The foreign exchange (FX or “forex”) market is, as its name suggests, the market where currencies are traded.
It was the termination of the Bretton Woods Agreement in the early 1970s that put an end to fixed exchange rate regimes and created the need for a global foreign exchange market.
The volume of transactions on this market has grown dramatically over the years.
The foreign exchange market is now the largest – and most liquid – financial market in the world in terms of volume: Daily trading volume in the global foreign exchange market averaged USD 6,5 trillion, according to the last Bank for International Settlements (BIS) survey.
Currency trading involves the simultaneous buying and selling of two currencies. In this process, the value of one currency (base currency) is determined by comparing it to another currency (quote currency).
One cannot know the value of a dollar, but only the value of a dollar expressed in euros. When we say that the value of the euro against the dollar is 1.1545, it means that the amount of U.S. currency that a trader can buy with one euro is 1.1545 dollars.
The price at which a currency can be exchanged for another currency is called its exchange rate. The main currency pairs traded are EUR/USD, USD/JPY, GBP/USD and USD/CHF. The most popular foreign exchange market is the euro to U.S. dollar (EUR to USD), which accounts for nearly 30% of daily trading volume.
One of the peculiarities of the foreign exchange market is that it is made up of a global network of financial centers that carry out transactions 5 days a week, 24 hours a day (the market only closes on weekends). The market operates on the principle of a “rotating book”: When a major foreign exchange center in the world closes, another hub in another part of the world opens. So, when Australia closes, Asia takes over, when Asia is about to close, Europe takes over, and then towards the end of the European day, the United States completes the cycle and hands over to Australia on the other side of the globe.
As a result, the liquidity available in the foreign exchange markets is always available, which adds to its appeal as the largest asset class available to investors.
The other main peculiarity of the foreign exchange market is that almost all operations are carried out over the counter (around 99% of transactions according to the latest survey by the Bank for International Settlements). It is a market regulated by the banks themselves, since the participants negotiate directly with each other on a bilateral basis, with their bank as the only intermediary.
Due to the totally OTC nature of the market, forex is therefore not regulated by any central or national authority. This means it is a market of conventions governed by very precise rules of quotation. The way in which currency prices are shown is therefore very precise and often confusing for those who are not used to it.