Unlike other financial markets like the New York Stock Exchange, the Forex Spot Market has neither a physical location nor a Central Exchange.
The Forex Market is considered an Over-the-Counter (OTC), or Interbank market due to the fact that the entire market is run electronically, within a network of Banks, continually, over a 24 hour period.
The Forex OTC Market is by far the biggest and most popular financial market in the world. Traded globally by a large number of individuals and ordanisations.
In the OTC Market, participants determine who they want to trade with depending on trading conditions, attractiveness of prices and reputation of the trading counterparty.
Let’s have a look at the most actively traded currencies:
- USD 84.9%
- EUR 39.1%
- JPY 19%
- GBP 12.9%
- AUD 7.6%
- CHF 6.4%
- CAD 5.3%
- Others 25%
Source: BIS Preliminary Triennial Survey 2010
Because two currencies are involved in each transaction, the sum of the percentage shares of individual currencies totals 200% instead of 100%.
Forex Market size creates Liquidity
Having a large market isn’t a benefit itself. While being big is good, it isn’t the size that makes the foreign exchange market one of the best market’s for traders. Instead, it is the secondary benefits that come from the market’s size that make it an excellent market to trade.
Liquidity is one of these fringe benefits.
Liquidity is a word that describes how easily a financial product (in this case, a currency) can be bought and sold on the Market. When markets are high in Liquidity, they allow traders to buy and sell large amounts of currency in an instant. When markets are less liquid, buyers and sellers may have to wait for a transaction, or even worse, they may not be able to complete the transaction at a price that is close to the market price.
Let’s look at two common investments to show how Liquidity works. We’ll compare real estate and Currencies:
Real Estate: is a very illiquid investment because there aren’t many buyers and sellers. in many cases, it takes weeks, months, or even years to find a match between buyers and sellers in the market. to sell real estate quickly, a seller would have to agree to offer a very big discount to attract a lot of buyers. That’s not good from the sellers perspective, since they are losing money each time they lower their price.
Currencies: everyone has to use currencies, unlike houses, currencies are the same thing as long as they’re worth the same amount of money. A $20 bill isn’t any different from four $5 bills. As a result, currencies can be exchanged easily and rapidly, since there are many buyers and sellers. To sell $100,000 for Euros, for example, isn’t nearly as hard as selling a $100,000 house to a buyer. There are many different types of $100,000 houses, but there isn’t a difference between $100,000 worth of a currency.
Speculation in Forex
The majority of all foreign exchange transactions that take place each day are made by speculators, who seek to earn money by correctly guessing which direction a currency pair will go. Will it go up? Will it go Down?
In other words, most trading volume comes from traders that buy and sell based on intraday price movements. The trading volume brought about by speculators is estimated to be more than 90%. The scale of the forex speculative market means that liquidity – the amount of buying and selling volume happening at any given time – is extremely high.
This makes it very easy for anyone to buy and sell currencies.
From the perspective of an investor, liquidity is very important because it determines how easily price can change over a given period of time. A liquid market environment like Forex enables huge trading volumes to happen with very little effect on price, or price action.
The Forex Market chain of Command.
As we can see above, information flows through the Market.
- The interbanks at the top are the ultimate source of information as they act individually.
- Electronic Brokering Services & Reuters Dealing 3000-XTRA Services distribute currency quotes from the biggest banks to the smaller players and brokers.
- Smaller banks pay to link up to EBS and Reuters Services. Banks use this data internally, but also use it to interact with forex brokers.
- ECN Services and forex brokers operate between individual clients and the banks. Orders are routed from us, the retail traders to the smaller banks which process the orders.