of mo oney in thei account n tied to a ir not pos sition). If the trader has $2,0 r 000 in his s acc count, and he is buy ying a $100 0,000 lot o of EU UR/USD, he has $1,000 of his $2, e 0 ,000 tied up p in margin, wit $1,000 le to allow his position th eft n fluctuate do ownward wi ithout being closed out. g . to f

Ra ank

Cu urrency Uni ited States dollar Eur ro Jap panese yen Aus stralian dollar Swi franc iss Can nadian dollar Hon Kong ng dollar New Zealand w dollar Sou Korean uth won Sin ngapore dollar Nor rwegian krone Mex xican peso Ind dian rupee

1 2 3 4 5 6 7 8 9 10 11 12 13 14 15

Pou sterling GBP () und g AUD ($) CHF (Fr) CAD ($) HKD ($)

Swe edish krona SEK (kr) a NZD ($) KRW () SGD ($) NOK (kr) ) MXN ($) INR ( )

Un nlike a stoc market, the foreig exchange ck gn e ma arket is div vided into le evels of acc cess. At the e p er-bank mar rket, which is made up p Other O 12.2% top is the inte of the largest commercia banks an securities al nd s Tota [15] al 200% dea alers. Withi the inter-bank mark in ket, spreads s, whic are the d ch difference be etween the b and ask prices, are razor sharp and not kn bid p nown to players outside e the i inner circle The differ e. rence betwe een the bid and ask pr rices widens (for example from 0-1 pip to 1-2 s 2

pips for a currencies such as the EUR) as you go down the levels of access. This is due to volume. If a trader can guarantee large numbers of transactions for large amounts, they can demand a smaller difference between the bid and ask price, which is referred to as a better spread. The levels of access that make up the foreign exchange market are determined by the size of the "line" (the amount of money with which they are trading). The top tier interbank market accounts for 53% of all transactions. From there, smaller banks, followed by large multi-national corporations (which need to hedge risk and pay employees in different countries), large hedge funds, and even some of the retail FX market makers. According to Galati and Melvin, Pension funds, insurance companies, mutual funds, and other institutional investors have played an increasingly important role in financial markets in general, and in FX markets in particular, since the early 2000s. (2004) In addition, he notes, Hedge funds have grown markedly over the 20012004 period in terms of both number and overall size. Central banks also participate in the foreign exchange market to align currencies to their economic needs. Transaction Costs and Market Makers Market makers are compensated for allowing clients to enter the market. They take part or all of the spread in all currency pairs traded. In a common example, EUR/USD, the spread is typically 3 pips (percentage in point) or 3/100 of a cent in this example. Thus prices are quoted with both bid and offer (i.e. "ask") prices (e.g., Buy EUR/USD 1.4903, Sell EUR/USD 1.4900). Traders buy at the higher "offer" or "ask" price, and sell at the lower "bid" price, thus giving up the difference, or the spread, as the cost of the transaction. Of course, the actual price level may also change during the interval between buying and selling. That difference of 3 pips is the spread and can amount to a significant amount of money. Because the typical standard lot is 100,000 units of the base currency, those 3 pips on EUR/USD translate to $30 paid by the client to the market maker. However, a pip is not always $10. A pip is 1/100th of a cent (or whatever), and the currency pairs are always purchased by buying 100,000 of the base currency. For the pair EUR/USD, the quote currency is USD; thus, 1/100th of a cent on a pair with USD as the quote currency will always have a pip of $10. If, on the other hand, your currency pair has Swiss francs (CHF) as a quote instead of USD, then 1/100th of a cent is now worth around $9, because you are buying 100,000 of whatever in Swiss francs.