Foreign Currency Trading
Foreign currency trading is done in a foreign exchange market where one type of currency is exchanged or traded for another type of currency. Currency trading is considered to be the largest financial market on the planet. Players taking part in currency trading within a Forex market are the large banks like Citibank and Deutsche bank, nationalized and government banks, multinational firms, financial institutions and investment companies. The daily volume of the present global forex market is about US $3 trillion. Provided the large size and high liquidity of the markets globally, small players can’t quickly do trading in a Forex market.
Trading within a market is performed in levels, where a player in a level does not have access to other levels. The top level is the inter-bank market comprised of big banks such as Deutsche bank, Citibank, Union bank of Switzerland along with other banks across the world. The top ten players sweep off 70% of the total business done in the Forex trading. In the top level, the difference between the bid and ask price known as Spread is very minute and isn’t available to other circles outside. As the levels descend, the difference increases primarily due to the volumes traded. Level of access for a player is determined by the ‘line’, the money with which one is trading. Currency trading has almost doubled today ever since 2001 mainly because of the recongnition of Forex trading being an investment and asset class and also a rise in the fund management assets of pension funds and hedge funds.
Commercial companies do currency trading mainly to pay their customers for their goods or services and trade in small amounts compared to large banks. Investment management companies do trading to take care of the pension or endowment or investment portfolio of their customers and are often in big amounts, because they need to invest in foreign equities for which they need to exchange currency to buy those equities.
Let us see the typical characteristics of a Forex currency trading. Because of the over-the-counter nature, the currency markets doesn’t trade in a single dollar or even a euro rate, but rather a different number of rate applicable just to that particular market. There’s no central house or hub or exchange or clearing house as traders deal directly with each due to this OTC nature. Usually these rates are close to one another; otherwise special traders called arbitrageurs make the most of the difference in the rates and make huge profits out of it. Main trading centers across the globe are in London, New york, Tokyo and Singapore. As the time zones differ, trading is done pretty much 24 hours a day. Fluctuations in the rate happen due to changes in the inflation, interest rates of banks, GDP growth, trade deficits and surpluses, cross-border M&A deals, economic situations, financial health and some other macro economic conditions.
Currencies are traded for each other and each pair of currencies is a separate and unique product and usually denoted by XXX/YYY. During creation, the XXX, referred to as base currency, is the strongest and YYY the weakest. Today the US dollar is in almost 88% of the transactions followed by Euro (37%) and yen. Essentially the most traded pairs are Euro/US dollar, US dollar/Yen and GB pound/US dollar.
Trading is done by means of different kinds of instruments such as derivatives, spot transactions, forward transactions, options and futures, swaps and exchange-traded funds. Currency speculation is done through speculators who do an important job of transferring the risk from those who cannot bear to those who can bear it. Speculators constantly confront controversies because of the risk they take up. Currency trading is affected by some factors like economic and financial situations, political scenarios, and other psychological issues related to the markets.
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